Silicon Valley Frontlines: Shocking Stuff At Canopy Financial - And Why You Should Always Have A Strong CFO On Board ...

I don't know if you've seen the shocking stuff that has jumped into the headlines about Canopy Financial, until recently one of the hottest startups in the Bay Area and potential IPO candidate for next year. Long story short, this company just filed for bankruptcy protection after raising $75 million in venture capital funding in July (of THIS year) and a total of $105m in its relatively short (4 year) existence. The bankruptcy filing says it owes creditors between $50m and $100m. Read this WSJ article for more background.

So, how could this possibly happen? Let's get to that in a minute. First, why am I focused on this? Well, I got introduced to the Canopy story at an investment banker conference in San Francisco early this year. At that event Vik Kashyap, the young founder and CEO, presented the company in a 20-minute session, alongside many other companies. I was blown away by the pitch - specifically the numbers. Here are some extracts from my notes from his presentation:

The company provides services for the management of health savings accounts (HSA's), flexible spending accounts (FSA's) and health reimbursement accounts (HRA's)
Working with 12 of the top 25 health plans in the country including 85% of covered Americans
He claimed they had 400,000 accounts under management handling 8 million claims a year
His revenue (he claimed) went from $9m in 2007 to $20m in 2008 (and a $3m profit) and projected $47m in 2009 (with a $17m profit) and forecasted $126m in revenues and a $72m profit in 2010. He actually said all this (which, frankly, is a big red flag - more on this in a moment)
50% of revenues are payments-based (fees for transactions processed)
4th fastest growing company in the Valley

Now, if you see numbers like that presented by a private company you have two conflicting reactions. One is "Holy crap, this is a HOT company". And the other is "Someone needs to advise this kid that you don't go around putting this kind of thing in black and white - not in this kind of climate - unless this is all rock solid. And certainly no public forecasts". Oh yeah, and the "this is too good to be true" reaction as well.

Anyway, so my investment banker friends have already told me that Vik is looking for a CFO to fill out his team. And based on his pitch and the way he presented it - yes, he needs one, for lots of reasons. So I approach Vik after the pitch and suggest we talk about the position. He's in a hurry but says "send me the resume".

After a few months we get to talk on the phone for 15 minutes and the net is that he wants a CFO, yes, but someone with payments systems experience. OK, that's not me. No problem. But its still a hot company and I keep it in the back of my mind. Fast forward to a month ago. Another investment banker friend tells me they has still not found a CFO - maybe I should get back in touch with Vik. As I'm about to do so, everything blows up.

So what's going on? Obviously I don't know for sure but I'll tell you what I suspect. I think this is a young, inexperienced CEO with a rapidly growing business that got way out of his control and he got way out of his depth. And the key missing link was (not having) an experienced, strong CFO. Fraud? Don't know, though I hear the SEC is planning to file fraud charges. Can fraud happen without a CEO's knowledge? Yes, absolutely, though not altogether likely - unless you really don't know what your job is as a CEO.

On top of all this you have to wonder something else. What were the VC's thinking when they invested in this thing? Did they do the detailed due diligence they should have? Surely you don't give $75 million (with an "m"!) to someone without really taking an in-depth look. Apparently not, judging how quickly this thing went belly-up.

Lessons from the story - so far:

Very few young founders are right to continue as CEO's of rapidly-growing, complex businesses. Some can, but the vast majority cannot. Experience matters.
Always have a strong, experienced CFO no matter how good you think you are, the rest of your team is and how much it costs
Always do your due diligence ... on an investment, on a job opportunity ... etc!