12 May Financial projections an investor might actually believe
By Matthew Cushen…
When an investor hears about a business, it is usually the product and the marketing behind it that piques interest and qualifies a business in or out of further consideration.
But somewhere down the line, before parting with their cash, an investor is going to need to hear how a business expects to create a return on investment (ROI), which involves some numbers and – more often than not – creates nervousness for entrepreneurs and/or provokes incredulity among investors.
These tips should help avoid both:
1. Get some help if needed, but still own the numbers
I love spreadsheets. For me they are a blank canvas waiting to receive a rare combination of logic and creativity. But I’m also well aware that will sound ‘unusual’ (OK – downright weird) to most. If you are not a natural with numbers and spreadsheets then do get some help. Be careful to choose an accountant or other financial mentor that understands start-up businesses – ask for references and look at prior work.
It is an art not a science to construct a financial projection for a new business with no existing data – one that many accountants struggle with. And help is different to delegation. I’ve too often heard from an entrepreneur that they cannot answer questions about the financials as someone else compiled them. That is an immediate turn-off for an investor.
Regardless of who compiled a spreadsheet they are your numbers. You need to intimately understand their origin and then own and deliver them.
2. Not too much, not too little
When looking at numbers, an investor will be looking for a balance of commercial pragmatism and ambition. Revenue projections shouldn’t be outlandish – either in eventual size or the speed it takes to get there.
My business partner and I most often find ourselves discounting numbers by 50% or adding a couple of years before we believe most financial projections. Once you’ve constructed your numbers, take another look at the end result and make it as real as you can. For example, maybe you have a product for mothers with babies.
Once you have done your calculations (see point 3 below) you might have come up with a sales number of say 100,000 per annum in the UK. You’ll want to check that against the 700,000 babies born each year in the UK – would it be realistic to expect 15% of mothers to be purchasing that product? Always remember, the best thing you can do is beat your numbers over the first year or so. That will create enormous credibility and trust going into another funding round.
Equally, the projections cannot be too conservative. Any numbers that look like a lifestyle business – large enough to amuse and give a salary to the founders but not large enough to support an exit or healthy dividends for investors – are not going to attract funding.
3. The assumptions matter more than the answer
Although the headline numbers will create a sense of what might happen, no investor will believe them. They will want to know the assumptions used to get to the numbers. They won’t believe these either. But if they can understand the logic then a) they can start to feel their way towards their own sense of what is achievable (they might even be more bullish) and b) if they like the thinking, creativity and structure of the assumptions it will build credibility regardless of belief in the numbers chosen. For example, say you were putting together a plan for a restaurant chain. You might have a couple of different set of assumptions:
Assumption A: You might have some good benchmarks from similar units in similar locations. So you may start with a benchmark and then have some assumptions around how your restaurants might be different: say, a% more or less footfall driven by better or worse location, b% more or less covers as bigger or smaller, c% greater or lesser transaction value, d% more or less repeat custom from greater or lesser loyalty etc.
Assumption B: Or you might start from scratch and come up with a number based on, say, q number of people in the catchment area, r% interested in your type of food, s% responding to some marketing, t% choosing to visit, u% at breakfast, v% at lunch, w% at dinner, spending on average £x on breakfast, £y on lunch, £z on dinner – along with the split between food and drink as they will make a big difference to margins. We can go on, but you get the picture.
Coming up with different sets of assumptions is a highly creative exercise. And the more different routes you use the more confidence you and others will build in your projections.
However, there is a watch-out. If you are constantly optimistic or pessimistic, then aggregating lots of different assumptions will create a wildly too optimistic or too pessimistic picture. You need to be consistently realistic and pragmatic. You’ll know that every one of your assumptions will be wrong, but you can expect that while some might be a bit too high others will be a bit too low. And so roughly the figures will net out (i.e. make sense).
The additional advantage of breaking out all these assumptions is that when you start experimenting or trading for real, you can judge where your assumptions were close or wildly out and then update them with real life experience.
4. A pithy summary
As with everything around selling your business to investors, the way you tell the story counts for a lot. In your document or presentation to investors you will want to include:
- An annual profit & loss summary for three to five years – showing revenue, gross margin, the main expenses (including salaries split out separately) and net operating profit;
- A quarterly cashflow for three to five years – showing when investment is expected;
- A monthly cash flow until the next raise – to show the monthly cash burn and the runway from the current investment until more funding is required;
- The main assumptions used.
If you really want to impress, you might include a couple of different scenarios – maybe a conservative and a stretch scenario. These can be based on changing the two or three assumptions that have the most significant impact on your overall projections. This will help give investors’ confidence you are able to understand the commercial dynamics of the business and have different plans in place as reality kicks in.
It is best not to get too detailed, just draw out the most interesting elements. And the good news: a balance sheet is not usually useful. It is only interesting to an investor in exceptional circumstances (for example if you are expecting to be able to use debt finance later in the maturity of the business).
5. All the workings out
Beyond your document, make your working spreadsheet model available to investors. This should be structured well enough for an investor to find their way around. A little time spent formatting and making the spreadsheet easy to navigate and use will raise confidence in the thinking behind the numbers. Then an investor can play with and stress test the assumptions they don’t agree with to come to their own conclusions.