Fundability Levers Part 3: Strong Finance & Data - enablers of scalable growth and solid business foundation

Best-in-class Finance & Data function is more than accurate and timely reporting. Finance translates your strategy into quantifiable targets, helps all teams track progress towards these goals, and enables them to course-correct quickly when needed. It consolidates financial and non-financial data across the organization to give executive leadership a comprehensive picture of the past, present and the future. If I had to summarize what a strong Finance & Data function can do – it helps you scale intelligently and plan resources so that you don’t run out of money in the process.??

From a fundraising perspective, by demonstrating strong financial capabilities, startups can show VCs that they have the financial acumen and the necessary infrastructure? to manage growth and scale effectively. Long gone are the unicorn mass production days of 2021, when growth aspirations alone could secure funding. Finance & Data are now front and center in every due diligence process:

What exactly does having “strong financial capabilities” entail? This is not an easy question for even the best founders and CEOs to answer. Finance & Data is a G&A function it has no direct responsibility for revenue generation. As such, their KPIs are not as universally defined as for Sales, Marketing or Customer Success departments, which makes it hard to evaluate your Finance & Data function performance.

Below are the key indicators of “strong financial capabilities” VCs are likely to be screening for as they conduct due diligence for your next funding round:?

1 - A well-structured finance function appropriate for the startup's stage

For early-stage companies (pre-revenue to $10M-15M), Finance & Data function is fairly basic and could involve an outsourced team from a full-service accounting and finance firm. At this stage VC’s expectations mostly revolve around accurate and timely financial reporting, unit cost notion, a basic set of KPIs, and accurate 1-3 year forecasts. As the company grows in size and sophistication the expectations for Finance & Data evolve as well. For more mature startups and scale-ups (Series B and beyond), VCs may look for comprehensive 3-5 year operating and hiring plans, detailed and accurate forecasts and budgets, finance and data tech stack (e.g. ERP, FP&A tools, etc.), strong FinOps capabilities, extensive sales and marketing and revenue analytics, well defined and consistently tracked KPIs aligned with strategy, and more.

?????Recommendation: Finance & Data evolve over time and CEOs should increase their expectations of the value this function is adding while providing it with the resources to meet these expectations. As a CEO, you might be comfortable with an outsourced accountant and an experienced financial analyst as a Series A company.? You should, however, stay ahead of your company’s strategy and business goals? and build the necessary Finance & Data capabilities ahead of time as an enabler for that next phase of growth. This involves continuous improvement of the team, processes, tech stack, and alignment of analytics capabilities to your strategic objectives on a regular basis. Just as your company scales and becomes more sophisticated, your finance should be focused not only on producing mandatory monthly and quarterly reports but also on becoming a real thought partner to all areas of organization, equipping teams with KPIs, historical, real time and predictive data, and frameworks for data-driven decision-making, and intelligent resource allocation.???

2 - Readily available and accurate reporting

Your reporting should go well beyond financial statements. balance sheet, income statement, cash flow statement – that barely covers the basics). In your next round, you can expect VCs to request additional analysis, which should be either readily available or could be produced within 1-2 business days.?

Here is some of the data typically expected (there may be more data needed depending on your industry and stage of growth):

