VCs try to consider many different criteria in their investment processes to assess startups. The attitude and energy of the entrepreneurs during the process, the competence of the team, investor presentation, product, competition, market size, past investment rounds, legal processes, the cohesion of the startup with the VC’s portfolio and investors, the potential to scale globally and many other criteria are very effective in making the investment decision. Another criterion that every investor wants to check is the financial projection. VCs usually request financial projections for 3 and 5 years. Especially in early-stage startups, it is almost impossible to accurately predict the financial situation in the 3rd year from the present day. So why does every investor review startups’ financial projections carefully?
The financial projection provides investors with quantitative information on many topics such as the startup’s business model, customer acquisition and revenue channels, and hiring and scaling plan. Entrepreneurs communicate many of these topics visually and verbally in their pitch decks. However, financial projections show these narratives on a mathematical plan, and being able to present a logical projection at this stage is a crucial indicator for investors. Financial projections are difficult to realize, especially in early-stage ventures. In an uncertain and challenging growth journey, scenarios can be much better or worse than the projections presented at the investment stage. This is the nature of venture capital investments. However, when reviewing these financial projections, investors pay attention to how well the entrepreneur knows their business, how realistic scenarios they can draw, how logical assumptions they can make on customer acquisition and revenue channels, how they focus on the team size and cost when the startup should proceed with a lean business model.
Below are three points that an entrepreneur should pay attention to when preparing a financial projection.
Be realistic: When creating your financial projection, don’t work on better-than-likely scenarios to attract investor interest. Base your assumptions on realistic calculations and create a financial projection accordingly. Especially for startups with no sales history, you can use the top-down method to project your revenues from the total market size with a market share that you estimate as a result of your sales and marketing actions. For startups with previous sales performance, you can use the bottom-up method to calculate your revenue based on your previous sales volumes and product prices. When making these calculations, instead of creating too optimistic or too pessimistic scenarios, create a realistic projection by accurately using industry, sales, and growth data you have. Remember; a realistic financial projection is also an important guide for you.
Make sure your financial projection matches your investor presentation: The first meeting with investors takes place through the pitch deck. This includes scaling plans, the amount of investment required, hiring, sales, and marketing plans. Your financial projections should be in line with what you told in your investor presentation, and in a sense, they should be a validation of your presentation. The cash flow resulting from your projections reveals your investment need for the runway you have identified. Employee costs in your expenses show the investment you will make in the team after the investment. What entrepreneurs say verbally and their financial calculations should match.
Specify your assumptions: Many unknowns come into play when creating a financial projection. Entrepreneurs try to make the right prediction about the future from the data they have. In making this forecast, different variables that are not in the hands of the entrepreneur, such as exchange rates, interest rates, and taxes, need to be taken into account. These variables should be reflected in financial projections based on certain assumptions by following macro and micro-economic indicators. These assumptions should be clearly stated in the financial projections. Thus, the investor can better understand the financial projections. It will be effective to examine the financial statements of your competitors whose financial information is publicly available while preparing your financial projections to improve your assumptions.
Paying attention to these three points will help you prepare healthier financial projections.