You need a financial model when you pitch VCs, now more than ever. Like it or not, venture capitalists’ risk tolerances have at least been slightly negatively affected by the horrific market conditions. While solid venture firms continue to make investments in startups (as proof, here is one of my European partner’s blog posts about Atlas’ recent investment in Inspiration Stores), everyone is subconsciously affected by the capital markets turbulence. In other words, venture capitalists want and need to make investments in promising technology companies… but when the market keeps falling by 300+ points day after day even the most risk loving investors can have dangerous conservative thoughts. You, as an entrepreneur seeking venture capital funding, can combat this by signaling to the VC that you will be a respectful steward of their investment. One of the best signaling factors you can create is through a realistic financial plan.
I am specifically addressing R&D/development stage companies - companies who will not have meaningful revenue for the near near term. I should also define financial plan - I mean a detailed spending plan for the next 2ish years, the period during which the funding will be used. Of course, if you will have revenue during this period of time you should also have a realistic plan for how and when you will earn this revenue.
A well formulated financial plan is a non-too subtle indication that you intend to be careful with the funds. While it might seem silly to have a financial model for a company without revenue, venture capitalists need to know where you intend to spend the money you raise from them. Help them check that pesky “where does the money go” box with an intelligent model.
The model will also help you get your thoughts and assumptions on paper. One of the better ways to begin crafting your financial model is to work backwards. Start with the milestones that you are trying to achieve with your fund raise (here is my post on the importance of milestones) and compute the resources you will need to hit them. Include all expenses that you can think of - employee expenses, capital equipment, rental space, any consumables, utilities, legal fees, travel expenses to conferences/meeting with potential customers, marketing, contractors, insurance, any sort of data licensing fees, recruiting expenses. Obviously show this to the VC in a neat, consolidated fashion, but have the details underlying for your own benefit and for the investor if/when they ask.
You model will help you and the VC understand:
- The amount of capital you will need;
- How long the capital will last;
- The use of the proceeds; and
- What you will have produced when the capital is starting to run out.
You will also need one of those pie-in-the-sky longer term revenue/profit models, the one where you “prove” that you will be bigger than the Ecuadorian economy in five years. But, that merits a whole different blog post…
