Monday, August 3rd 2020 (9 months ago)
A financial model can make or break your fundraise. Your model is the backbone of data behind what is otherwise a well-rehearsed pitch for a cool idea. No matter how strong the team or how creative the marketing plan, investors need to see a carefully strategized forecast backed by data-based assumptions.
In the early stages of startups, founders often extrapolate assumptions to prove wild projections to investors. Most investors will immediately latch onto these common mistakes and, inevitably, discredit the entire pitch as a joke.
Here at Forecastr, we like to think we know a thing or two about financial modeling. Avoid making the below mistakes to prevent being laughed out of your own pitch.
1.) The Monthly Growth Rate
Founders often use this oversimplified formula to calculate their monthly growth rate or any key driver of revenue:
Forecasted Revenue = last months revenue * % monthly growth
What happens in this scenario? If you arbitrarily insert a 5% growth rate, you forecast a hugely impressive number at the end of five years. Unfortunately, investors learn nothing about the drivers of your business from this strategy. Virtually no business consistently generates organic growth month over month. Even more, this statement indicates to investors that you have no plan to drive revenue.
Instead, execute a “bottoms up” forecast to emphasize assumptions underlying specific sales and expenses. How and where are you acquiring new customers? How much money will you spend on each channel? You might build a sales team, invest in paid ads, or implement a referral program. Show investors how your strategy evolves throughout the stages of your start up. Prove strategic and realistic growth. For more information on this type of forecast, check out our blog post: Financial Modeling for Operations: Part 1 – The Growth Plan.
2.) The “Percent Market Penetration”
Have you ever heard a founder say this? “This is a $5 billion dollar market. If we could just get 1% of that, then we are all rich!”
It doesn’t take a finance expert to understand that any percent of a huge number is still a huge number. Arbitrarily choosing a seemingly tiny percentage of a huge market tells investors nothing about sales or sustainability of your business.
If you choose to use this tactic, describe the significance of the percentage stated. Achieving even 1% adoption within a billion dollar market requires brilliant sales and marketing, effective operations strategies, and a financial model that proves it. Show investors those strategies and clearly communicate your growth plan with reasonable data extrapolation.
3.) The Nonsensical Projections
We have seen startup founders project their five-year growth to surpass the size of Amazon. We have seen founders claim their companies will be cash flow positive from day one. We have seen founders forecast 90% net margins after only three years.
Asserting such absurd output in your financial model immediately indicates to investors that you have no idea what you’re doing. While these examples are extreme, you must ensure each projection in your model stems from realistic assumptions. Perform the appropriate research on your market to set expectations. Use specific extrapolation from your growth strategy to support that forecast. You can gut check margins for your industry at maturity here.
Developing and sharing your financial model may be the most daunting part of your pitch. Founders who rely on these specific growth strategies and data-based expectations build strong financial models and equitable investor relationships.