Highlights
- Growth in business opportunities and significant labour shifts for financial professionals since the 90s tech boom have provided a growing market for short-term financial experts.
- A Fractional CFO provides specialized financial services to SMEs and startups, using their credentials and extensive experience in financial management and strategy.
- The seasoned Fractional CFO is better served planning/managing cash flow to minimize the risk of bankruptcy and evaluating/supporting growth strategy and opportunities to maximize returns.
- A Fractional CFO is less-suited to certain roles. The Fractional CFO is not an Officer of the Company, is less valuable if focussed more on reporting-related activities, and usually should not take the place of the CEO when pitching potential equity investors.
Introduction
The late 1990s tech boom sparked a significant shift in professional labor, leading to the rise of highly-skilled experts working more short-term work arrangements, and particularly financial experts.
Demand for short-term financial expertise during the period was sparked by the tremendous increase in opportunities for entrepreneurs, fueled by the greater information, advancing technology, new markets and decreasing startup costs across the 90s.
However, the rise in opportunities and lower barriers to entry for companies also provided for intense competition and the growing need for businesses to be flexible with labour (favouring shorter-term arrangements).
Finally, this environment also caused a significant increase in the venture capital funds available for those companies that had the high-level financial expertise to attract these investors. Venture Capital under management in the US grew from US$31.6 billion in 1993 to to US$234 billion by 2000.
On the supply side, the burst of the tech bubble in 2000 and subsequent labour market shocks (2008 Global Crisis and the Pandemic) have pushed financial professionals away from climbing corporate ladders and into a growing market for shorter-term, flexible work arrangements.
Sustaining this market has been the faster and efficient exchange of labour information over websites and apps that has removed the friction for short-term professionals to finding sufficient contracts.
https://fred.stlouisfed.org/series/TEMPHELPS
The Fractional CFO
A Fractional CFO is a flexible, experienced financial expert that offers specialized, strategic financial services, primarily to startups or small-to-medium-sized enterprises (SMEs) in a growth stage.
Serving as an interim solution, a Fractional CFO fills the gap for businesses that require the deep financial expertise in certain areas, but lack the resources or the abilities in-house.
A Fractional CFO generally carries either an accounting or financial designation, along with significant experience in areas related to the finances for a growing company.
What a Fractional CFO is Not
Since a Fractional CFO provides a seasoned financial professional capable of handling a wide array of financial functions within a company, let’s start to define the role by what they are less-suited to perform:
- Not a Legal Officer: Unlike a Chief Financial Officer, a Fractional CFO does not hold the title of “Officer” of the company. Officers are legally responsible for the company's management. They are often delegated significant authority by the board of directors to run the company and often have legal duties outside of a job description.
- Less Accounting, More Strategic: The higher value of a seasoned Fractional CFO lies in forward-looking strategy, financial analysis and guidance, rather than rear-view recording of financial transactions or financial reporting. Although a Fractional CFO usually can provide general accounting services, the focus of the higher-level Fractional CFO should be much more on evaluating strategy, growth and value.
- Not the "Jockey": Many investors base their decisions on the attributes of the entrepreneur more than the product. Although the Fractional CFO's role is highly supportive in an equity financing, it is usually best served for the entrepreneur to be front-and-center in equity financings with new investors, at least initially.
"...distinctive CFOs don’t solve for accounting, much less quarterly accounting. They solve for long-term value creation. They discern the company’s unique value proposition, which is always relative to peers and potential disruptors. They partner with the CEO and the board to allocate resources toward value-maximizing projects within and across businesses over different time horizons."
- McKinsey & Company
What Does a Fractional CFO Do
The functions of a for-profit business can be loosely broken down into return- and risk-oriented activities that are completed on a proactive- or reactive-basis.
These groupings can be used to form four categories, each category representing a group of activities that best serve to orient the focus of company leadership.
Using this structure, we describe the possible roles of the Fractional CFO and how they are best used to support the entrepreneur.
- Financial Reporting & Compliance: A Fractional CFO service can ensure adherence to financial reporting and compliance, usually including accounting / bookkeeping services.
- Cash Flow Planning & Analysis: Although there are many reasons used for why businesses go bust, a lack of cash in the short-term is essentially always the reason. Academic studies have shown a positive correlation between proper cash management activities and firm performance. In a US Bank study, it was found that 82% of companies failed due in some part to poor cash flow management. Control of cash is one of the easier tasks for a company to manage, but many times is unnecessarily and detrimentally ignored.
