Run this fast check before presenting your hockey stick financial projections to investors!
Let’s face it: most startups say they are innovative and their business models will scale up following the omnipresent hockey stick curve. So, if you have founded a start-up and you only have a pitch deck with very nice sentences, pictures and graphs, your odds are not good.
We at Strata review more than 100 business plans and pitch decks per year. Focused on game-changing innovations as we are, most business plans are usually extremely aggressive. This article gathers a number of recommendations for game-changing disruptive startups and for all those that still believe in the “hockey stick power”.
My general recommendations are as follows:
- Be ambitious but realistic. It makes no sense to draw unreasonable sales and profit projections. Even if you are creating a new market or bringing an unprecedented innovation, your company would always be part of an “industry”. Research the industry and benchmark growth rates of similar companies in the past. It is unlikely that your start-up will outperform every previous company in the same industry.
- Be aligned with your funding strategy. A very common mistake of tech startups is to assume that they can create extraordinary growth with very limited funding.Rapid growth always requires funding. Establish a sound founding strategy that is aligned with your corresponding growth stages.
- Elaborate your hiring plans. In parallel to sales growth, you will need to scale up the team.Any savvy investor will carefully look into your hiring strategy because it is an extraordinary good signal of your real knowledge of the business processes and dynamics. Be as much detailed as possible with your hiring plans, at least for the next 5 years.
- Establish a solid busines model. Your business model might change in the future or adapt but, even if you are far from the market yet, you will need to make assumptions about pricing, margins and profits. Surprising as it may sound, we see too many start-ups that have no idea about their pricing strategy.
- Last but not least… build the P&L projections bottom-up, not top-down! Please, do not derive your sales projections from market size and an invented market share. Do the opposite! Estimate the sales dealflow (even per geography) and define sales ratios (conversion, churn rate, etc.). This together with the pricing strategy will make up a good sales projection.Market shares are usually irrelevant for most startups.
Once you have followed the previous general recommendations and you get your first financial drafts, your are ready to make some fine tuning! These are easy-to-do checks that you should run on your financials:
- Gross margin – COGS. There are typical ratios that apply to specific industries and business models. We rarely see businesses that break these ratios. For instance, it is unlikely that a manufacturing business will have a gross margin of 90% (nothing it’s impossible, though!).
- Gross profit per employee. This is a typical ratio that is miscalculated by start-ups yielding extraordinary high ratios in some cases. My recommendation: do your work and research your industry. Here are some good references to start with: “Revenue per employee in selected companies in 2019, Statista”, “The new metrics of profit company performance: profit per employee, McKinsey” or “Fortune 500 companies, Fortune”.
- Growth rate. Dodging industry average growth rates is challenging. Every company is affected by industry dynamics. If you work in agro-tech, even if your company is heavily tech-based, your sales cycle will probably be long and will affect your growth.
- Salaries. Looking at average salary estimations gives a very good idea of the management experience of team. An issue that is easy to solve by making a very fast investigation about salaries by industry and geography and accounting for the necessary overhead costs.
- R&D costs vs Operation Costs vs Sales cost. Extracting these ratios gives a very good overview of the business dynamics and of the experience of the management team. Very often, when the startup is heavily product focused, operation and sales costs are extremely underestimated. Again, make some research in your industry and vertical!
- Marketing costs. It deserves a separate individual bullet point as it is very common to see tech startups that almost neglect marketing costs. Marketing costs in many businesses surpass by far development costs! Even if you product is unique and wonderful!?
- ROI. Last but not least… Return on Investment. Needless to say, many startups provide unprecedented ROIs. This is tricky because if you want to attract investors you really need to provide a very high ROI. As you probably know, professional investors are looking at returns that multiply by 3 or 5 the investment, not because they are exceptionally ambitious but because according to experience many startups will fail and only if they have an exceptional success they will have any return. Therefore, my advice is to be aggressive but explain very well all the assumptions, opportunities and risks.
Counting with professional experience when making financial projections may represent the turning point in getting funding, especially if you are aiming for a significant round.
Good luck with your financials!