By Lior Ronen | Founder, Finro Financial Consulting

Raising money for a startup? A good financial plan can be your best friend. It shows your business can work and helps you share your vision with people who might invest.

But, making a financial plan that's on point, interesting, and just right for the stage your business is at can feel like a big challenge.

In this article, we'll talk about why a financial plan can be a game changer.

We'll discuss how different plans work best at different fundraising stages.

And we'll give you some handy hints on making and sharing a financial plan that could boost your chances of getting that all-important investment.

So, if you're ready to make financial planning less of a headache, let's get started!

The benefits of building a financial model

Think of a financial model as your startup's secret weapon when trying to win over angel investors or venture capital funds. It's like a crystal ball, showing a glimpse of your company's financial future, typically for the next 3 to 5 years.

This tool illustrates how you plan to turn your idea into real money and put your business plan into action.

Sure, crafting a financial model might seem daunting at first, but the payoffs are huge. It's like the cherry on top of your pitch deck or company plan.

It wraps up your message, showing your strategy and aims, and helps investors really get their heads around your business model and financial forecasts.

To squeeze all the juice out of your financial model, you need to set it up right.

This means including everything that matters: your expected revenue, costs, cash flow, and growth, as well as the assumptions and factors that drive these numbers.

Building a detailed financial model is like laying the foundations of a house.

It helps you uncover valuable insights down the line and forces you to think about stuff you might've otherwise overlooked.

A good financial model isn't just a shiny sales tool. It proves your startup can make money and turn a profit in the future.

It also makes you as a founder face up to some less glamorous but super important issues, like controlling costs, managing cash, and setting realistic targets.

Showing investors you've got a solid plan to manage costs and hit profitability can boost their confidence in you.

Plus, if you add features like sensitivity analysis, adjustable manual inputs, and interconnected sheets, your financial model becomes a powerful testing tool that helps bring everything together.

A well-built financial model can be a game changer for your startup. It paints a clear and compelling picture of your business's financial health, aims, and potential, winning investors' trust in your long-term success.

And let's not forget – it's a great storytelling tool that could help you secure the funding you need to take your business to new heights.

What do investors even look for in a financial model?

It's not an easy question to answer. Different investors have different preferences, focus areas, and methods for assessing the viability of a business model and its founders' ability to lead the company toward success.

In general, many investors tend to look for these several vital elements when reviewing a startup's financial model:

1. Revenues: Investors want to see the startup's clear path to revenue generation and eventual profitability. This includes detailed revenue projections, assumptions, and drivers explaining how the startup plans to generate revenue.

2. Expenses: Investors will also want to see that the startup has a well-constructed plan for managing costs and that the expenses align with industry standards.

3. Cash flow: Cash flow is crucial for a business's survival. Investors will be looking for a detailed projection of cash inflows and outflows and an explanation of how the startup plans to manage its cash position.

4. Growth: Investors will look for evidence of the startup's potential for growth. This can be demonstrated by forecasting future market share, sales, and other key metrics.

5. Valuation: Investors will be interested in the estimated worth of the business. This can be presented by applying appropriate valuation methods like discounted cash flow, multiples, etc.

6. Scenario Analysis: Investors will be interested in how the business might perform under different market conditions. A scenario or sensitivity analysis can provide insight into how the company would perform under different assumptions and help identify potential risks and opportunities.

7. KPIs and Metrics: Investors will be interested in seeing how the business is performing and how it will perform in the future. Key performance indicators and metrics relevant to the company can provide a clear and measurable way to evaluate the business's progress and ability to achieve its goals.

8. Clarity and transparency: Finally, investors will be looking for a clear, concise, and transparent model that is easy to understand and that provides a realistic view of the business's financials and how it will achieve its goals.

Of course, this is a general list, and each investor might have specific needs and interests.

How to use a financial model in different stages of fundraising?

A startup financial model evolves over time. 

When starting a new business, you don't have much to go on. It's up to you to fill the blank canvas with your ideas, thoughts, estimates, and research topics. As the business grows, founders know more about their business, clients, and market dynamics. The financial model should reflect this transition.

When starting a business, it is better to focus on the basics and not get carried away with complicated models. It is essential to polish your idea, understand how to generate revenues, and figure out how to turn this idea into a business.

