Kurt Rathmann told his big-name investors he had developed groundbreaking AI to do the books for small businesses. In reality, humans did most of the work.
Accounting is the bane of small business, a tedious task made worse by its costly expense. Kurt Rathmann’s startup had a magic fix: artificial intelligence-powered tools that could replace the accountant, and do so much more. For a fraction of the cost, ScaleFactor promised to take care of bookkeeping, bills and taxes. If customers had doubts, they were reassured by the $100 million invested by big-name venture capital firms. “Because evenings are for families, not finance,” ScaleFactor’s website proclaimed.
But some of the startup founders and cafe owners who did take the night off soon regretted their decision to hire ScaleFactor: they didn’t get what they paid for. Instead of software producing financial statements, dozens of accountants did most of it manually from ScaleFactor’s Austin headquarters or from an outsourcing office in the Philippines, according to former employees. Some customers say they received books filled with errors, and were forced to re-hire accountants, or clean up the mess themselves.
None of this was known publicly last month, when Rathmann announced that ScaleFactor was closing. In an interview with Forbes on June 23, the CEO blamed the Covid-19 pandemic for almost halving ScaleFactor’s $7 million in annual recurring revenue as demand from small businesses crumbled. About 100 people would be laid off with three months of severance, and cash would be returned to investors — a seemingly tidy end to another startup afflicted by the pandemic.
Customers were the first to cry foul. “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, a ScaleFactor customer, wrote online after seeing the news. “COVID-19 is just a convenient scapegoat.”
Though the pandemic may have been a death knell, ScaleFactor was on rocky ground long before, Forbes found. Technology startups are often rewarded for a “fake it ‘til you make it” mentality by venture capital firms willing to throw money at a product until it meets expectations. But ScaleFactor used aggressive sales tactics and prioritized chasing capital instead of building software that ultimately fell far short of what it promised, according to interviews with 15 former employees and executives. When customers fled, executives tried to obscure the real damage.
Along the way, big name VC shops including San Francisco-based Bessemer Venture Partners, Canaan Partners of Menlo Park and New York’s Coatue Management continued to pour more money into the business, compelling ScaleFactor to keep growing with a software product that proclaimed to replace accountants, but was relying on them all along.
“That’s what I found out ScaleFactor is: pretty much a glorified bookkeeping firm,” says one accountant, who, like other former ScaleFactor employees that spoke to Forbes, asked to remain anonymous because they signed non-disclosure agreements and feared retaliation from the company.
The typical process of accounting involves thorough consultations to understand the nuances of a company’s books; for instance, whether to consider an Amazon purchase as an expense or bill payment. Errors in this process can lead to bills being paid twice or not being paid at all, snowballing into disaster.
ScaleFactor promised to digitize this process with a dashboard centered on five main automated tools: bookkeeping, financial forecasting, bill pay, tax completion and payroll. Customers just had to hand over paperwork, receipts and login information for their sales software.
For its core bookkeeping tool, ScaleFactor told customers that after an initial consultation, the artificial intelligence-powered product would do the work: pull numbers from other software, like Quickbooks or Xero, and then figure out how transactions should be listed or organized. Rather than monthly statements, ScaleFactor’s software would show real-time updates on its portal, according to sales materials seen by Forbes.
“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.”
But in reality, the tool was glitchy and couldn’t be relied on to accurately sort transactions, so ScaleFactor employed a team of bookkeepers and accountants who instead would manually complete a customer’s books or correct errors from the software, according to employees who worked on its product, accounting and customer sales teams. To bolster this effort, ScaleFactor hired The Outsourced Accountant, an offshore firm in the Philippines, to help. But no matter where they worked, the unpredictable technology continued to lead to errors in customers’ books.
After cancelling her contract in April, Reinders, who complained online, says that she learned a ScaleFactor employee had incorrectly credited $17,000 to a customer of her e-commerce business. But by the time the error was realized more than 6 months after the fact, she was unable to recoup the money because a collectable term period had expired. “We had really good, clear, clean books when we hired them,” she says. (ScaleFactor offered her a partial refund on her annual $23,000 contract, Reinders says, if she signed a non-disclosure agreement barring her from talking about her experience; she didn’t.)
Now that the company is closing, other ScaleFactor customers are reckoning with the risks of doing business with a startup that might over-promise and under-deliver. San Francisco-based coffee shop owners Cornelia and Robert Stang, are hiring a new accountant to scrub months of erroneous bookkeeping. “How hard can this be? We are a coffee shop,” Cornelia recalled telling ScaleFactor when she abandoned her contract this year. “If you can’t fix our problem you can’t fix anybody’s.”
ScaleFactor declined to make Rathmann available for an interview for this article and would only respond to emailed questions, before replying: “The email below is filled with numerous factual inaccuracies and misrepresentations,” said Rathman in an emailed statement sent by a spokesperson. “I have no further comment.”
“That’s what I found out ScaleFactor is: pretty much a glorified bookkeeping firm,” says one accountant.
Investors Bessemer and Coatue, two of the firms that led funding rounds into the company, also declined to comment while the third, Canaan, didn’t respond. (Bessemer partners with Forbes on its Cloud 100 list.)
Rathmann, 33, was born an entrepreneur. While his friends saved pennies for video games, he mowed lawns to save for his first business. At 17, he owned a company that installed lighting in Houston homes. By the time he launched ScaleFactor in 2014, he had worked as an auditor at KPMG, and as a CFO at a small telecommunications company. In these roles, Rathmann saw firsthand a glaring need for technology to help small businesses with their bookkeeping services.
