When it comes to pitching your business concept to investors, few are going to take your word for it when it comes to the potential success of your business. You're going to have to persuade investors that you have the ability to make intelligent decisions regarding the direction of your business. As President Eisenhower once said, "Plans are nothing; planning is everything."
So how exactly can you show investors how you are planning a successful direction for your business?
By building a good financial model. A financial model shouldn't be about predicting the future; in fact, financial projections are rarely right. Instead, your financial model should be about showing investors that you have an understanding and a good grasp on the things that will impact the success or failure of your business, and that you have a logical and convincing plan for executing effectively.
There are two main components to a financial model. These components include projections about the future of your business and a detailed spreadsheet.
When it comes to developing thorough projections about the future of your business, there are two main types of financial models that you can use - bottoms up financial projections and top down financial projections.
Bottoms up financial model - To create a bottoms up financial model, you begin by making a number of core assumptions about your business based on a clearly defined product direction, your planned distribution strategy or a specific partnership that could have a significant impact on your business.
Top down financial model - This type of projection is useful if you know how much money you need to raise in your first round of venture capital financing (also referred to as a Series A round) and if you've determined the types of revenue, margins and growth numbers that you need to hit to reach that number. With these numbers in mind, you can work backwards (top down) in order to show investors where you are now and where you will need to be.
To ensure that you are making accurate projections, always ask yourself if the numbers you are coming up with make sense. You can use both bottoms up and top down financial models to get an accurate range of potential outcomes as well.
Financial Model Spreadsheet
To illustrate your business projections, you're going to need to provide investors with a detailed and easy-to-understand spreadsheet. A financial model spreadsheet should include the following:
- Customer acquisition estimates that are based on organic, viral and paid acquisition strategies.
- Revenue forecasts for a number of different revenue models, such as e-commerce, commerce, in-app transaction and advertising-supported revenue models, to name a few. Revenue forecasts should consist various metrics, such as launch timing, flexible price points and more.
- A detailed expense forecast that is broken down by the cost of goods sold as well as the selling, general and administrative costs.
- A cash flow and income statement.
- An ownership structure estimation based on your funding estimates and capitalization.
These numbers should clearly show investors what elements will deliver the most growth, whether it be sales team upsells or website conversions. A good financial model should also show investors what aspects of your business need to built and fostered as you grow. For example, how many sales reps are needed for each additional million in revenue. Last but not least, the financial model should outline clear targets and milestones that need to be hit every month and quarter.
Use this brief guide in order to develop thought out projections and a properly structured spreadsheet to help investors understand your startup financial model.