Monthly Archives: July 2013
“Don’t aim for success if you want it;
just do what you love and believe in, and it will come naturally.
~ David Frost
The Purpose of Financial Projections
When it comes to financial projections, there are two types of entrepreneurs: first, the “visionary entrepreneur” who considers financial projections silly, so she makes up numbers that look good to investors; second, the “intense entrepreneur” who develops an 10,000 cell spreadsheet that includes the number of licenses of Microsoft Office that he needs to buy in year five.
If you are the first type of entrepreneur, you run the risk that the investor won’t trust you with his or her money. This type of entrepreneur often alienates investors because of his cavalier attitude. If you are the second type of entrepreneur, you run the risk that the investor will think that you actually believe your projections.
When it comes to financial projections, however, there is only one type of investor: people who don’t believe your financial projections, whatever they are.
So what’s the right balance of vision versus detail? The point of financial projections is to tell a story with numbers-a story about opportunity, resource requirements, market forces, growth, milestone achievements, and profits. Your job is to create a numerical framework that complements and reinforces the vision you’ve painted with words.
The investor isn’t interested in the precision of the numbers, but he or she is interested in what the numbers say about the economics of your business, and what they say about your understanding of your business. The goal is to tell a credible, as well as exciting, story about what your business could become.
To be credible, your numbers have to make sense on the first review. If you are suggesting that your company will grow faster or be more profitable than any company in history, you will lose credibility. Your numbers must survive simple questioning:
- Do the capital requirements shown in your projections match the funding you are asking for?
- Do you know how many customers you have to land to generate the revenues you are projecting?
- Do you know how long it takes and how much it costs to acquire a customer?
- Do you know what resources will be required to support customers?
- Do you know how much you will have to spend to stay ahead of the competition with your product or service offering?
Why Have a 5-Year Financial Model?
The reason to develop a financial model of your business for five years going forward is to make explicit the driving factors behind your revenues and expenses as you pass through several stages of product development, market penetration, and organization growth. As they say, if you don’t know where you’re going, any road will get you there.
Most important, you need to show investors how you will grow your company from the bottom up-sale by sale, employee by employee-rather than building a model from the top down. No one believes that a model built on getting “only one percent of the target market” is a credible plan.
You won’t be presenting your operating plan to investors in your first few meetings, but you’d better understand how you are going to run the business once you raise capital. A well thought-out operating plan will reflect your ability to allocate resources-people and money-to the highest priority objectives.
Building from the Bottom Up
The problem with financial accounting, however, is that it forces you to present your numbers using big company functional categories, such as sales, marketing, engineering, general, and administrative. But startup companies really operate as projects, with most projects running across functions.
You need to run your company as a startup, but present your financials using the standard framework of accounting. That means that the details of your operating plan will reside in a model built around the activities required to achieve your critical milestones.
That way, when an investor drills into why you are planning to spend money the way you are, you can frame your answer in terms of business priorities and deliverable milestones, rather than saying something like, “Most companies spend 25% on sales.”
Still, building your operating plan from the bottom up based on projects you need to execute is challenging. We all over-estimate how much we can accomplish in a month. Make sure your projections are tempered by real world experience. You want to over-deliver during those early years, not under-deliver. You don’t want to have to ask for more money before you’ve proven what you promised to prove.
Two Final Tips
First, don’t call your projections “conservative.” We refer to this as Entrepreneur Lie #1. Investors want to see a bold plan that is well thought-out and realistic, if everything goes reasonably well. They don’t want to see a delusional plan. Your job is to show that you have tapped a team with the experience and insight to justify your bold optimism.
Second, model your company on other real world successes. You don’t have to make up your business model. You should be able to model your financial projections on companies that have been successful before. Use the S-1 IPO filings of companies with business models similar to yours to get an idea of what is realistic. If your projections are wildly different than other highly successful companies, then your assumptions are probably off.
