Originally Published MX May/June 2001
Finance
Small Companies, Big Financial TalentA special breed of CFOs can make small-company ventures pay off big.
Stacey L. Bell
To survive, small companies must do everything in a big way, including finding financial talent that will help them meet today's demands while growing the organization into tomorrow's Johnson & Johnson. Finding the right financial whiz can be a challenge.
"The first thing a start-up company needs to decide is its exit strategy," says Joseph Mullings, president and CEO of The Mullings Group (Norwalk, CT, and Del Rey Beach, FL), an executive search firm specializing in pharmaceutical, biotech, and medical device firm hirings. "Are you going to go public, get acquired, or remain private? The answer to that question dictates the type of CFO you bring on. Too many companies try to play all three fronts, but failing to decide can kill a company—the burn rate (how much money it costs to operate the business versus how much money is in the bank) can cripple you."
Before 1997, most companies went public; the dot-com bomb has turned that trend around. "Previously, about 70% of medtech companies would go public, and most of the remainder would be acquired," says Mullings. "Since mid-1997, that trend has swung 180 degrees. Today, nearly 80% of companies are acquired. In 1997, companies were swinging for the fences—looking for home runs. In today's environment, singles and doubles are okay."
Designated hitters for both pre-IPO and preacquisition hopefuls should exhibit experience in an organization of about the same size and growth stage, as well as the ability to construct a financial infrastructure for the company. While CFOs are necessary, they also can be pricey. In an environment where every dollar is critical, companies need to determine when nothing less than a fully seasoned CFO will do.
Start-ups often find that the services of a part-time controller, who can set up basic accounting systems and clear the books each month, are sufficient for a time, reports Bob Curtis, president and CEO of Medtech Ventures (San Mateo, CA), a venture capital incubator. It's when more-complex transactions and a need for fundraising arise that only a CFO
will do.
"Often, it is 12 to 18 months before going public or at the beginning of significant manufacturing or revenues when a company needs to bring on a fully seasoned CFO," Curtis says. "Since it can take three or four years before a company is at a point where it's ready to think about going public, there's lots of time in which some financial expertise is necessary, but a full-time, permanent, high-cost CFO isn't warranted."
"If a company is within four to six months of an IPO, is ramping up significant sales volume, or is entering into major contracts, it may be time to bring a permanent CFO on board," says Clyde Taylor, an interim CFO and vice president of David Powell Financial Services Inc. (Menlo Park, CA), which provides interim financial management to high-tech start-up companies in Silicon Valley and Austin, TX.
Part-time interim CFOs and CFOs appointed by venture capitalists (VCs) provide big experience without the big paycheck. Interim CFOs receive a monthly stipend along with a stake in the company's equity. VC-appointed CFOs are protecting their firms' investment and are typically overseeing three or four companies at any time, managing data points, and searching for buyers.
Bluebloods versus Street Fighters
"Interim CFOs are best for companies that need high financial horsepower, but less than 100% of the time," says Taylor. "If a company doesn't absolutely need full-time financial help, its cash is better deployed developing its product or service. Even in cases where a company can afford full-time help, it may be better to take a different approach. The type of person a company should hire as a full-time, permanent CFO is often very different from one who can meet its needs as a start-up. In a start-up environment, you're taking a business concept and developing it into a product or technology. The business model and product or service is still gelling, and CFOs need to remain flexible in this environment. If a CFO focuses too much on structure and controls, he may actually impede the business."
Aside from a mentality that welcomes change and uncertainty, a company's first CFO needs a more-diversified skill set and must be willing to get his or her hands dirty. "Finding the right CFO is really about cultural fit," says Mullings. "CFOs at large, established companies are the bluebloods. They're excellent at keeping the books. CFOs at start-up companies must know how to get things done in a street-fight fashion. They have to know how to raise money and position the company with bankers. They have to capitalize on their connections with the major investment houses and VCs. They must be adept at estimating the market capitalization of a product and the value of technology, and then selling that potential to a possible buyer or investor."
They also must be adept at devising more than financial strategies. "I wear numerous hats," says John Bagnatori, an interim CFO now working for David Powell Financial Services. Bagnatori served as CFO for three software and hardware company start-ups before entering the biotech arena. "At the very beginning, in addition to setting up financial systems, banking, leases, and business modeling, we will help the CEO with policies and procedures as necessary. You do it all in a small company; it's really hands-on."
"CFOs at smaller companies also have a different time perspective than CFOs at larger companies," reports Mullings. "At smaller companies, CFOs are often forced to act and respond to issues that have significance in one to two years, such as, Who else is competing? What are they doing? Everything is a race—who can get technology to market the fastest. The CFO has to keep referring to his company's burn rate and the results of its clinical trials and work to get a decent buyout at the right time. At larger companies, CFOs are making decisions that affect a company's future 10 to 15 years from now. Their decisions are critical, but they have more time to make adjustments in strategy, and they're not decisions that affect the very life of the company so dramatically."
