Multi-year financial predictions can feel like a waste of time for firms in their early stages. In this post, we’ll go through the strategies for producing the most reliable startup valuation possible, increasing your chances of getting funded and facilitating better judgment.
Forecasts of future profits are often seen as wishful thinking in the early stages of a startup’s existence. Imprecise, ill-defined, and a complete waste of time. Why then do we, as founders, keep copying and pasting the same Excel formula?
Despite our distaste for it, financial predictions are important because they let us see what the near and distant futures hold for our company. They make it possible for us to make the necessary adjustments and achieve optimal performance within a realistic financial framework. These must be computed before a pitch to investors, valuation, or deal can be made.
So how can we develop projections in the middle of all this uncertainty, and how do we ensure that they are meaningful? As well as convincing potential backers, your estimates must inspire confidence in the company’s founders and management.
In this article, let us focus on the essential processes that will ensure your early stage projections are strong, credible, and dependable.
Step 1: Make the most of your (likely limited) past experience
This is the starting point for everyone, but it bears repeating: any information, no matter how limited, biased, or imprecise, is better than none at all. Maybe start with a low budget of $50 to test the waters of advertising. Well, even if the buyer is a long-lost high school pal, you still need to make that initial sale. The sheer volume of contacted prospects and the shockingly high rate of early conversion show just how ineffective this strategy was. Although seemingly insignificant, these assumptions should be employed (or at least taken into account) when developing your bottom-up financial estimates.
This emphasizes why there is so much focus on testing and iterating for new startup companies: to ensure they get the most solid data on which to build their models for calculating business valuation. You can’t test and tweak forever, but it’s worth spending the time that you can to test your assumptions.
Step 2: Look at established norms in related industries
The viability, investability and valuation of your startup are heavily dependent on growth potential and final profitability margin.
Neither can be predicted with any certainty from a new venture’s preliminary financials, which is where familiarity with the industry comes in. There is likely to be a connection between your initiative and another sector where similar businesses already exist. You need to make an effort to learn the financials of these corporations. What is their rate of expansion, and how profitable are they currently? How (and how fast) did they get started?
These are going to be great references for your own startup projections, especially for your net and gross profitability.
Step 3: Make use of metrics appropriate for a startup
For a startup, expected expansion is highly influenced not just by the nature of the business itself and the rate of expansion in the sector, but also by the company’s current level of maturity. As a general rule, startups expand slowly at first, and then at a breakneck pace once they’ve found Product Market Fit (PMF).
When developing a business plan for a startup, it can be tempting to make wildly optimistic projections that leave investors questioning your sanity and competency. You may help prevent this by comparing your growth rate to that of other firms that are analogous to yours in terms of both stage and industry, or at least stage (having received a similar amount of investment, being about the same age, showing similar momentum, etc.).
Step 4: Limit your inquiries to two key elements.
Despite this, it is not uncommon to encounter crucial variables that, regardless of our depth of industry knowledge, can have a decisive impact on the entire model. Growth rate, primary conversion rate, repeat purchase rate, and customer turnover are all examples of these.
A minor shift in these factors can have a major impact. We may look at the average throughout the industry, but averages aren’t perfect either.
As a last resort, try not to worry about things. If you’ve done your homework, you should be down to just one or two variables that are both crucial and unclear at the moment. Fantastic; those are the assumptions you should test next, if at all possible.
Step 5: Make your model flexible and stress-testable
Financial projections are not all about the numbers; presentation and clarity are also important. Uncertainty is sown at the outset in a poorly described Excel with assumptions that are difficult to update or, even worse, hard programmed.
There is little to no impact on estimates from minor adjustments to most early stage assumptions. The startup is still expanding rapidly and making a lot of money. Without the ability to immediately understand the model and verify the difference, however, the result could be very different: no investment.
Maximizing the reliability of your projections requires a well-defined model with well-documented, easily-modifiable assumptions, such as a note or the formula used to derive them.
Step 6: Always seek out and evaluate comments
No one will expect you to know everything, even if you follow all these instructions. Get feedback from early investors and use it to improve subsequent versions of your pitch.
Investors’ (or anyone else’s who’s willing to provide you with feedback) cumulative input can be broken down into two distinct types:
Knowledge – This includes the person’s personal insights gained from their own experience. Their knowledge may have come through observation or study of the business world, new ventures, the community at large, successful fundraising strategies, etc. It’s important to collect as much data as possible so that you can refine your assumptions and plan.
Perspective – Feedback from a different viewpoint can also quite helpful. Both investors and your staff will view things from a different angle than you. Each person will interpret your predictions based on his or her own preexisting worldview. You may hear from a potential investor that your goals are too modest. This may seem excessive, but the reality is that they probably just need to see a higher rate of return before they’ll even consider investing. Remember to factor in as much information as possible when making estimates; your ultimate goal is to strike a balance between the “realistic” expectations of all stakeholders and the ambitious goals of the organization.
Step 7: Improve and act sensibly with each iteration
When you do this procedure thoroughly and methodically, you may realize that your aspirations have been severely limited. It dawned on you that you’d need to make $2 billion in sales in just six months, but now you’re starting to fear that it’ll take a lot longer.
Just don’t let this dampen your spirits. It is not the numbers themselves that are the issue, but rather the unrealistic expectations that people have of them. Even though the most successful founders were likely pessimistic in their predictions, their businesses grew faster than they had anticipated. The fastest rising companies’ growth rates are mind-boggling, though probably not as much as the Excel-only projections of some competitors.
Take advantage of this insight to fine-tune your tactics, presentation, and assessment. If you take the time to plan ahead, you’ll be able to make the kind of informed business choices that will lead to genuine results for your firm. Talk to one of our advisors at Credo CFO to learn more about a startup’s financial projections.
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