Startups Financial Modeling: Simplicity is King
By Lior Ronen (@Lior_Ronen) | Founder, Finro Financial Consulting
There are three conventional approaches of founders to financial modeling.
The approach depends on the founders' experience, personal history, and ambitions.
However, a message is only useful if the other side received and understood it.
In this post, we'll cover the most crucial aspect of financial modeling - simplicity.
As a tech financial consultant, I talk to many startup founders and tech investors every week. I'm amazed to see the differences in thinking and understanding in private market investing between founders and investors.
A typical conversation between a founder and me sounds pretty much like this:
Founder: Hi Lior, can you help us develop our financial forecast and valuation? We're looking for a simple 3-5 year projection that breaks down our estimated MRR and ARR while emphasizing our CAC improvement to show our incredible growth. Our valuation should include an attractive WACC and send the message that we can outpace the growth rate of Facebook. Let's use the VC model, DCF, and CCA.
Me: OK, sure. What does the company do?
Founder: It's a mixed B2C and B2B model that taps the market of XX, capturing the value of AI / Machine Learning / other trending buzzwords in the niche.
Me: OK, how are you planning to monetize that?
Founder: What do you mean?
Me: How did you plan to generate revenues?
Founder: We haven't thought about it precisely, but we have a few ideas that we want to model.
Then, the founder explains eight different revenue streams. Some of them are difficult even for him to explain.
Investors that I work with are looking for simplicity. They want to see financial models and forecasts that genuinely explain the founders' beliefs, plans, and expectations. They are looking for presentations that concisely explain the product, service, and business model.
Startup Valuation
How to put all the pieces together? Which valuation method or equity allocation method is right for your case?
We have the answers.
Later I talk to one of my clients from the investors' side of the game (usually either private equity funds, VCs, family offices or even hedge funds) and they ask me to help them understand the business and financial projection of a startup they started reviewing because the spreadsheet is either too complicated and requires a few hours to understand, the business model is not clear, and valuation is through the roof.
Investors that I work with are looking for simplicity. They want to see financial models and forecasts that genuinely explain the founders' beliefs, plans, and expectations for the future. They are looking for presentations that concisely explain the product, service, and business model. Investors are looking for a story they could follow, which could help them understand what the founders have in mind.
On the other hand, many founders try to impress with large, complex documents that are often over-promising. It's common to receive a 50 pages business plan when I review startup's documents for investors. Typically this business plan is full of irrelevant text that adds little or no value to the reader. Lengthy descriptions of a market, niche, or business idea are tough to follow compared to a short, point table, chart, or other visual aids. A short 1 paragraph description that explains the product/service or business model is better than ten pages of detailed reports.
"Founders probably know their product/service best and even know how they want to raise funds, but if they cannot help their audience understand it, all their efforts are useless. “
There are a few founders characters that fall into these pitfalls:
Founder A: She raised money for a few startups before and even completed a couple of exits as a co-founder. Usually, this founder thinks that she already knows everything she needs to about fundraising; she can create a few documents herself and not interested in feedback or external view on her work.
- This type of founders usually asks me to provide just valuation for the business (and prefers the valuation to be around $500 million, but we trust your professional knowledge, ha? ) and gets back after a potential investors sent back to do some homework and improve the quality of the work.
Private Market Investing
Investment returns are historically higher in the private market than in the public stock exchange. Higher returns compensate investors for illiquidity, limited public accessibility, a high entry barrier, and complex transactions.
Here's our guide for the basics of private market investing.
Founder B: This is his first time raising money for his first startup, and he paid someone $250 to write a business plan. The BP advisor used a ready-to-use template, made some small changes to fit the current business, and sent back a 60 pages-long document that no one would probably ever read.
- This client doesn’t think it’s a big deal to convince someone to invest in her vision. This founder asks for the lowest available price to create a financial model and ends up with a $50 worth of financial model when the advisor forced the business model into an existing spreadsheet that he had.
Founder C: He raised money before and has an MBA from the right college. This founder creates a business plan like a college assignment and a spreadsheet full of acronyms and niche-specific jargon. He knows exactly what he wants to do, how he wants the documents to look like, what information to include, and is not willing to hear any feedback about it.
- This client will create a DCF valuation for this startup, mention a bunch of financial terms while overcomplicating the financial model, pitch deck, or business plan.
The types above are real and genuine clients that I had. Of course, not all of my startup clients fall into one of these types, and of course, they are generalizing the different characters. Still, they represent many of the founders that I talk to, and all of them are missing one main thing in their presentations – SIMPLICITY.
Additional read: 5 Essential Elements To Include In Every Startup Financial Model
More additional read: Startup Financial Modeling: Revenues Projection Made Easy
Founders probably know their product/service best and even know how they want to raise funds, but if they cannot help their audience understand it, all their efforts are useless.
Documents that you share with your potential investors. Whether it’s a financial model, pitch deck, business plan, or what have you – they represent you and your business in front of the investors. Make them clear. Readable. Easy to understand and follow. Don’t assume that your audience knows immediately what you are talking about or referring to. Take into consideration that most investors speak to dozens of companies each week, so try to help them understand your business and help them see the real value you can bring. In all of these cases, simplicity is king.