So in this stage, we recommend that founders focus on the TAM-SAM-SOM model components, which break down your total available market (TAM), your existing market share (SAM), and the number of sales you can make in the short term (SOM).

As you move forward, every new round peel more information about the business you should include in your startup's financial model. 

In the pre-seed stage, which usually happens around pre-alpha or alpha stages, a startup's financial forecast should focus on its burn rate, runway, and monetization plan. At that stage, the startup should spend its limited cash from investors productively and start figuring out how to generate revenues from the idea.

After a few more months pass, startups typically work on their MVP (minimum viable product). At this stage, a startup should have a clear vision of its initial business model and user acquisition process, which will probably change later. In most cases, a seed startup has a broader hiring plan than a pre-seed startup to beef up its staff in the right places and support expected growth.

A few more months (or years) down the road, the company either has a product-market fit (PMF) or works hard to get there. The company has an excellent strategy for reaching a PMF, and the team has laid out a clear path for accomplishing this goal.

These are typically businesses in series A or B. Businesses in these stages usually have a solid grasp of their business model, monetization plan, and costs. They usually have some historical financial data to help them gauge how much money they'll need to keep the business running and how to attract new users.

Their financial model should include a full expenses forecast of headcount, payroll, cost of revenues, and operating expenses, as well as a detailed revenue forecast that includes the user acquisition process, user base projection, and pricing per product or tier.

This is the time to have also a detailed cash flow projection that outlines incoming and outgoing cash flows from operating, financing, and investing activities. 

Startups in this stage should also show actual and projected KPIs and a clear path to profitability and positive cash flow.

Further reading: A Startup Financial Model Evolves Over Time: A Founder's Guide

How to build and present a financial model?

Building and presenting a robust financial model demands clarity and simplicity. Ensuring your model is clear, concise, and free of confusing jargon will make the crucial information you're conveying easily understood.

A good financial model doesn't shy away from the details of your business.

It digs deep into what drives revenue, how customers are attracted, and the plan for executing the road map.

It is also realistic about estimated conversion and growth rates, using real numbers instead of hopeful assumptions where possible.

Your model should brim with manual input assumptions, but they need to be both realistic and conservative.

This shows investors a clear and achievable path to profitability, which is what they're really looking for.

In terms of user acquisition, your model should detail the entire process: from first interaction to conversion, through to onboarding and retaining the customer.

It should also show how your product will evolve over time, and how you plan to continually invest in business expansion.

A sensitivity analysis is also a useful addition.

This analysis of how projections change under different scenarios helps investors understand the risks and uncertainties of your predictions, particularly when your model relies heavily on a few key assumptions.

One key aspect of a financial model is that it tells a compelling story.

This narrative should paint a vivid picture of your company's potential growth and profitability, aligning seamlessly with the main points of your pitch.

It's important to remember that simplicity is key, especially for early-stage startups, and any unnecessary complexity should be avoided.

As you build your model, remember to keep your audience in mind. Different investors have different needs, depending on the company's stage and the type of funding being sought.

Make sure your model addresses these needs by providing relevant information.

A well-organized, clean, and regularly updated financial model indicates professionalism and attention to detail, which helps to build trust with potential investors.

It's also a good idea to have your model reviewed by a financial professional or experienced entrepreneur.

They can help identify weaknesses, suggest areas for improvement, and ensure that your model is logical and coherent.

Finally, your financial model is just one part of your fundraising efforts.

It should work hand-in-hand with a compelling pitch deck, a well-prepared executive summary, and a solid team to present a unified, credible front to potential investors.

How to effectively present your financial model to investors?

Effectively presenting a financial model to investors requires clarity, precision, and an ability to communicate complex information in a digestible manner. Start by adopting an empathetic mindset, imagining yourself in your investors' shoes.

Aim to craft a model that not only suits your needs but is also precisely what your audience requires.

Here are a few tips on how to do this:

1. Adopt clear and simple language: Keep jargon and technical terms to a minimum. Make your financial projections and assumptions easy to comprehend, allowing investors to quickly grasp your business's potential.

