A fractional CFO can bring essential financial strategy and credibility needed to successfully raise capital for emerging growth companies.
A fractional CFO can bring essential financial strategy and credibility needed to successfully raise capital for emerging growth companies.
Cash is the lifeblood of any business, big or small. However, for many companies, the incoming revenue may not be enough, and extra funding is needed, be it to get over a sales slump or to meet aggressive growth targets.
However, as of this writing, getting cash injected into your business has become harder than it has been for a while. On the one hand, interest rates have reached highs we haven’t seen since the early 2000s, more than 20 years ago.
As for private funding, a study by McKinsey has found that it has slowed down a lot worldwide. The study found that private investments’ volume has decreased by almost 26% in the second half of 2022 compared to the same period only a year ago. Only North America recorded a meager positive growth in the volume of private investments even though private equity funding dropped a bit.
So, given that funding options are shrinking, companies need all the strategic edge they can get. To that end, a fractional CFO could be exactly the solution the doctor ordered.
A fractional CFO, now sometimes called a virtual CFO, is a Chief Financial Officer who supports a company on a part-time basis. Depending on the circumstance, a fractional CFO can work remotely, in-office, or in a hybrid arrangement. A fractional CFO usually works 2-15 hours a week, but the work schedule is flexible, subject to the company's needs. When companies need full-time CFO support, they will call on an Interim CFO.
Fractional CFOs offer plenty of the benefits you get from a seasoned finance professional while only costing a fraction of the price. After all, the monthly cost of a good fractional CFO averages around $8,000 per month, while you would have to pay around $33,000 per month for a full-time CFO.
Moreover, fractional CFOs have worked with several companies, so their breadth of experience makes them valuable contributors to your team. More importantly, they are aware of the funding opportunities for companies of different sizes, and many of them know how to get the best deal given the options on the table.
Depending on its size, a company will have different funding needs. For instance, a mom-and-pop shop will explore different wells of financing that would not be suitable for a Fortune 500.
So, we will explore the different options available to companies of various sizes as well as how a fractional CFO can help in each scenario.
When companies start out, founders usually lend the money to themselves if they can afford it. And if they can’t, they usually borrow their funding from family members or friends with lenient conditions.
However, as the company grows and starts needing more financing, founders need to consider alternative sources of capital.
You can think of governmental grants as free money, but it is only available to specific sectors within particular industries. Alternatively, you might want to consider governmental loans, which are usually offered to small businesses and come with favorable conditions and low interest rates.
So, if a founder is looking for cheap funding, their first question should be, “Is there a governmental grant or loan we qualify for?”
According to Beatty D’Alessandro, former CFO of companies like Univar and Merchants Metals, a founder should look for a fractional CFO who has navigated the Small Business Administration, also known as the SBA, and received financing from them more than once over the past 8 years. This experience would make them valuable, especially if the founder has never received government funding.
After governmental financing, loans from banks and private institutions are the cheapest method of funding your company. And even though some institutions may charge you hefty interest rates, you will still retain full ownership of your company.
And there are plenty of options to choose from here:
Now, let’s say your business relies on standard financing from your bank. How does that normally work?
Usually, when a founder is trying to get as much financing as possible while keeping the charged interest as low as possible, they’ll look at what they can pledge in return for the funding. So, they might pledge their receivables, their inventory, their property or equipment, or their fleet. The bottom line is that the cheapest type of debt is collateralized debt.
This is why when companies are accumulating assets, they should always bear in mind that they have more to pledge, bringing them more funding.
That said, when companies are still young, they usually develop a relationship with a single bank. After all, a single bank is enough to satisfy their financing needs, and founders build relationships with a specific banker they trust and feel comfortable working with.
When it comes to collateralized loans, there are plenty of compliance issues that companies need to navigate, and a fractional CFO can prove instrumental here.
Now, the founder will work with their banker to figure out the terms: how much they can get, what the rates will be, and how long they have to pay it off. But a fractional CFO can be the strategic voice in the room, exploring with the founder how much funding is needed to sustain the company’s future growth, what rates are affordable without jeopardizing future plans, and what payment schedules would make the most sense.
Regarding financing, founders are always faced with a dilemma: Should they borrow more money, or should they bring on new investors, give them a piece of equity, and share the risk with them?