ScaleFactor got its big break in 2017 at Techstars Austin, a startup accelerator, that was a co-investor in an early $2.5 million funding round. It then caught the attention of Michael Gilroy, an associate at Canaan Partners (now at Coatue). “Great products built by teams that understand their customer will win,” Gilroy wrote in July 2018, when his firm led a $10 million investment in the company. “We’re just getting started at ScaleFactor.”
Momentum built fast, and six months later ScaleFactor landed $30 million in a financing round led by Bessemer partner Byron Deeter, a prominent Silicon Valley cloud-computing investor who had made prescient bets on Box, DocuSign and Twilio. (He was also a founding partner of the Forbes Cloud 100.)
Despite the votes of confidence from well-known investors, customers were finding that ScaleFactor was falling short. Patrick Coddou, whose e-commerce business paid ScaleFactor more than $10,000, requested to cancel in April 2019 after his statements, expected to be delivered on a real-time basis, were delivered monthly because they were being processed manually. “They just didn’t deliver on the promise,” he says.
Potential investors were coming to similar conclusions. Ahead of yet another funding round, multiple venture capital firms passed on investing, according to people familiar with their decisions, having determined that ScaleFactor was more of a services business than a software platform.
During due diligence, one of these potential investors learned that ScaleFactor had a customer service team who they were told functioned as “account managers.” Further inquiry revealed the employees were accountants. “So the software might look automated, but they actually had all these people on the backend,” the potential investor said.
The fact was further obscured by ScaleFactor’s creative accounting: rather than budgeting the customer service team under “cost of goods sold,” ScaleFactor listed related costs under a separate category, clouding the true amount spent on servicing the product, according to two people familiar with the business.
In the end, the only tool with a true automation component, the potential investor found and employees confirmed, was an internal workflow engine, or “a guided to-do list” for ScaleFactor employees that organized tasks required to close a customer’s books.
Even as doubts about its product emerged, ScaleFactor scored a term sheet for a $60 million funding round at the start of June 2019. Coatue Management, a large technology investor overseeing $16 billion in assets, led the new funding round, joined by Bessemer, Canaan and others.
At a meeting to announce the impending funding to employees, ScaleFactor’s then-chief revenue officer David Loia told the sales team that if it could sell $800,000 in new bookings for the month of June, ScaleFactor would double the team’s bonuses, several employees say. (Loia declined to comment.) “This is the chance of a lifetime,” one person who attended the meeting recalled Loia saying. “No deal is off the table.”
Even though ScaleFactor was under confidentiality provisions barring it from discussing the funding round outside the company, Robert Stang, the coffee shop owner, says he was offered a discount because ScaleFactor was chasing a sales target ahead of an impending series C funding round. “This gave them a push for sales,” Stang recalled the ScaleFactor employee saying. He signed the $6,000 contract on June 18 to lock in the discount, even though his first bill wasn’t due until October, according to a copy of the contract seen by Forbes.
Some customers were offered discounts in exchange for a reference; others were signed on without billing information, former sales employees say. At the end of the month, the sales team was told the target had been met. The company celebrated by throwing them a party at an arts and crafts factory in East Austin, where employees took photos with oversized bonus checks.
“We really thought we could automate the entire back office of a small business,” said Kurt Rathmann.
But a few weeks later, the sales team learned they would not receive bonuses after all: some of the deals had been illegitimate, and the target had in fact not been met. ScaleFactor got the funding anyway, in a round that valued the company at $360 million.
As ScaleFactor scrambled to add new customers, existing customers were demanding refunds. The outflow only increased after the funding round closed.
David Rathmann, the CEO’s brother hired in April 2019, held weekly meetings called “Churn Desk” where cancellation requests were prioritized rather than immediately processed; if a customer threatened to complain on social media, they would be let go quicker, for example. This had the effect of delaying the true churn figures from appearing in ScaleFactor’s Salesforce data, which was used in board presentations. The true backlog of pending cancellations and cancellation requests were recorded in a private Google spreadsheet, four people who attended the meetings say. (ScaleFactor would not make Rathmann available for comment.)
Executives, including Kurt Rathmann, were stunned during a different weekly meeting in October 2019 when an employee responsible for tracking churn showed that close to $600,000 in annual recurring revenue was at risk of being lost — in part due to customers indicating or requesting cancellation — according to multiple people with knowledge of the matter. An informal limit on the value of contracts allowed to be cancelled during Churn Desk meetings was then imposed in an attempt to slow the outflow.
In January 2020 Kurt Rathmann called an all-hands meeting to announce that ScaleFactor would pivot to a marketplace model that connected traditional accountants with their clients. About 40 employees, mostly accountants and bookkeepers, were laid off when it was announced in February as ScaleFactor “2.020.”
Covid-19 swept the United States the following month, and existing customers weren’t buying in; Robert and Cornelia Stang balked after being told their contract would jump from $500-a-month to $1,700. In the spring, investors discussed ScaleFactor’s future before deciding to shutter operations, according to a person with knowledge of the discussions.
At the end of the day, Kurt Rathmann explained to Forbes last month, customers were craving a person, rather than a computer to do their accounting. “We really thought we could automate the entire back office of a small business,” Rathmann said. A lofty goal that more money couldn’t achieve.
Additional reporting by Alex Konrad.
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