Your operating plan and your longer-term projections will evolve. You should be constantly engaged in testing your assumptions and adjusting your actions as you learn. The trick is making sure you are always using your precious resources-people and money-most effectively, for the highest return, rather than letting inertia perpetuate activities and expenditures that are not productive.
It’s obvious, but it’s true: The number one cause of failure is running out of money. And the number one cause of running out of money is the failure to grow revenues faster than you are growing expenses.
As much as your investors may tell you, “We back teams,” they expect you to make money. If you deliver on your numbers, you will become rich and successful. If you fall short, you won’t. So as much fun as it is to paint an exciting vision, at the end of each month, you will be measured on your ability to deliver what you promised.
1. Professional Costs
Whether you’re setting up an LLC, a corporation or otherwise, you’re going to have to pay a fee just to move past the phase of conceptualizing your start-up by making it into a real, registered business. Countries differ on costs and registration procedures, but this is often the first check you’re going to stroke as you get your business off the ground. For Nigerian, yours is N10,000.
Your professional costs will expand and skyrocket from there: You’re going to need to shell out expenses for copyrights and patents. And, you’re definitely going to need an accountant and a lawyer at some point, and we all know how affordable those services are.
Another one of the initial startup expenses not to discount as you financially plan for your startup is the cost of designing, developing and hosting a website. A lot of people naively think that they can accomplish most of these technological feats themselves, and they can dream on. Designing, developing (and most importantly) efficiently hosting an e-commerce site to house your startup is no easy task.
Unless you have a fully-functioning, professional IT staff on board when you initiate your startup (which I’m guessing you don’t), you’re going to have to look into a qualified hosting company that can provide your site with the resources it needs to successfully get off the ground. This will likely include talk of servers, hardware, software, Web security, maintenance and further IT consulting.
And, don’t forget other tech costs like high-speed Internet access, printers, payroll software, cell phones, beepers and robots. Okay, just kidding about that last one.
It’s likely that you’re not going to forget about the fact that you’re going to be shelling out some money for advertising and promotion to effectively get your new business off the ground. But hear me out. There’s a chance you might not be factoring in quite enough funds in this department.
Sure, you know you’re going to want to place ads locally and nationally (who knows, maybe globally), and you’re probably going to be looking into paying for online advertising and SEO costs. However, common marketing expenses are often forgotten, like the fact that you’re going to be printing stationery, posters and other marketing materials. And don’t forget the cost of admittance to trade shows and industry events to get your name out there (as well as chamber of commerce membership fees and the expenses involved in joining industry associations). So I advice your to see a marketing consultancy firm or see a professional.
Public relations isn’t cheap, but investing in PR can take your business far, fast.
4. Administrative Costs
Little things add up, so take everything into account when budgeting for your startup expenses — right down to the purchase of paper clips and staples. Never mind the bigger expenses like desks, office chairs, filing cabinets, etc. Also, remember that administrative costs go far beyond office supplies to include licenses and permits, parking, utilities, rent and more.
Plus, if you want to really look professional, you’re going to need to invest in the proper packaging materials for your business (and don’t forget shipping and postage), which brings us to the next startup cost factor not to be forgotten.
5. Cost of Sales
It seems counterproductive to think of your startup’s first few sales as costing your business money; but that’s how it is when you’re just starting out. Raw materials are going to factor into the cost of your sales, and you’re going to have to beef up your product inventory in order to actually even make those sales.
If your startup is going big, then you’ll have to factor in warehousing and shipping insurance as well.
Don’t Freak Out
Take a deep breath and stop biting your nails. Now roll your shoulders a little and relax.
The above mentioned startup expenses shouldn’t freak you out and discourage you from accomplishing your startup dreams. But you should take note of them as you budget for the future of your business.
