Building Your Startup Financial Model


A conversation with Taylor Davidson of Foresight.is

You’ve heard the stories about companies getting funded based on a sketch on the back of a napkin. If your name is Ev Williams or if that napkin sketch is as compelling as Amazon’s, you may have a shot.

via a16z

If you aren’t a founder of Twitter, Blogger, and Medium or spend your free time saving journalism and launching rockets, people evaluating your business are far less likely to take your proclamations about the future at face value.

On this blog, we write a lot about the importance of storytelling for a company. No matter who you are talking to – team members, investors, potential investors – company storytelling doesn’t stop, it simply changes contexts and mediums. A financial model is one of those mediums through which your company can tell its story, even without the operational history one might assume would be necessary to persuade investors or make smart decisions about the direction of the business.

To get a better understanding of what it takes to build a compelling and useful financial model (as well as why it is important), we spoke with Taylor Davidson of Foresight.is. With Foresight, Davidson has built startup financial model templates to help early-stage entrepreneurs spend less time on finance and more time on their products. He has been building startup specific financial models for almost two decades.

The post that follows is drawn from that conversation as well as from our experience at Visible working with private, VC-backed companies on a daily basis.

 

Where to Start

When Warren Buffett invests in a company, he makes holistic decisions about the quality of the business as if he is buying the whole thing and not simply a decision about the direction the stock might move.

When building a financial model, a similar philosophy applies. Before breaking the business into discrete pieces and asking yourself which direction each will go, first look at the business as a whole and understand both what you as an organization are trying to accomplish as well as what the intended use of the model and startup financial projections you are building will be.

What do we need to accomplish over the next x months…

 

Being Right is the Wrong Goal

As Davidson put it in our discussion – and in multiple posts on the subject in the past – the goal of a financial model is not to be exactly right with every projection. The more important focus is to show that you, as a founding or executive team, have a handle on the things that will directly impact the success or failure of your business and a cogent plan for executing successfully.

Mark Suster of Upfront Ventures puts it similarly:

See I don’t care if your projections prove wrong over time. I care about your assumptions going in. I care about the thought that you’ve given to the customer problem. I care about how much you’ve thought about market share, competitors, adoption rates, etc.

 

How to Build Your Startup Financial Model

Among technology companies – especially ones located in a certain geographic region – the very mention of a financial model evokes thoughts of calculator toting, tie-wearing, number crunchers sitting somewhere in a suburban cubicle.

With the direction sentiment is shifting in the early stage market, this mindset couldn’t be further from reality. A well-constructed financial model displays a professional approach to running your business and shows that you “take seriously the fact that you are deploying other people’s capital.”

A good financial model consists to two things:

  1. Well thought out projections about the future of the business
  2. A properly structured, understandable, and dynamic spreadsheet

 

Bottoms Up Startup Financial Projections

A bottoms up financial model – where you start with 5 – 15 core assumptions about the business – is most useful for a company contemplating a specific product direction, distribution strategy (i.e. invest in paid advertising), or a certain partnership that could potentially have a major impact on the business.

 

Top Down Startup Financial Projections

A top down financial model may be most useful for a company who, for example, knows that it will need to go out and raise $X million in a Series A round 15 months from now and has spent time gathering data on what types of revenue, margins, and growth numbers they need to hit to have a successful fundraise. (Note: If you are a SaaS company, the Pacific Crest SaaS Survey is a great starting point to benchmark yourself)

Maybe in this case, those numbers are $1.5MM in MRR with at least 100% YoY growth. With those in mind, you can work backwards to understand how much you need to grow and which distribution channels may provide the best bridge from where you are now to where you need to be.

 

Does This Make Sense?

While putting together projections, Davidson recommends constantly asking yourself whether the numbers you are coming up with make sense. To best understand how sensible your projections are, it can be useful to look at things in both directions – top down and bottoms up – to build the right ranges of possible outcomes for your business.

 

Don’t Reinvent the Wheel…Use a Template

Unless you spent the first couple years of your career cutting your teeth inside an investment bank, your best bet is to lean on existing resources for the structural composition (i.e. the spreadsheet) of your financial model.

The Standard Startup Financial Model that Davidson has put together on Foresight.is has been used by over 15,000 people across the world – from one-person operations just getting started to companies raising large VC rounds or considering acquisitions.

And while we don’t recommend building your model from scratch, it is useful to understand how one can construct a professional financial model. Here are a couple quick resources, recommended by Davidson and us here at Visible:

Finally, if you are looking for a less sophisticated model or something to fit a specific modeling use case (user acquisition, revenue growth, or operations) here is a quick list of resources recommended by Davidson:

Note: You can dive deep into financial modeling and find a ton more great resources by checking out the Foresight blog and reading the Financial Modeling Best Practices post.

 

Financial Modeling Mistakes

Failing to hit both of the requirements we mentioned in the last section – well thought out projections and a well contstructed spreadsheet – will quickly render your model unusable and will reflect poorly on you as a founder and on your company.

Common Financial Projection Mistakes

 

Common Spreadsheet Mistakes

Putting Your Financial Model to Work

Another Mark Suster quote sets the tone for how Davidson thinks about taking the financial model you have built and using it to help grow your business:

Financial models are the Lingua Franca of investors. But they should also be the map and the Lingua Franca of your management discussions.

Financial models play a key role in the all of the major discussions you have about your business with all of your key stakeholders. A comprehensive financial model will have within it a number of different pieces that are relevant to different conversations within your company.

The interplay between your revenue growth, your current burn rate, and the amount of money you have in the bank are all useful when putting together a hiring plan. Your assumptions for revenue can be isolated and used as a jumping off point when discussing a change to your distribution strategy. And as mentioned above, the projections you build around your key performance metrics are a crucial part of a successful fundraising process.

In some cases – whether internally with management or externally with investors – the conversation will be high level and in other instances you will need to be more granular. If you have taken the time to thoughtfully prepare your assumptions around the future of your business, your most critical conversations will be more productive and you give yourself a strong advantage in the daily battle for capital and talent.

 

 

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