- Keep it simple, stupid
- Understand your KPI's
- Talk to friends
- Cross check
Do I need a financial model?
At Forward Partners, we invest across Idea and Seed stages. The Idea stage can sometimes be referred to as the “PowerPoint stage”, which begs the question – do I need a financial model?
While at the earliest stages, where your MVP may have not even launched into the market, the need for a model is not always less obvious. However, the process of creating a model forces additional structure to your thoughts and, in many cases, can unearth questions that you hadn’t thought of.
Keep it simple, stupid
Financial models have the odd capability of taking on a life of their own. What begins as a simple representation of your business, gradually becomes a trumped-up 25-tab monster as you try to capture every nuance. While this finessing can be a strangely satisfying process (just me, then…?), it’s important to focus on the basics.
In an environment where the average VC spends less than 4 minutes reading a pitch deck, you have already done tremendously well to get someone to spend time looking at your model. Therefore, it’s important to keep the model as user-friendly as possible – here are a few classy tips that should help:
- Size: Try to keep the model lightweight and the number of tabs to a maximum of 3-4. Any more, and the model can become cumbersome and confusing;
- Complex formula: Sometimes they are inevitable, but they can limit the ability to trace the flow of your model. There are no prizes for excel wizardry, so split out those complicated formula into multiple lines;
- Assumption tab: Particularly relevant for a slightly larger model – by consolidating all drivers into 1 tab (and linking from it), you enable users to easily play with your assumptions;
- Colour code: By including a simple legend (and sticking to it!), like the one below, you make it very easy to distinguish which cells the user should focus on.
Understand your KPI’s
For any given company, you can likely pick out 10’s, if not 100’s of KPI’s. However, the purpose of the model is not to pick apart your business to this granular level – instead, it’s about identifying the 3-4 that are truly fundamental to your business. Definitely check out Claire Faquier’s classy guide to some of those relevant to subscription and eCommerce businesses.
Once those KPIs have been identified, you should understand their historical evolution and craft a story around how you’ve projected them. Why does CPA halve next year? Why does conversion rate triple over the coming 18 months?
Talk to friends
The more time spent working on a model, the easier it becomes to build a huge wall around it, and the more difficult it becomes to spot problems. It is always worthwhile having someone fresh take a look at it, whether that be a colleague, a friend or family. This is a particularly useful exercise to identify mistakes, but also to ensure that they are able to intuitively understand the flow and structure.
Models are built bottom-up, looking at the small levers within your business that effect the top and bottom lines. Once you’re happy with your outputs, an invaluable exercise is to crosscheck with macro information. Have you projected £500m revenue in 2019 in a market that is expected to be £400m?
Finally, ensure that your model ties in with your pitch deck. Costs should match the % split you described. And, if you have said that you are raising £1m to last 18 months, make sure you don’t run out of cash in Month 14!
As an old boss used to say to me, “The only thing I can guarantee is that your model is wrong”. And this is a fact accepted by most investors. It is very unlikely that you will be held to your projections (and should raise alarm bells, if someone views this as a requirement).
Instead, the financial model is just one part of a broader picture of the company. Most investors are looking to confirm that the founder has a logically thought process about the individual components of the business, has an understandable flow, and knows the key drivers behind building long-term value.