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Forecasting Like Goldilocks

Sean Dowling
August 6, 2013

Last week I participated in a panel for the GoodCompany Ventures accelerator program.  We represented the final topic for the summer, which focused on two key aspects of the investor presentations each of the entrepreneurs were preparing for Demo Day: financial projections and the fundraising ask.  As I tried to put myself in the shoes of the audience, it struck me that the advice from the panel could be viewed as somewhat contradictory.  One panelist made the good point that an introductory deck or Demo Day pitch should only seek to whet an investor’s appetite, not secure a check on the spot, and as a result should offer an exciting enough vision for the future of the business to warrant a second conversation to explore those projections more thoroughly.  However, I countered that those projections can’t look too rosy, as that could undermine the entrepreneur’s credibility about what is required to build a business; creating a company is hard, and an estimate that suggests $50M of revenue by year three raises some questions about management’s business acumen.

To the entrepreneurs in the audience, it must have sounded like the investors on the panel wanted them to be like Goldilocks, in search of projections that are just right.  The message: don’t try to sell us cold, unexciting “conservative” estimates, but also don’t serve up a bowl of projections that are overheated with unrealistic assumptions.  We look for the right blend of realism and optimism, and are far more interested in how you think about the path toward success than your revenue in year five.  Finding that balance is admittedly difficult to strike early on, as financial projections rely almost entirely on hypotheses and assumptions that can only be tested and refined with experience in the market.  To use the cliché, the only certainty about a financial model is that it won’t be correct; businesses face far too many unknowns to project the future five years out, and only trouble awaits if you allow the conversation to focus on 2018.

Instead, use the financial section of an investor meeting to achieve four objectives (always keeping in mind that the goal early on is to secure the next meeting, not a check).  First, demonstrate that you truly understand the drivers of success for your business.  Outline the critical assumptions that will determine your fate, and link your financial projections to your fundraising ask to demonstrate how you will use the capital to achieve specific milestones that validate the hypotheses underlying those assumptions.  For a Series A investment, we care far less about the actual numbers than the thought process used to arrive at them, and will want to grow comfortable that you will be able to adjust the plan in a reasonable way as you learn.  Second, rather than use the slide to talk primarily about the potential in year five, focus more on what falls within your control; consider presenting specific financials for just the next 12-18 months, which is the time horizon that will be most relevant to your investors (we typically invest based on a belief that our capital will provide a company with at least 18 months of operating runway).  While you will need to adjust the level of detail for the situation, limiting the conversation to this much shorter time window minimizes the risk of setting unrealistic long-term expectations that may come back to haunt you and allows you to have a more relevant discussion.  Third (and again that issue of striking the proper balance arises), offer an indication of how the business will operate at some level of meaningful scale (for enterprise software businesses like those OVP invests in, that is around $20M of revenue), including gross margins and operating expenses.  Fourth, to tie the pieces together, provide a rough order of magnitude estimate of the lifetime capital required by the business to reach that level of meaningful scale, to show both that you recognize the resources required to build a company and to offer some insight into your philosophy on capital efficiency.

Like Goldilocks (well, minus the threat of being eaten by bears, although some entrepreneurs might view investor pitches that way), entrepreneurs should build a set of financial projections that are just right: optimistic enough to generate excitement about the potential upside of the business, but grounded in the reality of the challenges associated with and resources required for achieving that upside.  If you can do so, you may also find some investors willing to write you a check that could cover a new chair or two (and the people to fill them).