In May’s article we talked about how to prepare for investors from a big picture perspective: learn the language of investors, tell a good story, make sure the numbers add up, be realistic, and be professional.
These big picture tips rest on the cornerstone of building financial projections:
- Learn the language of investors, so you can use it properly as you present your financials
- Tell a good story, based on the numbers
- Make sure your numbers add up, in your financial projections
- Be realistic about how you will launch and grow, and show this in your financial projections
- Be professional, as you present yourself and how you present your numbers.
Ultimately, investors want to see solid projections to know that you will be a good steward of their money. When creating financial projections, you have three main objectives:
- To force discipline and objectivity into your business dream through a methodical approach.
- To demonstrate thorough understanding of your company’s business model, building credibility with your potential investor.
- To provide answers to the question “What if?”
While the bottom line in your financial projections is important, you may notice that the objectives above have a common theme: investors are more interested in the financial assumptions underlying the bottom line: that is, how did you get there?
When projecting future revenue, it’s important to understand what the company must generate to be profitable, but you must also think in terms of tangible building blocks. For example, if you estimate the size of your market is 20,000 people; and the industry average market share is 4%, then you can reasonably project that your sales will derive from about 800 customers.
It’s also important to understand what will drive your revenue: price or volume. Will you be offering a lower-cost solution requiring a high volume of sales, or a higher-cost solution requiring a lower volume? Investors will want to be sure that you thoroughly understand this aspect of your business.
A bottom-up approach is critical when projecting expenses. Call your identified suppliers to determine costs, terms, and development costs. Include details of all expense categories and research your competitors’ financial statements (or search for templates on the web) to get an idea of expenses you might have missed.
You can certainly add 10% to miscellaneous expenses to cover any unknowns, but that also suggests an uncertainty of what your costs will be. Be sure to include every little expense, no matter how trivial it seems. A few dollars here, a few dollars there… all the little expenses add up!
The entrepreneur’s pay is always a big question. Specifically, how will potential investors view your plans to pay yourself? The short answer is that it depends on your personal financial situation. Investors want to see that you are able to support yourself so that you’re not distracted by your personal finances. On the other hand, they want to see that you are investing everything you can into the business. And forgoing a salary during the ramp-up period is one way to demonstrate that.
If you can afford it, the entrepreneurs should not take a salary during the startup phase. If you need to take a small salary in order to keep yourself out of financial peril, the investor will view your salary favorably (since they want you to be fully focused on the business).
The bottom line: If you’re raising equity investment to fund your salary, you are giving up more of your company in the long term, for the sake of short-term comfort. The less salary you take, the more equity you’ll have in the company.
Investors like to see two separate sets of financial projections based on a hypothetical worst-case (“conservative”) scenario and a hypothetical best-case scenario. When building out these scenarios, focus on your key metrics (sales transactions, gross margins, incremental head count, etc.). Your total fundraise ask amount should encompass your most likely scenarios so that you (and the potential investor) can avoid expensive “Bridge” or “A-1” rounds of fundraising that will dilute equity for you both.
Another critical piece of the fundraise ask amount is to remember that the fundraising itself takes time. Each fundraise ask usually covers about a 12-18 month timespan. Identify specific milestones and the cost of each milestone. The sum of those milestones is how much you need to raise. The “cushion” amount in your raise should be the cost difference of your most-likely scenarios.
DETAILS, DETAILS, DETAILS
Assumptions are the backbone of your financial projections. As the entrepreneur, you should know these numbers cold.
In your pitch deck to investors, your financial projections can be stated on a quarterly or annual basis. However, in your full-blown financial spreadsheets, your income statement, balance sheet, and cash flow statements should be presented on a monthly basis for at least two years. While the summary of a year may leave you with a positive cash flow, you could run into trouble somewhere in the middle. Further, the investor will want to play with sensitivities and assumptions in your model to see what exact month your business might get to positive cash flow and what could trigger trouble.
Need help putting together your financial projections? We have some tools to help you… and if you need more help, give us a call!