Let’s look at what each of these choices entails.
It becomes increasingly difficult for a single, small bank to finance the company. Ergo, rather than going to their hometown’s bank, companies of this size have to either go to larger banks or take out loans from a group of banks. This is when founders will reach out to your Bank of America or Wells Fargo. However, the real problem is that most founders don’t have an in with those banks.
The other problem is that regional and national banks are used to dealing with sophisticated companies. After all, at this stage, founders are no longer dealing with that one banker who’s known them for years, knows their children’s names, and has been to their Christmas parties. Instead, founders are now dealing with bankers who are on a first-name basis with Fortune 500 CEOs.
For starters, companies that decide to raise debt at this stage need a fractional CFO with ample experience dealing with national and regional banks. The CFO should also have a robust network and a healthy working relationship with many of the bankers operating in those banks.
Assuming that you, as a founder, have found someone who fits the bill, then you can expect your fractional CFO to lead the charge. What will usually happen is that they will talk with their connections and then come back to you and say, “Based on where your company is at and based on the assets available for collateralization, we can get this amount of money for this interest rate, based on a payment schedule that looks like this.”
In return, the founder can either accept the loan or ask the CFO to negotiate for a better one.
But, before even going deal hunting, a good fractional CFO will prepare a company so that it can land favorable terms. After all, the better a company comes across to a banker, the more likely the banker will offer decent terms.
For instance, before giving out a loan, banks will ask businesses plenty of questions regarding their systems, especially if it is the first time they lend them money. Banks will inquire into the business’s capability of providing them with financials and the accuracy of those financials.
So, suppose a multimillion-dollar business still uses QuickBooks as a legacy piece of software from when it was growing. In that case, the bank will be concerned by the business’s lack of sophistication, making it reluctant to give out a loan. The bank will also be worried that the business might have some trouble scaling.
To that point, Beatty D’Alessandro says:
“You make the calls to the bank, and the bank says: do you have financials? And you say, yeah, I have some from the end of last year, and they're going to say, well, what about last quarter or last month? Well, we don't do that because we don't have the systems to do that.
It's going to be a giant red flag for them, right? They're going to think you don't even know if the business is off the rails until year-end, and we don't want to lend money to people who don't know if they're hitting targets or not, right?”
Therefore, in this scenario, a fractional CFO should start by installing systems in the business that support growth and systems that support compliance and reporting. This could involve setting up a new ERP system.
Once those systems are in place, your business will be in a much better position to ask for favorable terms when taking out a loan.
While equity might be more expensive than loans, especially for founders wanting to maintain control of their company, it is still a viable option.
One avenue to consider is selling shares to private equity firms, usually shortened as PE firms.
Now, once companies pass the $50M mark, private equity firms start taking interest in them. In fact, many PE firms feel that $50M-$500M is their Goldilocks zone.
That being said, the caveat here is that very few PE firms are comfortable being minority owners. Instead, most firms want at least 51% of a company, making them the majority shareholder and giving them the power to steer the company as they see fit.
So, let’s say that after plenty of soul-searching, you’ve decided that you are ready to sell a part of your company to a private equity firm. What would that look like?
For starters, the private equity firm will have its own consultant, who could be an investment banker, a seasoned CFO, or some other finance professional. This consultant will pore through your company’s financials, going through every little detail. And if your company offers future projections, the consultant will go through those too, making sure that they make sense and that these projections are realistic and not inflated.
Once everything seems in order, the private equity firm will proceed with the purchase.
No founder can wake up tomorrow and decide that they want to sell their business by the end of the week. That would constitute a fire sale, and the business would be sold at a significant discount.
Instead, if a founder has decided to sell their business, or at least controlling interest in it, they should prepare for that at least two years beforehand. This includes setting up the proper systems, specifically when it comes to accounting and compliance. They also need to go through the proper audits and ensure that all of the company’s tax concerns are settled.
This is where a fractional CFO comes into play. They would be the key figure helping the founder/ CEO set up those systems.
A fractional CFO can also perform several vital functions to prepare the business for sale:
There are even certain decisions the fractional CFO can take to protect the founder’s best interests. For instance, the CFO can set it up so that the owner owns the real estate assets the company uses, and the company rents them from the owner.