2. Narrate your growth story: Your financial model should offer a compelling narrative about your company's potential growth and profitability. Illustrate how your company is primed to capitalize on market opportunities and generate profitable returns.

3. Highlight key performance drivers: Draw attention to significant indicators of your financial performance such as revenue growth, gross margins, and customer acquisition costs. Ensure these are easy to find and interpret in your presentation.

4. Showcase your unique value propositions: Detail what makes your business stand out from competitors and how these unique attributes drive the projections and assumptions in your financial model.

5. Use visuals to explain complex data: Incorporate charts, graphs, and other visual aids to simplify the understanding of your financial projections.

6. Prepare for investor inquiries: Be ready for questions about your model and respond clearly and concisely. Maintain transparency regarding assumptions or uncertainties in your projections, and clarify how you arrived at your figures.

7. Exhibit confidence and flexibility: While it's important to stand firm on your projections, remain open to feedback and demonstrate a willingness to refine your model based on investor feedback or new information.

8. Demonstrate real-world results: If you have historical data supporting your financial projections, use it to validate your predictions, showcasing that your company has already achieved a measure of success.

9. Discuss risks and uncertainties: No model can predict the future with absolute certainty, so identify potential risks and uncertainties upfront. Use sensitivity analysis to illustrate how projections might vary under different scenarios. This not only demonstrates that you have a solid understanding of the business landscape but also helps investors comprehend potential investment risks.

Your ultimate goal is to build trust with potential investors by demonstrating your company's potential. Being clear, concise, and transparent can significantly boost your chances of securing the necessary funding to scale your business.

Common mistakes that entrepreneurs make when creating financial models for fundraising

There are several common mistakes founders make when creating financial models for fundraising.

Here are a few:

1. Over-optimism: One of the most common mistakes entrepreneurs make is being overly optimistic in their financial projections. This can be due to a lack of understanding of the market, competition, or the industry or simply because the entrepreneur is too excited about the potential of their business. Investors are looking for a clear and achievable path to profitability, so being overly optimistic can make it difficult for them to take your projections seriously.

2. Not including enough detail: Another common mistake is not including enough detail in the financial model. Investors want to see detailed and relevant information, such as customer acquisition costs, gross margins, and other key metrics, to help them understand the critical drivers of your company's financial performance and growth potential.

3. Not including enough analysis: A financial model should provide a clear and coherent story, but entrepreneurs sometimes make the mistake of not having enough research and analysis. They may give the projections and assumptions but don't explain how they arrived at them. Investors will want to understand the underlying assumptions and drivers of the predictions.

4. Lack of sensitivity analysis: As mentioned before, sensitivity analysis is a powerful tool that allows investors to understand how the projections change under different scenarios. Entrepreneurs may sometimes make the mistake of not providing this type of analysis, which can leave investors uncertain about the robustness of the projections.

5. Not presenting a clean, up-to-date, and well-organized model: A well-organized, clean, and updated financial model shows professionalism and attention to detail, which can help establish trust with potential investors. Entrepreneurs may make the mistake of not taking the time to make their financial model as polished and professional as possible.

6. Not tailoring the model to the audience: Different investors will have different information needs depending on the stage of the company and the type of funding being sought. Entrepreneurs may make the mistake of not tailoring the model to their audience and not providing the information that is most relevant to them.

7. Not having the model reviewed: Before presenting it to investors, it's a good idea to have it reviewed by a financial professional or experienced entrepreneur. Entrepreneurs may neglect this step and present a model that has mistakes or is not coherent.

Remember, a financial model is an integral part of the fundraising process, and making these common mistakes can undermine the model's credibility and ultimately decrease the chances of success in raising funds. The best way to avoid these mistakes is to work closely with a financial professional, be open to feedback, and be willing to make adjustments as needed.

Summary

In this post, we have discussed the benefits of financial modeling for startups.

We highlighted how financial modeling could provide investors with a clear and compelling picture of the business's financial situation, goals, and potential.

We also discussed how financial modeling could help startups communicate their story more effectively and secure the funding they need to bring the business to the next level.

Whether you are just starting out or looking to take your business to the next level, financial modeling can be a powerful tool to help you make informed decisions, manage risk, and reach your goals.