How to Build Your First Startup Financial Projections That Pass Investor Scrutiny

Three years ago, I was working on my financial projections in a small cafe. While I was at the cafe, waiting for an investor to join me, I was sweating profusely over my spreadsheet, on the verge of a heart attack while I tried to decide what metrics to assign to my company’s projections. I remember thinking to myself that I had figured out everything I needed to know and then when it was time for me to present my numbers to the investor, I froze at the question about my company’s customer churn, as my numbers were just random guesses that I had compiled and labeled as calculations. It was then I realized that investors want to see your potential product; however, they are ultimately measuring your ability to present yourself and understand how to run your business.

 

The Problem: Most entrepreneurs treat financial forecasting as an item they need to complete when preparing their pitch, which can lead to inaccurate/manipulated representations of their startup’s performance that crumble, with little to no indication of due diligence being conducted.

 

The Constraints: There is limited historical data, the founders have no experience in estimating the variables used in forecasting and they have competing objectives of wanting to achieve significant/expansive levels of growth versus just having enough cash to continue to fund their business during that growth period.

 

The Solution: To create a developing/expanding-model financial plan that focuses on being logically sound rather than accurately estimated, which will allow for better understanding of how your business operates financially on a real-time basis.

 

Prerequisites and Context

 

To create a successful financial model for a startup seeking seed funds, be proficient in the use of Microsoft Excel or Google Sheets. Although you do not need to be a CPA; you do need to have an understanding of the relationship between your Income Statement, Cash Flow Statement and Balance Sheet. Also, ensure that you have created a comprehensive unit economics (Customer Acquisition Cost (CAC) and Lifetime Value (LTV) and completed a thorough management hiring plan and you have pinned this information on your whiteboard.

 

Why Investor-Ready Financials Are Your Startup’s First Product

 

Your financial projections will ultimately demonstrate to potential investors their confidence and/or lack of confidence that you are truly competent in running a successful business.When your numbers don’t add up, investors think your business won’t run. It’s not enough to show a steep increase in growth; you must demonstrate your understanding of how to build a business.

 

Building a Robust Startup Financial Model for Seed Funding

 

Defining Your Revenue Streams and Growth Assumptions

 

First, break your revenue into logical pieces. As a SaaS provider, do not report “Total Revenue,” but report customer segment, price point and average “churn.” Use a revenue forecast template to ensure you include a timeline for how long it takes to acquire a customer. Your assumptions about how fast you will grow need to be tied to your marketing spend versus some arbitrary/monthly percentage increase.

 

Structuring the Expense Projection for Startups

 

When you create expense models for startups, split your expenses into fixed and variable expenses.

 

• Fixed Expenses: rent, software subscriptions, and base salaries.
• Variable Expenses: server expenses, credit card transaction/processing fees, and selling commissions.
• Visualizing the Spreadsheet: Picture an area where each row in the table is an expense category and each column is the month during which the expense will occur. Group the expense type together so you may see exactly where your money goes as you grow.

 

What Didn’t Work For Me

 

In my earlier days, I made the mistake of modeling from the “bottom-up” without regard to the “top-down” reality. I thought we needed 20 engineers in the first six months to develop a product, and I completely disregarded how long it takes to recruit, onboard and train new staff.Before the launch of my company, I experienced a significant spike in my burn rate. I learned the lesson that you must always align your hiring plans with your revenue growth rates.

 

Translating Operations into an Income Statement for Pitch Deck

 

Your income statement for your pitch deck should be a simplified version of your complete financial model. The income statement must tell a story that indicates profitability.

 

Forecasting Monthly Revenue and Cost of Goods Sold (COGS)

 

Pay attention to your COGS. Most founders do not consider COGS, however, when your investors are asking about your gross margins, they will want to know your COGS as well. When selling software, COGS includes the hosting and support for your customers. When selling hard goods, COGS includes the cost of manufacture and shipping.

 

Calculating Your Cash Burn Rate Calculation and Runway

 

Your monthly cash burn rate is the most critical factor for your survival as a company. Your monthly cash burn rate is determined by subtracting your monthly revenues from your monthly operating expenses.

 

• The Formula: Total Cash at Start – Total Cash at End / Number of Months
• Visualizing the Trajectory: Imagine the graphical representation of your banking position over time; on the X-axis (time), and your banking position on the Y-axis; the slope of the line is your burn rate. If the line hits $0 before your next funding round, you need to be concerned.

 

The Art of the Break-Even Analysis and Sensitivity Testing

 

Identifying Your Break-Even Point in Units and Dollars

 

A break-even analysis allows you to specifically know how many units you will need to sell in order to cover your costs. Your break-even analysis is the number of subscribers you will need to cover your rent and salaries – which is a specific, actionable goal.

 

Stress-Testing Assumptions: The “What-If” Scenario Planning

 

Investors always love to ask, “What happens if your CAC doubles?” Be sure to have a sensitivity analysis or “what-if” scenario table prepared to respond to the following:

 

• Scenario A (Base): 10% growth, $50 CAC
• Scenario B (Stress): 5% growth, $100 CAC
• The Impact: Show the subsequent impact of these changes through to your net profit. This will show they have taken the risk of your assumptions into account.

 

Beyond the Numbers: Cap Table Basics and Equity Dilution

 

Mapping Ownership Stakes and Future Dilution

 

Knowing cap table basics is absolutely crucial. You Must Know who owns what percentage of the Company and how much you will be giving away. Each time you raise money, your percentage of ownership will go down. This is known as dilution.

 

Aligning Financial Projections with Your Cap Table

 

Your financial model should drive the strategy for your fundraising. You can now calculate how much equity to sell based on how much funding it will take to get you to the next milestone. Use a standard cap table guide to make sure you’re not giving up too much too early.

 

The “Investor Blind Spot”: Accounting for Undocumented Contingencies

 

Why Standard Templates Fail During Due Diligence

 

Most templates assume “everything goes right” and that there are not going to be many legal expenses, compliance issues, or unforeseen pivots. You will typically find that legal costs, compliance issues, and unforeseen pivots constitute the reality of your “services” – that is, the reality of what constitutes as startup companies.

 

Incorporating “Hidden” Costs: Legal, Compliance, and Pivot Buffers

 

Always add a contingency line item to your budget. I typically recommend adding 15-20% to your total opex in order to accurately account for the “unknown unknowns.” Doing this demonstrates to your investors that you’re a realist, not just a dreamer.

 

Frequently Asked Questions

 

How far into the future should my seed-stage financial projections extend?

 

18-24 months is the target. This is enough time to get you through to your next major raise (Series A).

 

What is the most common mistake founders make when presenting a revenue forecast template to VCs?

 

The biggest mistake that founders make is hockey-sticking their revenues without showing any corresponding increase in their marketing dollars or employee headcount. This looks inaccurate.

 

How do I justify my growth assumptions if I have no historical data?

 

Utilize industry benchmarks. If you are a B2B SaaS company, you can review average growth rates of other similar companies at your same business stage. Cite the sources of your benchmarks to increase credibility.