- Strategic Planning: This area focusses on the bigger picture strategies for the company's finances over the long-term that would affect cash flow. These activities are more about outlining the risks from certain types of financing, investment, M&A and other larger opportunities that pose downside risks to the Balance Sheet if not properly executed or aligned with business goals.
- Operational Efficiency for Finances: Fractional CFOs can help implement management systems, technical applications and the flow of proper information to enhance both financial and operational decisions that affect finances.
- Evaluating the Return on Growth Initiatives: Growth initiatives are generally originated by management, but should always be subsequently evaluated to ensure viability. A Fractional CFO can assess these potential investments, projects and partnerships from an expert, objective point-of-view that are crucial for the growth of a company, especially post-Series A. These evaluations include gathering information and then analysing to assess the costs, viability and the ROI of the initiative. The Fractional CFO can also ensure the initiatives are aligned with company objectives and prioritize these initiatives.
- Investor Relations and Growth Narrative: Capital is the fuel for a growing company. The Fractional CFO can provide communication with current investors to keep investor relationships warm and positive. This includes highlighting the qualitative and quantitative characteristics of the company into a compelling investment thesis. The Fractional CFO can also provide ongoing communication of company advancement towards milestones, as well as other growth-based successes to current investors. This keeps investors confidence high in the company and management, and therefore more likely to provide capital at the next round.
- Fundraising and Financing: While entrepreneurs generally handle direct origination activities for equity financings, Fractional CFOs can be best served spear-heading debt financing, grant funding applications, and supporting equity investment initiatives. Both grant funding and debt financing requires significant time and financial information, while both are judged on the numbers and facts rather than the merits and abilities of the entrepreneur (as equity financing is to a great extent).
- Exit Strategy and Action Plan: A Fractional CFO can help devise and implement strategies for investment exit, whether that is a company/asset sale or going-public. For a potential sale, the process for the sell-side should be started 3-to-5 years prior to sale. For going-public, communicating with investment bankers and lawyers, completing work on a prospectus, supporting an RTO transaction, and other similar activities are areas well-suited for a Fractional CFO.
Risk-Oriented / Reactive-Based Activities
This category is an urgent risk for companies, as improper reporting can cause issues for the company; however, it is of the lowest importance from a growth point-of-view for all business entrepreneurs, and should be the first task to be automated/delegated to the most cost-effective means, and as soon as possible.
That said, depending on the skills and cost-structure of the Fractional CFO, using these services to complete accounting or bookkeeping tasks may not be the most effective use of time and money.
Risk-Oriented / Proactive-Based Activities
Items two-through-four above can all be put into the same category as related to being proactive to reduce the risk of cash depletion. This bucket is more urgent than financial reporting, in that cash depletion generally represents a more catastrophic business risk.
Because of the risk that poor decisions and zero cash represents, the entrepreneur cannot ignore the information needed to make proper decisions. That said, it is optimal for the entrepreneur to delegate gathering this information to experts in order to generate the best possible information. In addition to better decisions, this also allows greater time for the entrepreneur to be more focussed on return-based activities.
Return-Oriented / Reactive-Based Activities
Again, the CEO does need to make proper decisions with the investment of time and money for growth initiatives. Poor decisions in this area for a small company can choke off growth. But again, this should be more about the CEO receiving information rather than doing a DIY back-of-the-envelope for the evaluation work.
At best, an entrepreneur taking the time to financially evaluate these initiatives will take time away from the pure growth activities that the entrepreneur should stay focussed. At worst, this creates the risk of poor or sloppy decision-making, despite the time spent.
Return-Oriented / Proactive-Based Activities
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Talk to UsConclusion
The entrepreneur should be highly focussed on value-maximizing activities, while automating and delegating as much of the remainder as possible.
For a growing business, the Fractional CFO can provide deep financial experience to help where and when needed. They bring a strategic approach to financial management, focusing on areas critical for business growth like cash flow management, financial planning, and navigating growth opportunities.
However, care should be used by the business owner in understanding the skills of the individual working as a Fractional CFO, and knowing where they would be possibly less valuable, not equipped to handle, or not well-suited.
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