Preparing your company’s financial and business models is a lot like preparing a look book for real modeling. You need to make it compelling, eye catching, to the point, and get the deal done. Time is money, a model or designer bounces around to multiple go-sees a day to try and land a gig; while entrepreneurs can bounce around to multiple VCs all day to try and land funding. The look book is a representation of the designer or model’s career giving you an idea of what they are all about without showing you everything. Your financial and business models should do the same thing with a snapshot of your company.
When an entrepreneur goes for funding, he/she needs to present a financing package to its potential investors and understand all the detail and assumptions behind the numbers. The financial model is the key tool in arguing their views to investors. The VCs will have their own smarty-pants accounting analysts prepare their own models, but they are catalog level modeling compared to your runway experience level of modeling. Therefore, your experience in the field should make your assumptions behind the modeling more compelling. The VCs will create a funding structure element to their model, which will assist them in evaluating the funding terms. The management team should see how the VC’s ROI compares to their modeling scenarios and inquire what assumptions were made so they can compare to what they already have input.
To prepare a financial model for a funding round, you need to have these core elements, which are Assumptions, P&L statement, Balance Sheet, Statement of Cash Flow, Forecasts, and Key metrics. If you have accurate bookkeeping, then the P&L, Balance Sheet, and Statement of Cash Flow should be easy to generate straight from your general ledger system.
The presentation to potential investors requires due diligence on market size, growth, and unmet needs; value proposition; competition outlining strengths and weaknesses; a business model, which has assumptions, scalability, and key metrics; multi-year financial model; historical and future timeline of the business; investment rounds, returns, risks, and exit strategies; and finally the team and how they can make this happen. Investors have the mind set “actions speak louder than words” so do not have too much narrative or fluff in the presentation for funding. Show the investors a detailed financial model with the ability to test assumptions and sensitivity and to immediately see the outcome and how this startup is going to make them money.
Assumptions are key for forecasting the future position of the business. Use historical data or benchmarking of similar businesses to ensure your assumptions are believable. Assumptions vary based on your business model, but some examples of assumptions would be number of future users, percentage of users you will retain, how much money will you generate per user, new revenue streams, burn rate of expenses, etc. These assumptions are then plugged into the current reporting to generate multi-year financials to show what the future of the company will look like financially. It is important to create a model that allows you to play with the assumptions based on feedback received or new data that will impact the whole model.
Key metrics to keep in mind are ROE (return on equity), ROI (return on investment), Net profit margin ratio, Accounts receivable turnover ratio, Gross profit margin ratio, Debt to Equity ratio, and Working capital ratio, which indicates whether a company has enough assets to cover its debts.
Once you have your assumptions, key metrics, and financials prepared, it is important you have short-term and long-term cash flow strategies in place for the existing business and for the potential capital funding raised. Managing cash flow is an essential function in sustaining a business. Effective cash flow strategies assure that enough cash in on hand to meet financial obligations (e.g. payroll, suppliers, customers, credit, loans, inventory, or any capital expenditures) while maximizing financial return from excess cash.
The importance of the business and financial models does not end once the financing is complete. The management team should continue to work with it, improve and update it. As the business develops, the quality of the forecasting will become apparent. It is likely that the management team will be judged on their performance according to their forecasts so achieving milestones, identified in the modeling, will be an important factor in the relationship with the VC going forward. This will become a living document and part of the management’s toolbox for their management of the business.
So when going to a go-see make sure your presentation not only looks good, but that you can back it up with a killer catwalk.
