If you need to attract investors to your startup, your financial projections have to be as attractive as the idea. The problem is that these business financials are future projections, while the idea is “now,” so you believe the idea can do most of the selling. Your challenge is that investors recognize a good business, and they judge your idea by how you translate it into financials.
For example, every investor I know can tell you about meeting a passionate entrepreneur who is pitching a great technology innovation but has not done the financial homework on making it a good business. Thus the investor can’t visualize any return on investment (ROI), so the entrepreneur gets no money, and a good opportunity is lost to all.
Even if you are bootstrapping the business, and not looking for outside investors, the “rules of thumb” that smart investors look for should be the same ones that you use to assess your own risks and set reasonable expectations for progress and success. In that context, I offer the following financial projection strategies, from my own experience:
- Forecast a business that has plenty of room to grow quickly. Find some credible opportunity statistics that can support your own revenue expectations of between $20 million and $100 million in the fifth year. A larger number exceeds most investors’ rational growth expectations, and a smaller one implies a limited return potential.
- Demonstrate an understanding of business operation realities. No matter what the potential, every business is constrained in growth by the time and effort required to hire people, spread the message, and deliver and support solutions. If you insist on projecting $100 million in sales the first year, smart investors will likely run for the nearest exit.
- Assume margins and prices that are realistic in your target market. As an investor, when I see projected margins below 50 percent, I see low resources for scaling the business, high risk, and likely no return on investment. Even if you work harder than everyone else, you probably won’t stay ahead of rising costs and new competitors.
- >Market penetration and revenue targets related to opportunity size. Five-year projections should show at least a 10 percent penetration of the market segment you target, but not more than 50 percent. Don’t assume that you can dominate the market in a few years, or that the potential is so large that even a trivial entry will mean success.
- Project growth equal to or better than current premium startups. Companies that get investor attention usually double their revenue or more every year. Lower targets indicate a very conservative team or challenges that have not been disclosed. Investors want to bet on someone with aggressive targets, and a demonstrated track record, if possible.
- Clearly delineate the break-even point in your projections. Investors today are not interested in startups that don’t even plan to cover their own expenses for the first five years. A reasonable break-even point is two or three years out, which indicates an ability to manage your own show, and allows for investors to collect their own good return.
- Break funding requests into tranches, with dates and milestones. Rather than ask for a single million dollar investment now to forestall future requests, it’s much more credible to ask only for what you need in the next year. That may translate to $200K now, with increments of $400K to follow every eighteen months, based on specific milestones.
- Prepare an itemization of your intended use of investment money. Highest on your list of fund usage categories should be business scaling requirements, such as marketing, inventory building, and staffing. Unattractive uses, from an investor standpoint, would include research and development, buying a building, or large salaries.
- Define an exit strategy for investors to liquidate their share. Investors have learned that simple buy-outs of their share by owners often become major squeeze-plays. They prefer a liquidity event such as an IPO or an acquisition by an existing large industry player, with a valuation at that time of five multiples or more of your projected revenues.
- Back up your projections with a simple financial model. No matter how good your projections appear, you should anticipate being asked questions by investors, such as what happens if your costs go up, growth slows, or market explodes. With a simple Excel spreadsheet, you can answer these questions quickly and totally impress everyone.
Of course, projections don’t make reality, but they do force you to declare. Don’t create a fairy tale for investors, and hope to protect it with fast talk from probing and knowledgeable investors. You have only once chance for a good first impression with investors, so do your homework first and put together a plan that will get all of us excited and optimistic.