• Accurate and consistent KPIs (company-wide and functional) for 1-3 years (actuals) and target KPIs. On a company level there should be a set of financial and operational metrics relating to top line growth and expenses supplemented by generally accepted industry metrics (e.g. SaaS metrics). Bear in mind that methodology and data sources should be consistent to provide period-over-period and year-over-year comparisons. The set needs to be concise – 100 KPIs are as bad as none. It shows that the company is not doing a good job translating strategy into specific quantifiable targets and is unable to track progress towards its goals.
• Customer analytics. There is no maximum here as the better you understand your customers and their behavior, the more credibility you will have with VCs. CAC, LTV, retention, customer segmentation, concentration, and typical contract terms should all be available at a short notice.
• Deep analysis of the revenue line item. The more the merrier is a general rule. By product, by customer, by region – slice it and dice it, look for patterns, understand breakdowns between upsell, cross-sale and new logo revenue. This shows you know exactly where growth is coming from and where additional opportunities lie.
• Realistic and accurate budgets and forecasts. Forecasting of any type is a cross-functional exercise where your finance team connects the inputs from all other teams and distills them in one place. This is a complex endeavor that’s well worth the time and effort – so I will discuss it in more detail in a separate section (See 4- Establishing Finance & Data team as a partner to other teams (with a side effect of improving accuracy and reliability of your forecasts)).
• Cash position and cash flow projections. Understanding your cash runway is always required. A commonly ignored problem is the time gap between investment of resources (hiring, tech, etc.) and when you start receiving revenue from these investments. We all know of companies that ran out of money mid-flight – because as with home remodeling it always costs more and takes longer than you initially projected. Run stress tests and build multiple scenarios (including worst case) so that you can course-correct in a timely manner and avoid layoffs or begging for emergency bridge financing (which is much more difficult and much more expensive to secure than even? just 12 months ago).

?????Recommendation: VC’s requirements as to financial and data diligence increase with each round, so continuous improvement is key. For example, if you managed to get away with a notion of CAC and approximate LTV as a Series A company, there will be LTV/CAC analytics by cohort requested from you as you are raising Series B. There is room for improvement even with basics such as financial statements. As your company grows, work towards producing a set of audit-ready statements (2+ years back). It could be requested as early as Series B and is very likely to be requested in Series C. With regards to KPIs, it is best to use the guidelines of leading VCs specializing in your industry segment. If you are a SaaS company, for example, both Insight Partners and ICONIQ have a very good set of reports detailing KPIs, methodology behind each including industry benchmarks. Finally, try to collect high quality data in real time or as soon as it is available as it may be impossible to collect/recreate it post-factum for meaningful comparisons.

3 - Extensive COGS and Opex analytics?

Growth is always front and center in VC’s diligence. At times like now, when funding is not as readily available as in 2021 and the tech sector is still going through layoffs and budget crunch, it is important to demonstrate that the leadership team is mindful of both growth and expenses.?

To demonstrate an expert level cost analytics, I recommend the following:

• Increase granularity of costs accounting. Classify expenses in the P&L by department, function, and type to analyze expenses from various angles.
• Focus on unit economics as early as possible. If unit cost exceeds revenue per unit then your business model is not viable – you simply will not make money at any scale. Make sure you develop an in-depth understanding of every cost going into your product development, its sales and delivery.
• Map cost accounting exactly to how functional areas are looking at it. You should be able, for example, to map income statement line items to CAC the same way marketing is calculating CAC.
• Maintain and update Opex forecasts and hiring plans. These forecasts should be up to date and tie to the budget and long-term forecasts.
• Establish a cadence of monthly reports of variances. I recommend supplementing these with explanations of any meaningful deviations, which will be instrumental in the due diligence process.
• Document cost saving initiatives and cost controls. Centralization of purchasing decisions and process, investing in the right tools for financial analysis, regular reviews of tech stack for redundant apps – they all save more than you might think and demonstrate focus on financial discipline.
• Introduce True North KPIs incorporating growth and profitability. Profitable companies should certainly track profitability metrics, such as EBITDA. Any company should calculate FCF (free cash flow). Companies that are not profitable yet could use metrics like Rule of 40 to assure progress towards breakeven as opposed to only growth targets.

?????Recommendation: In certain market conditions, understanding the structure and nature of costs may not be critical for the success of fundraising. Unfortunately or fortunately, this is not the case now. The general recommendation is: the more - the merrier. Slice and dice your costs in all the ways you can think of and be prepared to produce a COGS and Opex report from any angle (and quickly). Start by reviewing and improving your cost mapping and the granularity in your financial statements. It will take you a long way.?

