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In a post on his blog, Dave Parker, Co-Founder and CEO of Bundled.com and mentor for the Seattle Founder Institute, provides a list of common failures entrepreneurs commit when presenting their financial assumptions to potential investors. He explains that, while no startup financial model is expected to be accurate, a good model shows that you understand the key concepts, costs, assumptions, and other metrics that will help you be succesful.
The original article was posted here. Below it is republished.
"I took a call a few weeks ago that was a referral from a friend. It was a “great new startup” with some young first-time entrepreneurs. I took the call, but with some hesitation. I try to do these first calls on the phone, not in a coffee or other meeting… here’s why
I’ll avoid the discussing the type of business or details given the loose “handshake NDA” I extended at the start of the call. But to set the context, they were going to compete against some very large tech companies. So, after listening to the pitch for a painfully long 10 minutes, I asked about their forecast, to which they replied, “Well, we expect to be a billion dollars in four years”.
I’ll admit I chuckled out loud, to which his response was, "You haven’t seen the spreadsheet”. Thankfully, he was correct, I hadn’t seen the spreadsheet! I had already done a similar, unrealistic and incomplete spreadsheet earlier in my career.
So here’s a list of epic fails for entrepreneurs with their Financial Assumptions:
- "Billion dollars in revenue in year five or less"
- Investors won’t buy it even if you do…
- Top down vs. bottom up revenue modeling
- For example, “1% of China is all we need to be $1B.”
- Likewise, attaining a large percentage of your Total Addressable Market (TAM) isn’t a good option either.
- Not ramping or flat-lining your expenses as a percent of sales
- This hows that you’re not paying attention to the expenses of the business (or just don’t know the details).
- Not connecting your financial model to your plan narrative
- For example - let’s say an investor starts reading your documents at the back of the plan and sees that you have a web sales model, but then gets to the go-to-market in your plan but there is a web sales model with no reference to sales people..
- Not using Accounting Terms or Formats
- If you starting from a blank spreadsheet make sure you use the right terms and layout.
- Not knowing your key success metrics, such as Cost of Customer Aquisition, Pricing, Churn, etc.
- You need to be able to articulate the drivers in your model. Ideally, all of the assumptions should be on one page (not hard-coded into the model) so they can test your assumptions by adjusting the drivers without breaking the spreadsheet.
If you don’t feel like you can do these things, then get some help. However, you can’t outsource this exercise. When you walk into an investor's office and they drill you down on the details, you have to know where they are in the spreadsheet – even if you have a CFO.
Every investor you show your financial model knows that it’s wrong. The question is just how wrong – in orders of magnitude. Doing a good financial model shows that you have the general concepts down and implies that you have some moniker of financial discipline.
What are some of your Epic Fails in Fundraising?"
Dave Parker blogs at http://foresttreesbark.com. You can also follow him on Twitter at @DaveParkerSEA.