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The CFOs of two large technology companies, Google and Salesforce, recently announced that they would be leaving their roles. Both Ruth Porat and Amy Weaver exemplified many of the qualities of world class CFOs. They helped their companies thrive in good times and navigate difficult environments.
Their track records are a good opportunity to review what extraordinary CFOs bring to the table. I’d argue that there are three main areas.
1) Profitable growth: a high-performing CFO will guide the rest of the team in understanding and optimizing for the important drivers of corporate value.
Making great products and services can lead to revenue growth, which is nice, but not enough to increase the value of a company. The key signal of profitable growth is free cash flow per share.
Free cash flow is the net profit that a company generates after all cash expenses have been paid out. A lot can happen before revenues translate into free cash flow per share.
Revenues are used to pay suppliers, employees, the government and, if there’s anything left, shareholders. Give too much to one group and the others suffer.
Amy Weaver recently led a significant change in how revenues are distributed at Salesforce. As a result, operating margins increased from 17% before the pandemic to 33% now. This expansion was initially triggered by demands from investors who argued that too much of the revenue pie was going to employees and suppliers, and not enough to shareholders. She, along with founder and CEO Mark Benioff, was smart enough to recognize that investors were right.
The margin improvement, together with revenue growth and a new share repurchase program, generated a 3x expansion in free cash flow per share during Weaver’s 4 years as CFO.
The challenge now for Salesforce is to balance this new operating efficiency with the opportunities and risks around AI. This is a very tough job, which is why the new CFO will also have to be world class.
For startups profitable growth means:
1. Balancing the need to expand revenues with the type of operating efficiency that Salesforce, and many others in the current environment, have embraced.
2. Having a clear understanding of unit economics.
3. Actively managing the dilution from employee stock options.
2) Capital allocation: this involves making intelligent financing and investment decisions. There’s a long list of companies that were destroyed by mistakes in capital allocation. Overpaying for large acquisitions and financing them with poorly structured debt is a recurring theme.
An extraordinary CFO will give the company a capital allocation framework. This is a set of principles that guide all financial decisions, big and small. If executed well this framework will eventually become part of the company’s culture, reinforcing other important cultural aspects.
The main metric to measure the effectiveness of capital allocation is return on invested capital (ROI). There are many ways to calculate this but they all point to the same concept: what is the relationship between an investment and the free cash flow it generates.
During her 8 years as CFO of Google, Ruth Porat helped drive the returns on invested capital from around 15% to 30%, and at the same time expand revenues and free cash flow per share by 4x. This was achieved while enduring covid, as well as multiple competitive attacks on Google’s search business, and the disruptions around AI.
For startups, great capital allocation means:
1. Raising capital at valuations that make sense, not too low (dilution) or too high (crushing preference stack).
2. Avoiding the use of financing instruments that don’t make sense, like venture debt.
3. Developing a framework to understand the ROI of marketing and other key operating expenses.
4. Measuring and communicating the ROI of all key projects and the company as a whole.
A comment on this last point. Becoming a “unicorn” does not say much about the success of a business. At its IPO, WeWork was valued at nearly $10 billion, which was well below the total capital that had been invested in it. That poor ROI was a sign of things to come - the company filed for bankruptcy two years later.
3) Risk management: there are two types of risks, those that can kill a business and those that can’t. An extraordinary CFO will help the CEO make this distinction and manage both types of risk.
That same CFO will ensure that her company can continue to invest in innovation while others in its sector struggle financially due to economic cycles or technological change.
The right capital structure, with a built-in margin of safety to survive any scenario, is a huge competitive advantage that the CFO can generate.
Both Ruth Porat and Amy Weaver have been effective risk managers, avoiding mortal risks and positioning their two companies to have a fighting chance in the upcoming transformation from AI. They achieved this while being nice and authentic, which is remarkable given that finance is usually characterized by more aggressive male-driven approaches.
For startups risk management means:
1. Managing the runway and burn rate, with a clear end goal in mind: not depending on a new round of financing to survive.
2. Growing the basic administrative functions, including accounting, taxes and treasury management, so that they keep up with the growth of the business.
3. Addressing any founder relationship issues that could threaten survival (this is not a financial risk, but it’s definitely a mortal risk).
In conclusion
Even the most talented and financially savvy CEOs rely on their CFOs. Jamie Dimon of JP Morgan and Jeff Bezos are two good examples. They understand that those 3 dimensions discussed above are a 24/7 job that requires complete focus.
If a company can’t afford a great full time CFO, there are other options like having someone with this profile join as advisor or as part-time “fractional” CFO. If you decide to go that route, the areas of profitable growth, capital allocation and risk management are great topics of discussion to understand how potential candidates for the role can help you.
The one suggestion I’d have for almost any startup founder or business owner is to avoid the do-it-yourself approach to financial management. Some things are easier in theory than in practice.