I talked in my last post about the value of numbers in running your business. For many entrepreneurs financial information looms largest when they prepare a business plan. I am still looking for as many people as possible to share your opinion on both these challenges –– final reminder I promise.
Some sort of financial forecast is integral to any startup business plan. There is no need to explain to founders why this matters. A good business plan can be the key to unlocking investors' wallets. I meet a lot of entrepreneurs who are focused on this stuff. Yet more often than not, they are a bit sheepish when it comes to the numbers.
In the glory days of amateur rugby the spirit of the game sometimes overcame the urgency for results. At these rare moments, Bill McLaren sometimes used to quote a mythical Irish wit “the situation is desperate but its not serious.” (See origin)
Financial forecasts in startup business plans remind me of this philosophy. A set of financial projections is essential to the whole fund raising process. But in truth they don’t count for much. Investors make decisions based on the team, the market size, the level of innovation/ disruption and maybe the business model.
Financial forecasts - why bother?
There is a good reason that financial projections don’t figure high on this list. In early stage, innovative businesses, the link between forecasts and reality is pretty tenuous. The business has no track record to act as a guide. The risk of failure is overwhelming. Most VCs and angel groups invest in 1-3 out go every 100 business plans. Then expect only 1 in 10 of those to succeed. No-one has the expertise or experience to beat these odds.
Investors talk all the time about being risk takers. And they are but that is not a good paradigm for how the process works. The key factors in any investment decision are all about reducing risk. The best chance of success lies with having a great founding team. A huge market also reduces the risk of failure. And so on.
Nonetheless, preparing a set of financial forecasts is an essential part of the process. You have a choice. Get lost in the process and pray that no-one asks about your numbers. Or use it as an opportunity to think about your business plan and enhance your credibility.
3 ways your business plan numbers are different
The way to tackle this is not to think about getting the forecast right. It will be wrong - get over it. These numbers are different for three main reasons:
The Chairman's view
The key to business plans is not precision. It is storytelling. A good financial forecast is driven by the business plan. The revenue numbers reflect the market opportunity and the sales model. For example, enterprise SaaS leads will take a lot longer to turn into revenue than SMB free trials.
Cost calculations are the same. Once you explain your business model, the structure of the cost base should be clear. Your audience will know where their money is going to be spent.
More important, investors want to see how that translates into growth. Its like filling up a car. Easy to do but hopeless if you don’t know where to find the accelerator pedal.
A lot of entrepreneurs take professional advice when producing a business plan. Nothing wrong with that. Remember you are not selecting for technical skills. These are important but easy enough to find. You pick a designer than can make your story come to life in pictures, fonts and colours. Select an advisor that can paint your business by numbers.
The startup world is all about the future. Founders talk about creating the future. Seizing the opportunities of a golden age. Never been easier to start a company. So you might ask, why bother investing time and effort in past performance?
Those board reports feel as if they are nothing but a mechanism for keeping investors and non exec directors happy. Annual accounts are even worse. They feel like ancient history. The numbers don’t make sense. For certain they don’t shine a positive light on the great things your company is doing.
Its all pain and no gain. Yet this misses some important point. Here are four simple reasons why that thinking is wrong. This stuff matters.
“I had also, during many years, followed a golden rule, namely that whenever published fact, a new observation of thought came across me, which was opposed to my general results, to make a memorandum of it without fail and at once; for I had found by experience that such facts and thoughts were far more apt to escape from the memory than favourable ones.” Charles Darwin
Four lessons from history
Any of these is a good enough reason to get some consistent reliable metrics about your SaaS. What about accounting numbers though. Aren't those for the birds?
Accounting rules are relevant
In some respects yes. The rules vary from country to country. Part law and regulation, part accounting standards. Accounting standards in turn are half local and half international. All before you get to the interpretations of well paid professionals (like what I used to be).
It can be quite hard to understand the story published accounts are telling. That is not a good reason to discard this data altogether. For a start standardisation and rules are limiting but also useful in some cases. Investors like comparing numbers. Knowing they are all prepared to the same standards adds a lot of value. And you need to be able to convince investors.
Most angel investors don’t make a big deal over this. Take a longer view and the situation changes. VCs and corporate investors want to see proper accounting numbers. The same is true for or any form of exit - trade buyer, financial buyer or IPO. Tom Tunguz wrote a good article on this exact point. Published when the accounting rules for SaaS changed this year.
Not only that, they want to know how you get from the figures you look at every day to the formal accounts. When I did due diligence, one of the first questions on the checklist was “Have the management accounts been reconciled to the financial accounts?” Its still there.
So you need to ask yourself, what happens when someone appears with deep pockets. Do you want to present the numbers with confidence? Or scramble around delating diligence until you are ready?
The Chairman's View
So numbers matter. Get the right financial information and you can make better decisions. Use your numbers to present your business with more credibility. Yet preparing and managing this stuff is still a burden. And it can feel that there is very little help out there. I plan to change that. Share your opinion and be among the first to hear how managing financial information can be faster, easier and better.
Please share your opinion - Sunstone Financial Information Survey
Kenny Fraser is the Director of Sunstone Communication and a personal investor in startups.