4 - Establishing Finance & Data team as a partner to other teams (with a side effect of improving accuracy and reliability of your forecasts)

This is a massive topic and could be an article in its own right. Finance & Data teams often end up siloed, which offers nothing but downside. If this is the case with your Finance & Data org, it will become apparent in the diligence process. A sure sign of Finance being siloed are large variances between your target KPIs, forecasts/budgets and the actuals.? Lack of accuracy, such as materially missing the budget or regularly missing the? quarterly forecast as well as other clues, such as discrepancy between sales funnel data and revenue projections, could become a major red flag undermining the credibility of your entire management team.?

Exercises like annual budgeting and quarterly budget reviews require collecting input from the entire GTM organization and other teams as to both revenue and expenses, then consolidating the inputs in one model. The quality and realistic nature of inputs determines the accuracy and reliability of the forecast.?

This all may sound a little hypothetical, so let’s take a look at an example of what a process producing accurate and realistic budgets between Finance and Sales & Marketing might look like. Your Finance team should partner on formulating a similar objective-driven budgeting process with every department / functional area.

Exhibit 1: Example of Budgeting Process (Sales & Marketing and Finance)

This example is based on my own experience. There may be other flows that work perfectly well. What I can guarantee is that none of them are one-sided – either strictly Finance-led (also known as top-down aka calculating sales quotas and marketing-generated revenue from target revenue) or solely GTM-led (bottom-up, the opposite of top-down). The joint budget planning will have your various teams partnering, negotiating, and looking for mutually acceptable solutions yielding the best combination of resources needed and return on the investment.?

?????Recommendation: The ability of the management team to produce accurate and credible forecasts is key in building trust with investors. Even though it is unlikely VCs will ask questions whether or not Finance and other teams formed a true partnership, the absence of such partnership will find a way to demonstrate itself in data – large variances between targets and actuals in particular.? It is a necessary culture-building exercise and will likely take a company several planning cycles to develop and perfect the processes yielding the best results. Finance alone can not deliver accurate budgets and forecasts as it is lacking functional expertise to validate numerous assumptions. Importantly, the partnership between Finance and other functions should not stop after budgets are agreed upon. Establishing a cadence for regular business reviews, working together to identify the causes for variances, and course-correcting early all contribute to making budgets accurate and forecasts achievable.?

5 - Frameworks for investment decisions and resource allocation

The question of resource allocation is becoming increasingly important as the company scales and budgets become larger. It may seem easy to control your cash and expenses as a Series A company, but I advise that you implement a shared company-wide framework to assess the ROI of various initiatives as early as possible. To successfully execute on the company's long-term vision your teams will put thousands of small and large plans into action. Whatever they are tackling – new market expansion, product launches, hiring push in a particular area – it will always result in incurring upfront costs. It adds a lot of credibility when a company is able to justify the investment with relevant data (e.g. 30% of our customers requested this particular functionality or we will be able to increase ASP by 25% hence increasing revenue by $X per annum).?

?????Recommendation: All resources including cash are unfortunately finite. While I don’t believe that not having an investment decision framework is a deal breaker for Series A-B companies, if you have developed internal discipline around resource allocation, it will make you stand with VCs. At later stage companies there will be entire departments inside Finance busy doing just that – evaluating ROI of various initiatives. For smaller companies it could be as simple as a fairly basic spreadsheet to help you build ROI focus across the organization. Such focus will give investors confidence that resources are used wisely and cash raised will not be used frivolously on pet-projects, adding very little to your topline or spending more than you can afford.?

To summarize, a strong Finance & Data function can and should give companies the tools to unlock scalability and profitable growth. It can also become an investment highlight in its own right for companies looking for VC funding. At the end of the day, any investment case is as strong as the data supporting it. Don’t think of the Finance & Data function as a cost center, think of it as a thought partner that will help every team become stronger and more efficient and enable the management org demonstrate their excellence through data.