When pitching your business to venture investors, sharing a well designed financial model is very important! Why? Because how a financial model is designed helps investors learn critical things about you and your business: it provides insights into how you think about your business, and also implicitly sends messages about how you are approaching it.
Just as important as the financial model itself, is the fact that many entrepreneurs, business owners and startups don’t have a good grasp of the numbers in their financial model and unfortunately, when they are presenting the model to investors, they’re unable to answer even the simplest questions which destroys their credibility. You don’t look like a business that an investor would consider investing his hard-earned money in, if you don’t even know your financial model or the main assumptions that drive it.
In order to make sure that you have a good grasp of your financials, keep these concepts in mind:
Keep it simple: This is most important. You are into all the details of your business. You really like to be on top of everything and might be tempted to create a model that covers every eventuality and every variable. Don’t. The purpose of a financial model to be shared with investors is to get them excited about your business. You may have budget spreadsheets that go into a lot of detail. But the place for that complexity is in your back office, not the model you share with investors. Think of the model as a way to tell the story of your business. It should be easy for someone to follow and understand. This requires effort and time and you need to put in the effort.
Build bottoms-up/ validate top-down. This is especially important for startups or early stage businesses. You don’t need projections that start with a huge market and then a revenue plan that is driven by an assumption of market share: “The market for this service will be $2BN in 2011 and if we get 2% of that market, which I think we can, we will be a $40MM business.” That is an instant loss of credibility. You need to build a revenue and cost plan based on actionable assumptions that you control and can demonstrate.
Altitude is important. Make sure you can see the forest and not just the trees. You need to know what level of detail is important to your audience. Understanding how much ink toner you are going to use is not relevant unless you are in the publishing industry. The level of detail has to be relevant to what your investor is trying to understand. Most likely whether the business has potential, can it grow fast, be profitable or require too much capital; not whether you can predict the travel budget of your salesperson in year 5.
Find the key drivers. Your financial model is not a crystal ball into the future and investors are not asking you to predict the future. What they want to understand is what drives your business. What will accelerate or slow down your business, what will make it more profitable or less capital intensive? In every business there are a few numbers that business performance is most sensitive to. The most important thing you can do with your model is help identify those things that drive your business: the key drivers. Is it sales conversion, number of customer calls per sales person, cost per widget by volume, growth in demand, etc? Understanding and clearly explaining what those are has a double bonus: it helps investors understand your business and also sends the message that you are on top of your business. Both build trust and confidence in investing.
Well-spaced bread crumbs. Investors need to understand the story of your business. You need to guide them so that they stay engaged and interested. You need to make it easy. Here is a practical example: create a powerpoint presentation to explain your business model. Highlight all your main assumptions, compared with key assumptions of your competitors and highlight why you think your figures are conservative and reasonable. This will make it a lot easier to follow and significantly shorten the amount of time the investor will have to spend on due diligence.
If you like this information, you’ll really like “Top 10 Mistakes That Cause Investors to Shoot Down Deals”.
About the author: David Brode is the Principal of the Brode Group. An economist by training, Brode has over two decades of experience helping ventures develop and communicate business strategies through financial models so they can launch, grow, and sell businesses. Brode’s financial forecasting models have been through due diligence dozens of times and have been successful in securing over $11 billion in financing for projects worldwide. Brode has a B.A. degree in Economics from the University of Michigan.
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