Getting to Work
Burn rate is paramount to a company's success—if raised capital is spent before critical product development milestones are reached, additional funds may not be forthcoming, and each time a company raises capital, the company's value is diluted. Thus, a CFO's chief responsibility is resource allocation.
Oversee Resource Allocation. "Setting up accounting systems and a budget are so routine," says Bagnatori. "But most companies do not have a good budget. CEOs think in big-picture terms and in $10 million and $20 million increments, but the little things add up. The first thing a CFO needs to do is talk with all of the company's managers and build a bottom-up budget so he'll know exactly how long current funds will last.
"In successful companies, you'll often find that the CEO isn't focused just on spending cash; he or she is really focused on the technology and bringing that technology to market," Bagnatori continues. "CEOs and CFOs are really business partners. Many times the CEO has an engineering background, and that's what he or she loves. I focus on financial issues and how to protect and account for a company's dollar. It's in technology where a company stands to earn billions of dollars."
Setting up a budget and infrastructure that will properly serve the company requires that the CFO be properly informed about the company's current status. "A company's first CFO must perform a market and industry overview and determine where his company fits in terms of product line, business strategy, market niche, goals and objectives, and how long current funds will last," says Larry Kuhn, president and CEO of Kuhn Med-Tech Inc. (San Juan Capistrano, CA), a full-service executive search firm that specializes in building infrastructures of new, entrepreneurial medical device and biotech start-ups, including placing senior management and engineering teams, and fundraising.
Set and Safeguard Priorities. Taking that information, the CFO can then advise the CEO on future strategies. "Start-up companies are usually trying to do too many things when they have very limited resources," notes Clyde Taylor. For example, companies may be building relationships with numerous partners and conducting trials for several products—projects that may all make sense, but scatter precious resources.
"One of the essential ingredients of success in the start-up is having a sharp focus," says Taylor. "A diffused focus or changing priorities equals additional cash burned and a longer time to market. One of the interim CFO's roles is to articulate and evangelize this message, and to keep management's feet to the fire. Cash is burning, and the clock is ticking."
The CFO also acts as a watchdog of sorts. "The most successful IPO companies are those that begin to act like a public company long before they are one," reports Taylor. "That is, they make projections and deliver performance in line with those projections, gaining confidence from the investment community. A CFO at a start-up company must make certain that the company stays on track and meets all of its milestones so that it can maximize value at its next round of financing and at the liquidity event.
"Through the financial plan, the CFO also plays a role in bringing the various parts of the company into balance," Taylor continues. "The CFO helps ensure that all parts of the organization stay in sync with one another—that sales is not too far ahead of product development, that administration and support do not exceed current needs. Essentially, the CFO strives to ensure that resources are used in the proper amount at the proper time to optimize a company's cash. Proper resource allocation is critical. Companies must deliver on the product and financial statements they make to potential customers or investors to build credibility, a key asset."
Write a Business Plan. Once fiscal controls and oversights are in place, the CFO must write a business plan for the company that describes in detail how the company will execute and deliver milestones to investors. "This step is part of the overall financial strategy," reports Kuhn. "In addition to making sure money allocated is well spent and administered properly, the CFO is constantly preparing for future rounds of financing by analyzing the burn rate and making sure capital is leveraged for maximum return. The CFO ensures that the invested cash lasts long enough for the company to achieve its set milestones and then helps the CEO determine how much money the company will need to raise, and when, in future rounds."
"VCs are more cautious about where they're putting their money now," says interim CFO Bagnatori. "They have doctors and scientists on staff so they really understand the technologies that companies are bringing to them. Certain technologies are hotter than others, and are thus more likely to win funding.
"But VCs get 10,000 to 20,000 plans per year, depending on the size of the firm," Bagnatori adds. "The CEO needs to develop a compelling plan to which the CFO can add business models. The CFO then delivers that full package to the VCs—usually those with whom he has cultivated relationships—who will be more likely to put the plan near the top of the stack and study it. It can take four to six weeks to learn whether or not the VC is interested. If the VC is interested, he'll call the CEO in for an interview to discuss the technology. At that point, the decision depends on the technology and the chemistry between the VC and the CEO."
Attracting the Right Match
Chemistry between the CEO and CFO is important as well. "Consolidation in the dot-com world has made people much more cautious about taking a job with a start-up," reports Mike Kelly, president of the global healthcare practice of Korn/Ferry International (Minneapolis). Korn/Ferry specializes in healthcare recruiting. "Just as VCs are performing more due diligence before lending funds, potential hires are performing more due diligence on a business before signing on. Of course, it helps that we're not in a commodity business. Even if the economy does poorly, people are not going to put off having heart surgery. While medtech companies can't offer 100% growth spurts every six months, they do offer stability and the potential for solid returns.
"There's a war for really good talent whether you're a large or a small company," Kelly says. "And while small companies may not offer the same compensation and perks that larger companies can offer, they still can attract great talent because of the huge equity opportunities they present."