Every company’s startup expenses and costs may differ, but chances are you’ll be spending some time and money getting some of these facets of your nascent business in order. And if you do so mindfully — your startup will grow into a full-fledged, successful company. Like our face book page on https://www.facebook.com/Biztalksblogs
“We are all faced with a series of great opportunities
brilliantly disguised as impossible situations.”
~ Charles R. Swindoll
I wish I could just say that if you do X, Y & Z, you’ll magically raise millions of dollars for your venture. But unfortunately, that’s not how raising capital works.
One key reason for this is that most sources of money, like banks and institutional equity investors (defined as institutions like venture capital firms, private equity firms and corporations that invest), are essentially professional risk managers. That is, they successfully invest or lend money by managing the risk that the money will be repaid or not.
So, your job as the entrepreneur seeking capital is to reduce your investor or lender’s risk.
For example, let’s say that two entrepreneurs want to open a new restaurant.
Which is the riskier investment?
Entrepreneur A has put together a business plan for the new restaurant.
Entrepreneur B has also put together a business plan for the restaurant…and he has also put together the menu, secured a deal for leasing space, received a detailed contract with a design/build firm, signed an employment agreement with the head chef, etc.
Clearly investing in Entrepreneur B is less risky, because Entrepreneur B has already has already accomplished some of his “risk mitigating milestones.”
Establishing Your Risk Mitigating Milestones
A “risk mitigating milestone” is an event that when completed, makes your company more likely to succeed. For example, for a restaurant, some of the “risk mitigating milestones” would include:
Finding the location
Getting the permits and licenses
Building out the restaurant
Hiring and training the staff
Opening the restaurant
Reaching $20,000 in monthly sales
Reaching $50,000 in monthly sales
As you can see, each time the restaurant achieves a milestone, the risk to the investor or lender decreases significantly. There are fewer things that can go wrong. And by the time the business reaches its last milestone, it has virtually no risk of failure.
To give you another example, for a new software company the risk mitigating milestones might be:
Designing a prototype
Getting successful beta testing results
Getting the product to a point where it is market-ready
Getting customers to purchase the product
Securing distribution partnerships
Reaching monthly revenue milestones
The key point when it comes to raising money is this: you generally do NOT raise ALL the money you need for your venture upfront. You merely raise enough money to achieve your initial milestones. Then, you raise more money later to accomplish more milestones.
Yes, you are always raising money to get your company to the next level. Even Fortune 100 companies do this – they raise money by issuing more stock in order to launch new initiatives. It’s an ongoing process-not something you do just once.
Creating Your Milestone Chart & Funding Requirements
The key is to first create your detailed risk mitigating milestone chart. Not only is this helpful for funding, but it will serve as a great “To Do” list for you and make sure you continue to achieve goals each day, week and month that progress your business.
Shoot for listing approximately six big milestones to achieve in the next year, five milestones to achieve next year, and so on for up to 5 years (so include two milestones to achieve in year 5). And alongside the milestones, include the time (expected completion date) and the amount of funding you will need to attain them.
Example: Launch billboard marketing campaign over 6 months, spending $18,000
After you create your milestone chart, you need to prioritize. Determine the milestones that youabsolutely must accomplish with the initial funding. Ideally, these milestones will get you to point where you are generating revenues. This is because the ability to generate revenues significantly reduces the risk of your venture; as it proves to lenders and investors that customers want what you are offering.
By setting up your milestones, you will figure out what you can accomplish for less money. And the fact is, the less money you need to raise, the easier it generally is to raise it (mainly because the easiest to raise money sources offer lower dollar amounts).
The other good news is that if you raise less money now, you will give up less equity and incur less debt, which will eventually lead to more dollars in your pocket.
Finally, when you eventually raise more money later (in a future funding round), because you have already achieved numerous milestones, you will raise it easier and secure better terms (e.g., higher valuation, lower interest rate, etc.).
It might surprise you what you can accomplish with less money! So write up your list of risk mitigating milestones and determine which must be done now and which can wait for later, focusing first on what is most likely to generate revenues.