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.
Showing posts with label venture capital. Show all posts
Showing posts with label venture capital. Show all posts
Thursday, September 2, 2010
Sunday, July 25, 2010
Why is it important to spend time developing a well-thought-out financial model?
I dropped by a client's office last week to check in on him and see how the company was progressing. The founders and I built a detailed financial model for their company late last year. Early this year they were successful in raising a series A round of $5M.
He had told me earlier that the potential investors were impressed with the model, but last week he told me how key that model was in the process. He said, "Did I tell you that the model got us an extra million dollars?" I didn't recall him telling me this, so I asked him to explain. He said that he had received a couple of term sheets for $4M in funding. He really wanted $5M, so he pulled the model out and said, "We really need $5M, and here's why." He took them through the model and explained in great detail what expenditures were needed to get them to the next major milestone. They ended up getting the $5M!
That is a great example of the benefit of taking the time to build out a realistic, detailed, well-thought-out financial model. My client took financial modeling seriously...because he took his company seriously. After I built the basic structure of the model, we spent several sessions where we populated it with assumptions and refined it. We attacked the assumptions from different angles and finally arrived at a model they thought was aggressive, realistic and defend-able.
When you've done a deep dive with a financial model, you understand where the inflection points are, where the trade-offs are, what the key metrics are. You have a tangible set of expectations as the company moves forward. Most importantly, all of this knowledge comes across to your investors as a much deeper understanding of the business and how to execute the next phase.
By the way, he also said that he's nailed the model so far (from an expense standpoint), and that has given him loads of credibility with his investors. In the board meetings, they're not worried at all about cash, because the company is executing per the plan. This allows the meetings to focus on other important issues.
What was that extra $1M in funding worth? That's hard to quantify, but I'm sure my client would tell you that it was definitely worth the cost of the model!
Cheers,
B
He had told me earlier that the potential investors were impressed with the model, but last week he told me how key that model was in the process. He said, "Did I tell you that the model got us an extra million dollars?" I didn't recall him telling me this, so I asked him to explain. He said that he had received a couple of term sheets for $4M in funding. He really wanted $5M, so he pulled the model out and said, "We really need $5M, and here's why." He took them through the model and explained in great detail what expenditures were needed to get them to the next major milestone. They ended up getting the $5M!
That is a great example of the benefit of taking the time to build out a realistic, detailed, well-thought-out financial model. My client took financial modeling seriously...because he took his company seriously. After I built the basic structure of the model, we spent several sessions where we populated it with assumptions and refined it. We attacked the assumptions from different angles and finally arrived at a model they thought was aggressive, realistic and defend-able.
When you've done a deep dive with a financial model, you understand where the inflection points are, where the trade-offs are, what the key metrics are. You have a tangible set of expectations as the company moves forward. Most importantly, all of this knowledge comes across to your investors as a much deeper understanding of the business and how to execute the next phase.
By the way, he also said that he's nailed the model so far (from an expense standpoint), and that has given him loads of credibility with his investors. In the board meetings, they're not worried at all about cash, because the company is executing per the plan. This allows the meetings to focus on other important issues.
What was that extra $1M in funding worth? That's hard to quantify, but I'm sure my client would tell you that it was definitely worth the cost of the model!
Cheers,
B
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