Startup Finances: Life on the edge
Join us next week for our last Meet the Entrepreneurs panel of the year. Hear successful entrepreneurs discuss the ups and downs of launching their social organizations. A demo pit will feature the latest social ventures working with the MaRS Centre for Impact Investing.
Last week at Entrepreneurship 101, speaker Dave Conte from Bright BLU Advisors tried to explain his job. He said:
“I go to work Monday morning and I look at the cash balance and I figure out if we run out of cash on Wednesday or on Thursday of that week. And then? I do something about it.”
Not everyone gets the same thrill out of growing a high-tech company and trying to project the financials. The cash coming in and out of your startup is like a heart pumping blood to different organs. You’re constantly asking yourself what organs you can live without.
If you’re part of a small team getting ready to launch a business, you know how important financials are. But what if no-one on your team excels at math, let alone can develop robust financial tools that show off your company’s special sauce to investors? Where do you start?
Michele Middlemore from MNP LLP and Aaron Bast from the MaRS Investment Accelerator Fund joined Dave at Entrepreneurship 101 to help answer these questions. They dissected the complex world of startup financials. They showed us how even the smallest teams without a financial background can develop a sound financial model that can continue to serve as a critical management tool as your assumptions turn into real experiences.
Let’s face it, it is difficult to forecast revenue for a business that doesn’t exist yet. Difficult, but not impossible. In fact, it’s done all the time. The trick is you can’t expect your model to be entirely accurate. A lot of guesswork and theoretical assumptions are involved, and the picture will change over time as you substantiate your business model. There are so many unknowns in early-stage businesses, particularly ones that are pre-revenue. Each speaker agreed that one thing you can count on with absolute certainty is that your forecast is going to be wrong. But your job isn’t to be 100% accurate—it’s to demonstrate that your underlying logic is based on reasonable assumptions that show a VC you know where the ship needs to go.
Start with a bottom-up approach
Saying you’re going to get 1% of an $X-million industry is meaningless to an investor. It doesn’t offer any indication of achievability. That’s not to say market research should be left out of your assumptions entirely. Investor Aaron Bast says that he finds this research useful because it gives him an idea of market trends, but he certainly wouldn’t base an investment on it.
Instead of hearing about market potential, investors want to know what is reasonably achievable with the resources you have. Although startups generally have no history of financial information, they do have unique data points to work with, be that beta customers, expressions of interest or industry benchmarks. You need to demonstrate a logical and thought-out plan. Make clear that your first-year revenue is coming from this group of customers and that you have these signed contracts to prove it. Explain that you plan to get X number of new clients next year and that you’ve got a sales funnel to prove it. Conveying data points in a clear, concise fashion will make a difference in getting a funder on board.
What great looks like
Whether your forecast is top-down or bottom-up, it needs to be flexible. Ask yourself what great will look like. If 20% more sales come in than anticipated, what are the associated costs with that scenario? Label that version great, and do the same thing if things were to go badly. If X% of your deals don’t go through, or payments are stalled, what fixed costs do you plan to reduce? Give yourself an upper limit of great and a lower limit of conservative to give your investors a sense of your company’s tolerance.
In the beginning, it’s all guesswork, but the exercise forces you to think through your business and come up with conclusions you think are reasonable on which to go and raise capital.
Getting investors from excited to aligned
A few things have to happen before you’re going to get a deal done—the VC has to get excited, there’s a “bunch of stuff that happens in the middle,” the VC gets aligned, you close the deal and you get your money.
The “bunch of stuff” that happens in the middle is the due diligence into your startup’s financials. Michele Middlemore advises startups to keep everything documented, organized and ready at a moment’s notice. Back-up what you can with purchase orders, written expressions of interests, emails—whatever you have that can support your assumptions.
Your ability to communicate how that data is relevant in growing your business is what takes an investor from excited to aligned. It’s a two-way dialogue. Throughout the due diligence process the investor will try to poke holes to see if you know what you’re talking about. After all, at the end of the day, it’s you they are evaluating. They want to know whether you’ve thought through the fine balance of measuring your runway, planned for surprises and hiccups, and tied it all together with your business plan. If you’ve done this successfully, the potential investor will be able to not only see the unique value offering of your product or service, but also trust that you’re the person to take it to the next level.
Watch the presentations
Watch the videos below to get a public, industry and VC perspective on startup finances.
Building a Solid Financial Model
A VC’s Perspective on Startup Finances
Entrepreneurship 101 course resources
And search “Entrepreneurship 101” on iTunes U.
Lisa Zarzeczny is the Manager, Entrepreneurship and Innovation Series at MaRS, where she oversees a suite of high-quality education programs to support the needs of entrepreneurs in Ontario and across Canada. See more…