The earlier you are in your business, the more simple your financial model can be. And conversely, as you progress through your first 5+ years in business, you will be expected by investors to have a clearer understanding of the key drivers of your business and a deeper analysis of how historical performance ties in to your pro forma.
1. Best practices
- Assumptions - Make realistic and defensible assumptions, but don’t be “conservative,” especially in the out years. Investors will discount your projections themselves as they see fit, so you don’t need to do that part for them. The model should show what is realistically possible if you successfully fire on all cylinders. Remember, the power-law governs venture capital and the investor wants to know that you intend to build a massive business.
- Sensitivity tables - Use sensitivity tables if it helps bolster your story. I.e., “even if CAC is X we still reach profitability by Y date.”
- Stress Tests - Create multiple scenarios to estimate the upsides and downsides of key assumptions in your model, but don’t show them all upfront. Wait until you are asked questions and share them as fast follows.
- Memorize your KPIs and unit economics - Have a very clear understanding and presentation of your KPIs and unit economics. You should be able to easily break down the business into its unit economics and build it back up on the fly.
- Use of Funds - Be very clear on the use of funds from the fundraise. The investor wants to know exactly how this raise will be used to increase the value of their investment.
- Rule of thumb is before the Series A you likely don’t need a three statement model but for the A and after you should
2. Explanatory deck
Don’t assume investors have the same level of financial literacy as you and your team. Even if they do, they won’t be able to follow every detail right away. Don’t leave room for interpretation or misunderstanding and help them cut down on the time it takes to get up to speed on understanding your financials.
- Create a short explanatory deck/guide to accompany your financial model and provide a detailed description of each line item and KPI.
- Call out what is, and what is not, included in each line item.
- Explain in detail any line item, margin, or KPI that leaves room for negative interpretation — get ahead of questions in this case instead of waiting for them, because once an investor has your financials they may just jump to conclusions and move you to the “no” column instead of investing more time in back and forth with you.
3. Data room preparation
- Create a password protected data room on Box, Dropbox or Google Drive (Box is the one we typically recommend).
- Use a platform that allows you to see who is accessing the data room, how many times they have logged into it, and what was downloaded.
- This will help you understand their level of interest (if they haven’t been diving into your data room they can’t be that far along in their process despite what they tell you on the phone)
- This can be especially helpful if you get a term sheet or are getting very close to a term sheet. You can begin to put a little bit of pressure on anyone else that is demonstrating serious interest (evidenced by their activity in your data room).
- You should create an unique folder for each new investor that is looking at the data room and label it accordingly. Your materials will inevitably get updated as the process goes forward and its good to know exactly which version of each document that you shown to each investor
- Use simple, clear folders to delineate each section of the data room (e.g. financials, product, customer data, etc.)
- Include a table of contents in the folder that inventories each folder and item in the data room with short explainers
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