Financial Models

Jason AltieriMember

Mintz Levin

Jeff KarrasGeneral Partner

Levensohn Venture Partners

2

“Plans are useless,

but planning is indispensable”

- Dwight D. Eisenhower

3

Company Perspective

• The VC Pitch Forces You to Hone Your Company’s Strategy & Economics

– Focuses your team on how the enterprise creates value– IDs metrics to gauge & guide your execution success– Enables you to determine how much investment capital is required - TODAY

• Revenue & Expense Forecasts Are CriticalYour business may be unique, your financial model is not– All forecasts are assumptions, the trick is to be reasonable– You will be expected to deliver: better to under promise and over perform– This document becomes the financial roadmap of the company

• Determines Valuation

• Establishes your Credibility as CEO – Must know the high level model– Must understand Cash Flow implications– Must know the key drivers & how they evolve with the plan

4

Venture Perspective

• Demonstrates mastery of business, company, and market• Baseline for board to measure management performance• Valuation of a company

– Comparable analysis

• VC Economics• Cash is Critical

– Top line revenue indicates pace of growth

– Cash indicates capital efficiency, VCs required commitment, and returns

5

Model Types

• Top Down (the 1% solution)– Market size down to sales revenue

• 10m users→.005% of the market →2k/user→$10m sales

• Credible?

• Bottom Up– Sales up to revenue

• 20 sales people – each selling 21 units/month at $2k/unit

• Credible?

6

Basics

• 5 year time horizon– First two help set cash flow expectations – Last three help define opportunity

• Income Statement • Balance Sheet• Cash Flow• High-level summary of the growth

7

Basics (cont.)

• Reasonable and defendable assumptions– Highlight key assumptions– Have assumptions on separate tab that drive the model– Assists in “what if” planning

• Some Key Assumptions– Price– Sales Growth– COGS

8

Line Items

• Rent/employee/month• Equip costs/employee/month• Benefits• Bonuses/Commissions

– Commission plan– What is it versus existing players?

• Payroll Exp/month– Capital raising often results in salary increases– Change in compensation mix with later employees– Less stock heavy more cash intensive

9

Line Items (cont.)

• Recruiting fees– Internal – $2-10k– External – 20-30% of first year package

• Contractors – Accounting function– H/R

• Customer acquisition costs• Legal• Accountants (post financing)• Unique business costs

10

Hints

• Headcount• Plan slow/run like hell

– Slower than expected• Hiring• Product development• Sales/revenue

– Higher than expected• COSTS

11

Hints (cont.)

• Investment capital is intended to fuel accelerated growth– Expectations vs. reality– This can kill a business before it hits its stride

• Economies of Scale– Bureaucracies rule (Amazon etc)– EoS – so old economy

• Magic revenue number?• Market share in year five

12

Model Input Sources for Startup CEOs

Venture Wire Deal size, competitive info, etc.

Metrics2.com Busy site, but great source of stats

InfoUSA.com Sophisticated contact list builder; build a list of your target market & get the count (you don’t have to buy it)

Trade groups Usually publish stat-rich reports that are very relevant

Salary.com Good geographically oriented compensation data

Analysts Analyst reports are filled with stats & business model data

Your Broker Research papers contain industry economics & an investor perspective

Friends, past & present colleagues, etc.

13

Forecast Example

ANY COMPANY INCOME STATEMENT

2005 2006 2007 2008Forecast Forecast Forecast Forecast

RevenuesProduct 1 150,000 1,350,000 4,900,000 9,800,000 Product 2 50,000 580,000 1,270,000 2,540,000 Maintenance 10,000 165,000 430,000 860,000

Total Revenues 210,000 2,095,000 6,600,000 13,200,000

ExpensesSales and Marketing 229,000 2,415,760 3,541,930 4,977,335 Exec, Fin, Admin, HR, Acctg 100,600 911,600 1,196,910 1,683,925 Engineering 168,000 1,023,000 1,590,000 2,226,000

Total Expenses 497,600 4,350,360 6,328,840 8,887,26030 38

145,012.0 166,548.4 Operating Profit (Loss) (287,600) (2,255,360) 271,160 4,312,740

Sales and Marketing 46% 56% 56% 56%

Exec, Fin, Admin, HR, Acctg 20% 21% 19% 19%

Engineering 34% 24% 25% 25%100% 100% 100% 100%

Year1 Forecast

Year2 Forecast

Year3 Forecast

Year4 Forecast

14

Financials for ongoing operations

15

Venture Perspective

• Communication vehicle with investors and shareholder

• Milestones for progress• Benchmarking company efficiency• Establishing track record

16

Company Perspective

• Models are Dynamic– Nothing ever works the way you thought– Reasonable models provide flexibility to adjust to reality

• Metrics (from Financing) Become Management Tools– P&L dials to flexibly deliver P&L goals– Health of the business indicators: ASP, sales cycle, ramp, payment & collections,

conversion rates, acquisition costs, etc.

• Numbers Allow You to Effectively Manage Your Team– They are not just your numbers– Useful tool for managers to prioritize

• Cross-Functional Communication– Tradeoffs– Forces Strategic Decisions

17

What happens if you don’t make your numbers?

18

Venture Perspective

• Another round quicker than expected• A bridge financing with unfavorable terms• More dilution to both existing investors and

management• Lost confidence from board• New CEO

Boards hate surprises!!!!

19

Company Perspective

Minor or First Miss:• Use the “miss” to realign for success

– Poor planning vs. execution, market acceptance or economic conditions• Focus on what is working &/or eliminate “waste”

Ongoing Misses:• Morale Suffers

– Recruiting gets hard– Employees leave

• Confidence in Management Erodes• Market Position is Weakened

– Early fundraising signals weakness– Competitors will raise concerns with prospects

• Board Support Diminishes– Boards hate surprises– Forewarned is forearmed

• Looking for a New Job

20

Top Ten Mistakes - VC

1. Presenting financials without ability to discuss detail if asked (while model are seldom reality, it demonstrates that the entrepreneur fully understands the full scope of the business)

2. Plan is overly optimistic. Revenue traction always takes longer. Must understand the sales qualification and challenges

3. Plan is overly pessimistic without clearly identifying upside 4. Revenue plan created solely to match the operational requirements5. Plan does not tie to pipeline, ASP, sales cycle, and ability to hire team6. Build plan to try and pump up valuation7. Failure to understand industry comparables and know the gross

margins, expense levels as a % of revenue, and operating margins 8. Failing to account for competition and its affect on prices9. Using the 1% of the market technique to justify opportunity (market size

usually off and most never get 1% of market)10. Entrepreneur does not understand cash implications and subtleties of

the timing of payments and receipts

21

Top Ten Things You Must Do - Company

1. Develop both a top-down and bottom-up plan2. Ramp-up of new staff must be realistic (including ramp-up and

availability)3. Quality, quantity, and stage of pipeline must be realistic4. Large deals and timeframe to close must be presented realistically5. Judgment needs to be applied to sales management6. In a small start-up, the CEO must know every major account7. Raise the right amount of money (What you need to deliver your plan

with a cushion)8. Working capital requirements must be carefully considered as they

impact CASH9. There are other ways to smooth out cashflow: AR lines, lease Lines,

debt, payables management, etc.10. Establish mentor/advisor relationships

22

Key questions that you should be able to answer

• How much cash is in the bank? • Forecast for the month?• What is the burn rate (Gross and Net)?• How long to cash flow break even?• How much additional cash will be required?• When will additional cash be required?• What will you use the cash for?