Who Controls the Purse Strings…

Has there ever been a more complicated time in the capital markets? The pressures on Chief Financial Officers have never been more acute, the job more challenging, and yet many early-stage companies still struggle to properly staff this critical function. The collapses of Silicon Valley Bank (and the possible cash crises that was about to be triggered for many thousands of companies), Signature Bank, Silvergate Bank, and now First Republic Bank have shined a bright light on this role. And the litany of issues just keeps coming. CFOs are the goalkeepers for the company balance sheets, and they need to be very prepared.

There is a running debate among founders and early-stage investors about when to hire a full-time CFO and how best to staff the finance function of a company. According to Bureau of Labor statistics, there are over 730k “Finance Managers” in the United States. Zippia, an online recruiting platform tracking this job category, tallies 132k CFOs, 14% of whom are in healthcare. Furthermore, 83.3% of people between ages 25-54 were employed or seeking jobs in April, the highest employment level since 2008. The talent pool appears to be deep, but the crosscurrents now at play make these decisions even more complicated.

Last week’s 0.25% interest rate hike and the news on Friday that unemployment ticked down (yet again) to a historic 3.4%, a level not seen since May 1969, have created even more confusion in the capital markets. This is especially so when there is a drumbeat of a looming recession. The 1Q23 GDP growth estimate declined to 1.1% from 2.6% in 4Q22, well below analysts’ consensus of 1.9%. Arguably there is evidence that demand for labor is moderating but the supply of talent is scarce. And there is now the specter of an imminent federal debt crisis, now thought to be in early June 2023 according to Treasury Secretary Yellin.

Effective Federal Funds Rate

Source: Federal Reserve Board, Haver Analytic

This fog of “economic war” is made even more opaque given that the Federal Reserve Board tends to cut rates just prior to the onset of a declared recession as shown above. And no one has yet declared there is a recession. Notwithstanding the ambiguous guidance provided by Chairman Powell last week, a mere 7% of investors expect the Federal Reserve Board to raise rates at its next meeting, according to a recent CME Group survey. The interest rate futures market suggests that there is a 75% chance of a rate cut by September.

One other new phenomenon adding to CFO consternation is the increasing politization of the capital markets. For example, issues concerning Environmental, Social and Government (ESG) matters, which are non-financial factors that investors consider in investment decisions, now is a topic of robust debate. While this mostly impacts public companies and institutional investors (most visibly in the energy sector and important elements of the healthcare sector (see abortion, vaccinations, etc.)), ESG concerns will likely radiate out to touch most corners of the financial markets. A recent University of Pennsylvania study calculated that municipal bond issuers in Texas paid $300 – $500 million more in interest on just the $32 billion borrowed in the first eight months of 2021 after that state instituted “anti-woke” guidelines. Two months ago, 19 Republican governors pledged to oppose investment managers that espoused support of ESG considerations.

According to Oxeon, a leading executive search firm specializing in early-stage recruiting, observed that so far in 2023, over 21% of the firm’s searches are for CFOs, up from 4% in 2021. Across the board, Oxeon data highlighted a 2.5% increase in compensation since 2022, but for CFOs, the increase has been 25% with an average total compensation of ~$413k. A recent analysis from Compensation Advisory Partners showed that CFO salaries actually increased faster than salaries for CEOs for companies reporting in 4Q22 in the S&P1500.

While compensation survey data tend to be all over the board based on stage of company, Carta, a company that specializes in capitalization table management, has a particularly interesting view into executive compensation across 35k companies tracked. A review of the Carta data below shows a wide range of salaries by quartile for start-up companies, from $80k at the bottom quartile to $208k for the highest earners. Looking at those amounts on a monthly basis begins to frame the “fractional CFO” debate as well, particularly in light of the recent SVB scare.

To underscore some of the professional turmoil in the CFO role, Russell Reynolds Associates published research recently which showed elevated levels of S&P500 CFO turnover between 2019 – 2022. Even more informative than the overall turnover is to look at where these executives are heading. Approximately 48% of these departures are due to retirement, with the balance taking on new roles; four out of five times those new roles are not CFO roles but rather other C-suite positions, mostly elevated to CEO jobs. Two-thirds of non-retirement departures see those executives staying with the current organization, suggesting management team depth and a high level of continuity at those companies. Interestingly, 36% of departures occur in 1Q while only 12% occur in 4Q.

Chief Financial Officer Turnover

The commercial banking wake-up call issued in March now has many corporate boards reviewing crisis management strategies. Financial pressures have elongated sales cycles, increased working capital needs, raised concerns about the quality of accounts receivable, increased the incidence of fraud, and challenged bookings pipelines. Economic concerns have pushed customers to demand hard dollar, near-term ROI for purchase decisions, while scrutinizing opportunities for improved workforce productivity. In the absence of liquidity and often shaky follow-on investor interest, many companies will need to navigate financings, tricky private-to-private M&A opportunities, and/or adjust cost structures to get to breakeven on whatever financial resources are on-hand.

All of these dynamics demand a greater level of engagement and experience of the CFO. Interest rates moved nearly 500 basis points in a year and companies needed to respond. There are certainly advantages to the “fractional CFO” model such as possibly lower cost (a Wall Street Journal analysis cited Countsy, an on-demand back-office provider of outsourced CFO services, which suggested costs ~$5k per month), greater operational flexibility, and access to more talented finance skills for very early-stage companies than otherwise might be possible.

There are other considerations, though, that boards and founders must now confront. The broader landscape is bifurcating between high- and low-quality companies, and that often turns on the completeness of the management teams. Even in challenging financing markets, such as now, great teams can raise capital (admittedly, perhaps at less than hoped for valuations or with less favorable terms). There is a premium for more effective investor relations skills, be it with venture capitalists or commercial bankers, which can be strengthened by full-time continuously engaged CFOs who are “all in.” Many companies now are having to restructure credit facilities, odds of which can be improved by long-standing relationships between borrowers and lenders.

Significant investment in the finance team also improves the level of analytical depth and understanding of the business model, versus simply serving as a reporting function. The increased velocity and cycle time with product development in this hyper-competitive environment puts greater pressure on company balance sheets, necessitating deeper financial analytical capabilities and insights. This commitment to analytics hopefully will pervade into all corners of the organization, creating a collective depth of understanding of the risks and opportunities facing the company.

Adding a strong full-time CFO earlier also signals to investment partners and customers the importance of these capabilities. These executives often develop a deep bench of talent, which is critical as this reduces the single point of failure risk. Continuity is critical in uncertain times.

Highly effective CFOs will drive greater operational efficiencies while lowering the company’s cost of capital. It is clear that an investment in great CFO talent early will generate a hard ROI for all stakeholders.