Financial Models

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Financial Models
Jason AltieriMemberMintz Levin
Jeff KarrasGeneral PartnerLevensohn Venture
Partners
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• Plans are useless,
• but planning is indispensable
• - Dwight D. Eisenhower

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Company Perspective

• The VC Pitch Forces You to Hone Your Companys
  Strategy Economics
• Focuses your team on how the enterprise creates
  value
• IDs metrics to gauge guide your execution
  success
• Enables you to determine how much investment
  capital is required - TODAY
• Revenue Expense Forecasts Are Critical
• Your business may be unique, your financial model
  is not
• All forecasts are assumptions, the trick is to be
  reasonable
• You will be expected to deliver better to under
  promise and over perform
• This document becomes the financial roadmap of
  the company
• Determines Valuation
• Establishes your Credibility as CEO
• Must know the high level model
• Must understand Cash Flow implications
• Must know the key drivers how they evolve with
  the plan

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Venture Perspective

• Demonstrates mastery of business, company, and
  market
• Baseline for board to measure management
  performance
• Valuation of a company
• Comparable analysis
• VC Economics
• Cash is Critical
• Top line revenue indicates pace of growth
• Cash indicates capital efficiency, VCs required
  commitment, and returns

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Model Types

• Top Down (the 1 solution)
• Market size down to sales revenue
• 10m users?.005 of the market ?2k/user?10m sales
• Credible?
• Bottom Up
• Sales up to revenue
• 20 sales people each selling 21 units/month at
  2k/unit
• Credible?

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Basics

• 5 year time horizon
• First two help set cash flow expectations
• Last three help define opportunity
• Income Statement
• Balance Sheet
• Cash Flow
• High-level summary of the growth

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Basics (cont.)

• Reasonable and defendable assumptions
• Highlight key assumptions
• Have assumptions on separate tab that drive the
  model
• Assists in what if planning
• Some Key Assumptions
• Price
• Sales Growth
• COGS

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Line Items

• Rent/employee/month
• Equip costs/employee/month
• Benefits
• Bonuses/Commissions
• Commission plan
• What is it versus existing players?
• Payroll Exp/month
• Capital raising often results in salary increases
• Change in compensation mix with later employees
• Less stock heavy more cash intensive

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Line Items (cont.)

• Recruiting fees
• Internal 2-10k
• External 20-30 of first year package
• Contractors
• Accounting function
• H/R
• Customer acquisition costs
• Legal
• Accountants (post financing)
• Unique business costs

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Hints

• Headcount
• Plan slow/run like hell
• Slower than expected
• Hiring
• Product development
• Sales/revenue
• Higher than expected
• COSTS

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Hints (cont.)

• Investment capital is intended to fuel
  accelerated growth
• Expectations vs. reality
• This can kill a business before it hits its
  stride
• Economies of Scale
• Bureaucracies rule (Amazon etc)
• EoS so old economy
• Magic revenue number?
• Market share in year five

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Model Input Sources for Startup CEOs

• Venture Wire Deal size, competitive info, etc.
• Metrics2.com Busy site, but great source of
  stats
• InfoUSA.com Sophisticated contact list builder
  build a list of your target market get the
  count (you dont have to buy it)
• Trade groups Usually publish stat-rich reports
  that are very relevant
• Salary.com Good geographically oriented
  compensation data
• Analysts Analyst reports are filled with stats
  business model data
• Your Broker Research papers contain industry
  economics an investor perspective
• Friends, past present colleagues, etc.

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Forecast Example
Year2 Forecast
Year3 Forecast
Year4 Forecast
Year1 Forecast
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• Financials for ongoing operations

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Venture Perspective

• Communication vehicle with investors and
  shareholder
• Milestones for progress
• Benchmarking company efficiency
• Establishing track record

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Company Perspective

• Models are Dynamic
• Nothing ever works the way you thought
• Reasonable models provide flexibility to adjust
  to reality
• Metrics (from Financing) Become Management Tools
• PL dials to flexibly deliver PL goals
• Health of the business indicators ASP, sales
  cycle, ramp, payment collections, conversion
  rates, acquisition costs, etc.
• Numbers Allow You to Effectively Manage Your Team
• They are not just your numbers
• Useful tool for managers to prioritize
• Cross-Functional Communication
• Tradeoffs
• Forces Strategic Decisions

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• What happens if you dont make your numbers?

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Venture Perspective

• Another round quicker than expected
• A bridge financing with unfavorable terms
• More dilution to both existing investors and
  management
• Lost confidence from board
• New CEO

Boards hate surprises!!!!
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Company Perspective

• Minor or First Miss
• Use the miss to realign for success
• Poor planning vs. execution, market acceptance or
  economic conditions
• Focus on what is working /or eliminate waste
• Ongoing Misses
• Morale Suffers
• Recruiting gets hard
• Employees leave
• Confidence in Management Erodes
• Market Position is Weakened
• Early fundraising signals weakness
• Competitors will raise concerns with prospects
• Board Support Diminishes
• Boards hate surprises
• Forewarned is forearmed
• Looking for a New Job

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Top Ten Mistakes - VC

• Presenting financials without ability to discuss
  detail if asked (while model are seldom reality,
  it demonstrates that the entrepreneur fully
  understands the full scope of the business)
• Plan is overly optimistic. Revenue traction
  always takes longer. Must understand the sales
  qualification and challenges
• Plan is overly pessimistic without clearly
  identifying upside
• Revenue plan created solely to match the
  operational requirements
• Plan does not tie to pipeline, ASP, sales cycle,
  and ability to hire team
• Build plan to try and pump up valuation
• Failure to understand industry comparables and
  know the gross margins, expense levels as a of
  revenue, and operating margins
• Failing to account for competition and its affect
  on prices
• Using the 1 of the market technique to justify
  opportunity (market size usually off and most
  never get 1 of market)
• Entrepreneur does not understand cash
  implications and subtleties of the timing of
  payments and receipts

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Top Ten Things You Must Do - Company

• Develop both a top-down and bottom-up plan
• Ramp-up of new staff must be realistic (including
  ramp-up and availability)
• Quality, quantity, and stage of pipeline must be
  realistic
• Large deals and timeframe to close must be
  presented realistically
• Judgment needs to be applied to sales management
• In a small start-up, the CEO must know every
  major account
• Raise the right amount of money (What you need to
  deliver your plan with a cushion)
• Working capital requirements must be carefully
  considered as they impact CASH
• There are other ways to smooth out cashflow AR
  lines, lease Lines, debt, payables management,
  etc.
• Establish mentor/advisor relationships

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Key questions that you should be able to answer

• How much cash is in the bank?
• Forecast for the month?
• What is the burn rate (Gross and Net)?
• How long to cash flow break even?
• How much additional cash will be required?
• When will additional cash be required?
• What will you use the cash for?