While companies of this size are still prime targets for private equity firms, there is another, more intriguing option that is available: Going public.
For smaller companies, the administrative hassle and costs involved with being public can outweigh any of the benefits that come with access to capital markets. After all, when a company goes public and becomes an SEC registrant, it needs to have an entire compliance group, which can be exorbitant for a company bringing in less than $250M in EBITDA.
That said, most companies north of $250M will already have a seated CFO. And you need a CFO on board full-time to go public; it’s an SEC requirement.
Why is it a requirement?
Simply, the CFO is the one who will be signing all of the forms when the company goes public. And they’ll be taking responsibility for the fact that all outgoing financial information is accurate.
If your company is partially owned by a private equity firm that is trying to exit its position, then the PE firm will already have a partner who specializes in taking their portfolio companies public.
But if your company is going public on its own, then it is a different story.
Now, even though companies going through an IPO already have a full-time CFO in place, they can still rely on the expertise of a seasoned professional who has been through numerous IPOs before. In this case, the fractional CFO would be coming on as a project CFO/ consultant.
The fractional CFO would help your company build an investor relations department, work on your relationship with analysts, and help you do all the necessary preparations to go public.
Regarding fundraising, startups are a bit of a different animal. Part of this is borne of the fact that there is an entire funding ecosystem that exists to support the startup community. So, you have angel investors, seed investors, and venture capitalists, all happy to part with their cash in exchange for some equity.
And why does this funding ecosystem serve high-growth startups exclusively?
The simplest answer is scalability. Startups, in general, and tech companies, in particular, have a capacity for exponential growth that dwarfs anything the average company can achieve. This growth is usually fueled by unique drivers such as economies of scale, network effects, and the absence of logistical barriers to expansion.
In fact, to truly appreciate how explosive the growth of a startup can be, just consider the speculative investment model employed by venture capital firms, also known as VCs:
So, a VC will have a portfolio of companies- for argument’s sake, let’s say there are 10 companies in the portfolio. Out of those 10 companies, 8 will fail eventually, and only 1 is expected to break even. But the remaining one company will grow so massively that it will make up for the 8 other losses as well as provide the VC with the returns required by the investors.
That being said, the abundance of funding in the startup scene has made it attractive, inviting entrepreneurs from all over the world to compete for this capital. So, companies still need all the help they can get to secure the best funding options.
So, the first thing to bear in mind is that the harder it is to raise, the more value a fractional CFO can bring to the table.
For instance, looking at the graph below, you can see that VC funding has been going down over the past few quarters, making fundraising a more competitive endeavor for all startups.
Now, the first thing a fractional CFO can do is to prepare you for what you’re about to face. They can start by providing you with a reasonable valuation for your company as well as the financial documents necessary to back your position.
A good fractional CFO will also help you build the plan you share with investors. This plan has to be realistic and data-driven, but it also needs to match the investment thesis of your audience. Moreover, if the CFO has done their due diligence and created their projections, these numbers can be integral to the founder’s pitch deck.
Additionally, the CFO will also prep you for some of the technical questions investors will throw your way.
And once a startup has received funding, the fractional CFO’s work is far from over. Now, they need to help the founder produce the documents needed by their board of directors. They also need to work on your capital structure and ensure you aren’t over-leveraged. And this is not to mention how fractional CFOs can help ensure the finance department is performing its day-to-day operations seamlessly.
And, when it is time to fundraise again, a fractional CFO will stop you from marching to your VC’s office and asking for more capital. Instead, the CFO will have a strategy session with you, helping you find the cheapest source of funding. So, they might convince you not to give out more equity to a VC if any of the following apply to your startup:
The bottom line is that whether it is before, during, or after a raise, a fractional CFO can bring plenty of value to the table.
Whatever stage you’re at, a fractional CFO can help your company raise the funds it needs. If you have a small company, the CFO’s role will be to either deal with governmental institutions or be the strategic voice in the room, ensuring the founder doesn’t end up over-leveraged. If the company is medium-sized, the CFO’s connections come into play, and they can play a much more active role. Finally, for large companies, the CFO’s role is still critical, especially if they have the necessary experience and have been through several IPOs before.
If you are fundraising and feel that you could use a little help, please do not hesitate to reach out. We are always happy to offer free consultations and help you find the best path forward for your company.