A strong financial model answers the tough questions.

In my world, it seems there are two types of business plans:

- Plan #1 has the obligatory 3-5 year annual financials, so the "numbers" box has been checked.
- Plan #2 is backed by a detailed, dynamic, well-thought-through financial model. It has the obligatory financials page, but shows the details in the addendum.

Plan #2 has a massive advantage over plan #1 because it really shows the founders have done their homework. They have taken all the product, market, sales channel, peer and competitor information and driven it down into a detailed, executable roadmap of how the product gets to market.

Once you go through the process of building a detailed financial model, you'll be able to answer the following questions:

Why are you asking for this particular amount of funding (good example of a successful answer here)? Exactly how far will your cash take you? Do you have enough cash to get you to the next major valuation milestone?

What exactly will you spend your cash on? Headcount vs. capital expenditures vs. outsourced consulting vs. marketing, licensing, etc...

Who are your key hires over the next year?  When will they be brought on?

What are the details behind the revenue assumptions?  Have you thought through the difference between revenue and cash receipts?  What

When does the business begin to scale? Once you begin to scale, how does your business compare to your competitors, your peers?  Are your key metrics in line?  Are you being realistic on your scaling assumptions?

What public company are you modeling yourself after? How does their growth and financing scenario compare to yours?  Are your valuation assumptions reasonable?

 Have you done sensitivity analysis? What are your downside scenarios, and what actions do you take - and when will you take them - if you find yourself in one of these scenario?  At any given point along the road, how would you circle the wagons and conserve cash?


Building a successful new business has a lot to do with focus and managing uncertainty.  If you take the time necessary to really build out a great financial model, you will have gone a long way toward increasing your focus and managing the uncertainty.  And your potential/existing investors will definitely notice.

Brian Royston
Royston Financial Consulting, Inc.

What's with the name?

Why the name Underpants Finance?

I provide financial consulting and modeling to growth companies in the San Francisco Bay Area. One of my social media savvy friends, Dave Nielsen, told me I should start a blog. After he convinced me to do so, I asked him what he thought I should call it. Dave thought for a while and then said, "Do you remember the Southpark episode with the Underpants Gnomes?" I had a vague recollection of the episode which came into greater focus as he explained it...

Underpants Gnomes were stealing one of the Southpark kids' underpants out of his dresser late at night. When the kids finally cornered one of the gnomes, the gnome took the kids to their lair and basically gave them a one slide Powerpoint presentation of their business plan, shown below:


Phase 1: Collect underpants
Phase 2: ?
Phase 3: Profit

Dave said, "That's what you do! The Underpants Gnomes need you to help them with Phase 2!" We laughed, and the Underpants Finance blog was born.

I came home and did some research. Per Wikipedia, the underpants gnomes and, particularly, the business plan lacking a second stage between "Collect underpants" and "Profit", became widely used by many journalists and business critics as a metaphor for failed, internet bubble-era business plans. Motley Fool referenced the episode in 2001, Businessweek referenced it in 2007. Six months ago, Paul Krugman evoked the Underpants Gnomes in a rant about the pending health care bill. There's a book on Southpark philosophy which discusses the Underpants Gnomes. These gnomes are everywhere. They're even in academia: Paul Cantor, a literary and economic professor who uses South Park episodes to teach courses, said "no episode of South Park I have taught has raised as much raw passion, indignation, and hostility among students as 'Gnomes' has."

Later that day I was on a bike ride, thinking about a financial model I was building for a client. I thought how funny it would be to rename my company Underpants Finance...or even better...Underpants Modeling. I laughed to myself and sent a text to Dave about the name Underpants Modeling. He shot back, saying, "I can just hear you tell someone...I will make you an 'underpants model' ;-)"

Anyway...that's where the name came from...bizarre, huh?

There are a lot of companies out there that have a great vision and a strong grasp of their market. What they're lacking is a detailed financial model. A detailed financial model takes the leadership's vision and translates it into an executable plan, with budgets, benchmarks and milestones that are measurable and actionable. It builds a bridge between vision and execution, and details how the resources (cash, personnel, capital equipment) will be used in getting from Phase 1 to Phase 3.

So that's what I'm going to focus on from now on...financial models to help you sell your underpants. So let me know if you want me to make you an Underpants Model!

;-)

Brian Royston
Chief Underpants Modeler
Royston Financial Consulting, Inc.