ScaleFactor

Finance and accounting software for SMEs
Startup Cemetery
GENERAL INFORMATION
Category:
Finances
Country:
United States
Started:
2014
BUSINESS FAILURE
Outcome:
Shut Down
Cause:
Poor Product
Closed:
2020
FOUNDERS & EMPLOYEES
Number of Founders:
1
Name of Founders:
Kurt Rathmann
Number of Employees:
100-250
FUNDING
Number of Funding Rounds:
7
Total Funding Amount:
$103M
Number of Investors:
17

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Why did ScaleFactor Fail?

In June 2020 the fintech startup ScaleFactor announced that it is winding down. The company raised $103M based on the promise that they were going to revolutionize accounting for small and medium businesses by automating their bookkeeping. However, this vision didn’t turn into reality.

ScaleFactor’s founder blamed Covid as the major reason for the shutdown, but former customers and employees revealed something shady: the promised automation was in reality almost non-existent. Not only did the company fail to deliver on their promises, but it seems that even the basic bookkeeping services ScaleFactor offered were sub-par at best.

So, in light of this, how did they manage to raise more than $100M from major venture capital funds like Bessemer and Coatue over multiple funding rounds? Even more interestingly, why wasn’t the news of their shutdown not making major headlines despite the amount of money involved and the fact that what was promised and what was delivered was borderline fraud?

It might be the case that stories like Juicero, Theranos, WeWork, and now ScaleFactor are not a freak accident in the world of startups, but rather an inevitability of the current tech startup investment climate of magnanimous ambitions and fake-it-till-you-make-it attitude.

ScaleFactor: Marketing vs Reality

ScaleFactor marketed itself as a tech startup. They claimed that they were able to automate SME bookkeeping and payroll thanks to a groundbreaking AI that they were developing in-house.

In 2017 the company launched their first software product which was built on top of QuickBooks and Xero with the goal to orchestrate the laborious process of bookkeeping.

On the frontend, ScaleFactor offered a beautiful easy-to-understand automated dashboard that targeted five main financial services: bookkeeping, tax, financial forecasting, bill pay, and payroll. And instead of delivering the books monthly as traditional bookkeeping firms, ScaleFactor promised real-time financial statements.

For these software services, ScaleFactor charged around $6k annually up to $30k for their most premium plans.

Yet, it turns out that it wasn’t an AI that was doing the books of their clients, but rather good-old human accountants from ScaleFactor’s office in Austin, Texas, and their outsourced office in the Philippines. As you can guess, the financial statements of customers were delivered monthly.

To make the reality less obvious, instead of calling their workers accountants, they called them customer service officers.

Moreover, ScaleFactor employed some creative accounting on their own numbers to boost the perception of growth and to give themselves a more tech-like sales margin (e.g. the customer service officers weren’t accounted for as cost of goods sold).

ScaleFactor: a Sub-Par Service Company

The situation was made even worse because ScaleFactor was delivering a pretty bad service and had some shady practices on the customer side of the equation.

Multiple clients confirmed that they were receiving books full of errors that they had to correct themselves. According to some ex-employees, the reason for this was that the software was very glitchy and mistake-prone, which made the work of the accountants harder.

Lindsey Reinders’ business lost $17,000 because of one such error that wasn’t caught for a couple of months. And when she demanded to be compensated, she was offered a partial refund under the condition that she wouldn’t share publicly her customer experience.

“If you're one of the investors that gave these clowns $100 million...You should know they've flushed it down the toilet with poor product and poor service,” – Lindsey Reinders, source


Why do VCs throw millions in obviously bad companies?

To a person that isn’t involved in the world of startups, all of this might seem like a classic case of fraud – the founders sold a lot of bullshit to VC funds and some customers, and the VCs bought it.

Yet, the detachment between ScaleFactor’s goal and the objective reality wouldn’t seem that surprising to a person more familiar with startups.

The land of tech startups is a land overflowing with investment money that generates almost all returns from a very few enormous successes. This means that to attract funding in this landscape, you need to dream big and sound confident in your vision. Laying a carefully thought out down-to-earth slow-and-steady business plan will simply fail to attract any startup funding simply because such companies are not a source of startup returns.

Automating the whole field of accounting is an audacious goal, but it sounds like something that would inevitably happen as machine learning technology progresses, which means that most VC funds would love to have invested in the company that successfully tackles this problem. Once a big name invests in such a company, a lot of other investors crowd together because of the simple fear of missing out.

Moreover, even the fact that humans were doing most of the work of the supposed AI isn’t a big surprise. In the world of lean startups, (temporary) spit-and-duct tape solutions are expected. Faking it initially is not only tolerated but outright encouraged to prove there is a market for the solution you are trying to build.

In the case of ScaleFactor, some investors were turned away after revealing the “customer service staff” behind the curtains, but obviously, a lot of others (17 to be exact) weren’t.

An early-stage (pre-seed and seed) investor would welcome temporary tricks as fake automation because they would allow the company to develop the tech solution after the demand for it has been validated and while testing it on real customers.

The best move for the early investors (in this case Austin’s Tech Stars), however, isn’t to conservatively wait and see if the solution would work out eventually. To minimize their risk and to maximize the chances of the startup to find the solution, it’s a great idea to try to attract further capital investment that would buy the company time to grow.

Since due diligence is costly, a single big-name investor that has already bought into the company means that it’s fairly likely other investors would buy in without doing extensive due diligence of their own.

This investor behavior might seem naïve to onlookers, but VC funds don’t spend money the same way as an individual does. This means that your intuition might be misleading when you try to judge their behavior. Spending a disproportionate amount of time and money on due diligence on companies who are more than 90% likely to fail anyway doesn’t make a lot of sense. In reality, it doesn’t matter if a startup loses all investor money because they did their best but failed or because they were Theranos-level frauds. The outcome is the same.

The combination of investors being ruled by FOMO and founders being encouraged to dream big and to move fast and break things means that the occasional ScaleFactor, WeWork, or even Theranos is an inevitability of the startup world in its current shape rather than a freak accident revealing the overall incompetence of investors and the general fraudulence of tech founders.

The danger of this status quo in which people like Adam Neumann (WeWork’s founder) could become billionaires after burning much more money than the overall value their business has created is that it could attract more ruthless people concluding that in the world of startups it’s easier to make money by selling dreams to VCs rather than by selling innovative products to customers.

ScaleFactor’s Shut Down

After their initial failure to automate the bookkeeping process, they tried to pivot to a marketplace for bookkeeping companies and SMEs. After all, ScaleFactor raised money like a tech startup, so they needed to develop a scalable tech product rather than to refine and grow their service business.

After failing to gain traction in this as well, investors decided to pull the plug and blamed  Covid for the failure:

“Business owners went into fight or flight mode. You don’t necessarily need all the planning tools, high end gadgets. You just get back to the simple ‘pen and paper.’" - ScaleForce CEO Kurt Rathmann

While Covid might have been the final nail in the coffin (allegedly it halved the company’s $7M ARR), it’s likely mostly a convenient occasion to close shop and save face - something quite common nowadays (see our article on Quibi’s shut down).

ScaleFactor returned the remaining capital to its investors, but the amount wasn’t disclosed. Employees received 12 weeks severance pay, and a small team was retained to maintain the needs of ScaleFactor’s current customers and to help them transition to alternative services.

Unfortunately, the major thing that customers got out of their experience was a lesson in the risks involved in being a first adopter of unproven, innovative solutions.

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