Startup Financial Projections: Rocket ship or Snake pit?
Fundraising woes can probably fill several therapy sessions so, for today, I am going to focus on one, particularly nuanced, challenge. We often hear that one of the most agonizing tasks for founders who are looking to raise angel, pre-seed and seed capital is how to present financials in your fundraising presentation when most of the numbers are just that: projections.
Most importantly, remember that the pitch deck is a sales document and the process of fundraising is partially a test of your selling abilities. Even for founders with a technical background it is critically important for investors to know that the CEO is capable of explaining the vision of the company to other investors and potential customers.
The underlying reason why financial projections are so vexing is that they are a Catch-22. It is unlikely they are going to be the highlight of your company that gets a VC or angel excited enough to invest. Conversely, the harsh reality is, not having a financial plan or missing the mark on the presentation of your financials can doom your deck to the dreaded ‘pass pile.’ One of the more memorable pitch emails I have received included the hook “we expect to achieve >$1 billion in revenue during the first year and we only need $500k to get there.” This is a pretty extreme example of ‘The Rocketship.’ The company was actually pretty interesting but it was apparent that the founder did not have much appreciation for what it takes to build a company with $1 billion in actual revenue [not to be confused with the absurd valuation threshold known as ‘Unicorn’] over several years; nevermind within the first year….
Naturally, I’m only one opinion but here is how I usually advise founders on this topic.
How you present your financial projections tells a story of 4 important attributes:
How you view yourself as a CEO and a self-assessment of your strengths and weaknesses as a leader
Your comprehension of the market and running the business
Your vision for the company and your goals as an entrepreneur
How much cash is needed to hit the metrics required to reach profitability and/or the next round of funding
Be extra mindful of some common financial projection pitfalls a.k.a. The Snake Pit. Below are some of the most common mistakes and examples of each:
Not allocating enough time to recruit, hire, train, and build pipeline for new sales reps
We regularly see two common mistakes around sales hiring.
Sales reps starting the same month as recruiting begins. Usually it takes 1-6 months to recruit and hire each sales rep.
Reps hitting quota during the first month on the job. Even in mature companies it usually takes at least three months for a sales rep to be fully ramped up and closing deals. You don’t need to share your ramp up projections with your sales team but you also don’t want to fool yourself into thinking they will be producing too soon.
Misalignment of contract values and sales model
Sometimes founders will plan on hiring highly paid enterprise sales reps to sell products that do not have a large enough Annual Contract Value [ACV] to support the costs associated with an enterprise team. Usually the tipping point is around $75k ACV to justify this sales model. [Note: sometimes this works in the early days of a startup to build the initial market adoption but will need to be corrected quickly]. Conversely, it is also rare to be able to close deals under $75k ACV with an inside sales model. Usually the sale is complex enough to require in-person meetings.
Omitting variable costs associated with sales
Yes, your sales team will definitely expect to be paid commission for deals they close. As will channel partners.
Which brings me to one of my most sensitive topics:
Relying too heavily on resellers early on in your business
There are very few scenarios where partners add real value to an early stage startup and, often times, are more likely to slow your progress because you do not have control over your distribution channel. For most startups under $10 million ARR, I like to think of each partner as the worst sales rep you could imagine managing.
What is your nightmare scenario for a sales rep?
Poor visibility into their pipeline? Yep. Good luck getting meeting notes into your CRM.
Hard to train? You bet. You’ll need to constantly create new materials and rely on another company to roll it out. They will have turnover on their team and you won’t know about it.
Unreliable closing projections? Deal timelines and contract values will be really hard to manage and, if your product is a barrier for your partner to get their own deal finalized, expect it to be dropped or negotiated down further than your already negotiated pricing.
Limited contact with the end customer? It could be non-existent so all of your information will be second hand at best.
Some founders turn to channel partners when the selling gets hard or rely on resellers as the exclusive distribution methodology before achieving clear product/market fit. This is usually a very flawed approach as partners rarely have any incentive to sell your product. They have their own quotas to hit so unless your product will get them there faster or easier, they are unlikely to spend much time worrying about your revenue targets.
[End rant]
Starving the marketing budget
Make sure you have a realistic expectation for the Cost of Acquisition [CAC] in your industry via various marketing channels. Hubspot is always a good source for marketing and sales related content and this blog provides a helpful overview of CAC and provides some industry benchmarks.
Underestimating UI/UX needs
Customers expect modern interfaces and, in most cases, it is necessary to build user engagement. This tends to be an area where founders try to be lean with their projections. Version 1.0 doesn’t need to be perfect but it needs to be good enough to gain adoption.
Relying heavily on outsourced development teams without adequate time/cost buffer
In an ideal world all development would happen ‘in house’ but outsourcing has its place. Try to keep it to non-critical development as much as possible and plan on extra costs and longer delivery times. The old mantra of ‘good, fast and cheap - you can pick two’ tends to be very applicable with this decision.
Projecting growth that is too slow for VCs or too fast to be feasible
This one is particularly nuanced. As mentioned earlier, don’t project $1 billion of revenue in year one…
Institutional venture capital funding really only makes sense to a very small number of startups. Your seed-stage plan needs to show that you can reach Series A metrics of ~$2 million in ARR within 18-24 months of your Seed round and then continue to grow at the famed ‘triple-triple-double-double-double’ pace for the next 5 years. There are many really strong companies that do not fit this profile... and that’s ok! The objective for any entrepreneur should be to build a viable and valuable company that can provide an adequate lifestyle for you and your employees. Succeed at that and financing will take care of itself.
Financial return profiles can vary greatly for angel investors, VCs, and corporate investment arms. Even within each of those buckets there will be many different expectations from different investors. [Note: This will be a blog of its own at some point soon but, until then, here is an article from Battery Ventures that gives a good overview of the desired trajectory from Series A to exit].
Engage a professional to build your financial model and spend time each month reviewing with them.
It’s not the most glamorous part of running a business but spending the time and money to build a thoughtful operating plan can neutralize some potential risks and possibly turn your hockey stick projections into a positive, or at least a checkbox, for potential investors. [Note: Please, please, when you do engage someone to help with your financials be sure they have 1). real experience with technology companies or whichever industry you are in and 2). Preferably are a CPA. [Just like you do not want a divorce lawyer negotiating your tech company term sheet, you do not want someone outside your industry looking over your financials]. If you work with the right accounting partners you will also have a valuable resource for customer and investor introductions as well. Reputable service providers in the tech community are an oft-overlooked source of meaningful connections. Put them to work for you!
Once you have raised outside capital working with a professional accounting firm may become a requirement by your investors and board of directors. Not everything goes as planned when building a company but you and your investors should never be surprised by a ‘cash out’ date. When founders and the board have a handle on your financials it is much easier to avoid some missteps and adjust to the inevitable bumps in the road with more agility.
I’m sure the list goes on. What other financial projections struggles are you having?
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