Business plan financial projections are designed to give an investor or banker a feeling for how well your company can perform, typically over a period of either three or five years. Bankers considering whether to extend a line of credit or grant a loan to a new business will typically seek a three-year model (the SBA standard), while angel investors and private investment firms/VCs look for a five-year model.
Financial projections are a blend of art and science. There is always a leap of faith in the modeling process, for example, can you really gain 1% of the market? Are the industry figures from last year going to hold true for next year? No one expects you to know absolutely “for sure,” but as long as you outline the assumptions and note how you arrived at your figures, you’ve done all you can.
One thing is certain – include your assumptions wherever possible, so an investor understands how you arrived at the figures in the model. Consider building a past performance table showing your profit and loss and balance sheet from the past 2 to 3 years, in table and graph formats, if your company already has some revenues. Make sure you can achieve break-even within a reasonable time – say 12 to 24 months – and keep your cash at a positive balance throughout the life of the model.
One key factor that an angel investor looks for is solid return on investment (IRR). Whether it’s capital for startup or business startup money, active angel investors are thrilled to build and finally create a thriving business model. The expectation for most investors is to be able to take out seven dollars for each dollar that’s invested into a company within five years.
Investors are always evaluating your financial sophistication before they trust you with their money. Unrealistic financial models that have unachievable margins or grossly understated expenses, valuations and market penetration will send them running. If your numbers don’t add up, start over. On the other hand, if you have a realistic assessment of your competition, well-thought out cash flows and cost assumptions, you’ll prove you have a strong understanding of your market. Investors know that you’ll have a much higher chance of success under those circumstances.
There are certain things that will kill your ability to get an angel investor. For example:
1) Unrealistic valuation. If you have a pre-revenue startup and say that you’re going to raise $1 million for 10% ownership (leaving you with a $9 million ownership before the investor even puts one foot in), you’ve just shown that your valuation is too unrealistic for an angel to be interested.
2) Unrealistic projections. If you say that your revenues are going to grow from $0 to $50 million in your first year of operations, an investor will probably laugh and tell you to go out and get some real-world experience first.
3) Integrity. Whatever you do, make sure your figures are as honestly protrayed as possible. If an investor thinks that you’re not being honest or that there is any chance you have lied about anything in your financials, they’ll never do business with you now or in the future.
These aren’t the only considerations you’ll need for strong financial projections but they will give you a start. Just make sure that your business plan and financial model support each other as much as possible. Paint a picture that supports your projections and if you can find average costs and income for your industry, model from those and that should give you fairly airtight financials.
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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