While full-time CFOs typically command $150,000 to $300,000 per annum, CFOs at smaller companies tend to earn salaries at or below the $150,000 level. "CFOs at start-ups may settle for $140,000 in exchange for a higher percentage of stock options and larger bonuses once certain milestones are achieved," Kelly reports. Car and club allowances, postretirement health insurance and benefits, and severance packages (ranging from three to 12 months of continuing salary in the event a company merges with another or is the victim of a hostile takeover) are offered as well.
"Equity is a strong deciding factor," says Larry Kuhn. "CFOs coming on board after one or two rounds of financing are getting 1 to 1½% of ownership in a company along with their salary and set bonus structure. To retain a top-flight CFO, companies are giving him or her a four-year vesting schedule. Twenty-five percent of the options vest after the CFO has completed one year of service. The remainder vest at a rate of 1/48 per month for the next three years."
"Vesting is critical since you don't want the top management team to leave immediately following the public offering," Kelly explains. "Departures at that time would be detrimental to both the company and its stockholders. It's important to tie senior officials' success to the long-term success of the company."
"Smaller companies often offer CFOs incentives to earn extra stock or cash based on meeting milestones such as maintaining cash flow until a certain goal is achieved," Kuhn says. "But perhaps the greatest benefit small companies can offer is pride of ownership. CFOs in smaller companies enjoy the excitement and challenge of being an architect as a company grows and matures."
"You have a direct impact on your success," Kelly adds. "And to some extent, CFOs can determine when a company exercises its exit strategy."
CFO Bagnatori says that companies expecting to attract a top-notch CFO must "offer a competitive salary and a significant amount of stock options. CFOs may need to be patient, though. It could take years before they see a return on their time and investment in their company, especially in the biotech arena."
Expectations are key for both companies and the CFOs they hire. "There's precise strategy involved in these deals; it's not just about money," Kuhn says. "Perception is reality to the person who considers these opportunities. The biggest challenge when hiring someone at this level is ensuring that both parties have the same expectations and perceptions of both the company's aspirations and the job's obligations. That's where a recruiter can be most helpful—in making sure everyone is seeing responsibilities, goals, and fair compensation in an equitable manner." How One "Small" Company Scored Big Pride of ownership and a desire to have more input into company direction were the draws when John Considine, formerly senior vice president of finance for $13.3 billion pharmaceuticals producer American Home Products Corp. (Madison, NJ), traded his big-company job for one at comparatively small Becton Dickinson and Co. (Franklin Lakes, NJ). As executive vice president and CFO of $4 billion Becton Dickinson, Considine has found hands-on responsibilities rewarding on several levels.
"It was at a time in my career when I wanted to be more integrally involved in a company's success," Considine explains. "When I met Becton Dickinson CEO Ed Ludwig, it became apparent that he was someone I could partner with. He said there were things that really needed to be addressed, and that he would give me the latitude to make appropriate changes."
Visits with Wall Street investors and analysts soon after Considine joined Becton Dickinson underscored the need for the company to do a much better job at setting expectations and achieving forecast results. Among the first tasks Considine tackled were instituting spending controls, implementing a worldwide restructuring to eliminate nearly 1000 positions during fiscal year 2000, discontinuing costly distributor incentive programs, and putting into place a foreign-currency translation hedging program to enable Becton Dickinson to better handle exchange volatility. When Considine joined Becton Dickinson in June 2000, its stock was trading in the $24 range. As MX went to press, shares were trading in the mid-30s.
"By necessity, I'm involved in just about everything the company does—from manufacturing to marketing to human resources," says Considine. "I also have a real impact on where the company is going. A good CFO, whether in a large company or a small one, should be a key player for the CEO in setting corporate strategy. In a smaller company, the importance of that role is magnified.
"A big part of the story for CFOs in the medtech arena is cash flow," Considine says. "There is tremendous cash flow in this sector, but our margins and resources are thinner than those you would find in the pharmaceutical industry, for example. At Becton Dickinson, we've pioneered a safety program to shield healthcare workers from accidental needlestick injuries. It's a tremendous challenge to put the right amount of capital in place to effect a program like this that will provide growth for the future.
"In the medtech sector, you don't have a billion-dollar product like a Prozac or Lipitor that can help carry the whole company or mitigate a poor decision. I compare this business to a football game. We have a good running game. We tend to run five yards at a time. Long-yardage gains are rare in this industry, but that's okay. We still score." Stacey L. Bell is a freelance writer specializing in business and marketing issues. Copyright ©2001 MX
Find Funds. Raising money can be the most difficult part of the job for a CEO and CFO, a challenge made even more difficult by the collapse of last year's dot-com ventures. Increasingly, VCs want to see a strong potential market and solid clinical trial results.
John Considine, executive vice president and CFO of Becton Dickinson and Co. (Franklin Lakes, NJ).
