Will Investors Believe Your Financial Projections?
It’s your first year of operating and you are focused on product/market fit. You have begun having initial discussions with investors and they keep asking for financial projections for the next few years. What? They expect you to predict what your sales will look like before you figure out your customer segmentation, pricing, and sales strategy??? I know this often frustrates founders, but seeing the assumptions behind even a very rough projection is a great way for investors to understand how you plan to build the business. It’s also a great process to help you think through your own growth strategy.
Before you get started, I wanted to highlight a few unrealistic assumptions that sometimes end up in your financial projections.
1. Your new salespeople will hit their sales quotas immediately
I sometimes see aggressive sales targets that do not align with a company’s hiring strategy and time required to get salespeople up to speed. This is especially concerning when I see very early stage companies that haven’t found product market/fit predict that they will hire a salesperson in a couple of months and have that person selling and closing deals after a short training period. First of all, if you are a Seed or Pre-Seed company you will most likely be focused on product/market fit, not a scalable sales strategy which means you will not be setting up a sales team with aggressive quotas. You can read more about this in the blog Finding Product/Market Fit.
If you have hit product/market fit, it still takes 6–9 months, on average, for a salesperson to become fully productive. Target quotas for new salespeople could look something like 0%, 0%, 25%, 50%, 75%, 100% in the first 6 months.
2. You expect no employee turnover
Hiring the wrong person for your company or hiring a person that is not right for the company’s stage is common especially if it’s your first time building a sales team. Including employee churn in your financial projections will make them more credible, and it will help you manage your capital requirements. In order to include this assumption in your projections, you will need to scale back your sales and revenue numbers or increase your costs, assuming you will hire additional people with the expectation that not all will stay.
3. You have developed a great product so you won’t have a long sales cycle
I have seen financial projections that show marketing and sales efforts in a month convert to customers in that same month or the next month. It’s safe to assume that your sales cycle will be longer than you expect, especially when you first start selling your product. Ensure your financial projections reflect a realistic time to close.
Implisit (acquired by Salesforce) analyzed hundreds of companies and found that, on average, the conversion time from lead to opportunity was 84 days and opportunity to lead was 18 days. So according to their research, the average sales cycle from lead to close is 102 days.
4. You already have great feedback on the product so customer conversion rates will be high
I highly recommend reading Predictable Revenue: Turn Your Business Into A Sales Machine With the $100 Million Best Practices Of Salesforce.com. The book helps you understand how a sales pipeline works and suggests a team structure to move your potential leads through the marketing and sales pipeline. This is important because your forecasted conversion rates should be based on a well thought through plan of moving customers through a sales pipeline.
Implisit (study above) found that on average 13% of leads convert to opportunities and 6% of opportunities convert to deals. This means the average conversion rate from lead to closed is 0.78%.
Forester studied pipeline conversion rates for B2B businesses in 2012 and found the following:
- 32% of leads convert to market qualified leads (MQL)
- 32% of MQLs convert to sales qualified leads (SQL)
- 28% of SQLs convert to the sales pipeline
- 26% of those convert to customers
Forester found that the average lead to sales qualified lead conversion rate was 10% and 0.75% of leads convert to customers. In Startup Management Best Practices #3: How to Structure a Sales and Marketing Team, Tomasz Tunguz talks about an average qualified lead rate of 7%. In The 7 Factors to Consider When Pricing Your Startup’s Product, he found that an inside sales person that is selling contracts with an annual value of $5k-30k can handle closing 3–8 transactions per month.
I know I have thrown a lot of averages at you. These are only meant to help you sense-check your sales projections. Every business is different, so you need to think through what numbers are realistic for your business. But take time to understand what typical sales metrics look like for businesses like yours. Investors will have seen other companies like yours and will be using those companies’ actual performance to sense-check your projections, so make sure you do it first.
In The 5 Hows, I mention how important it is for a founder to know how they will execute their vision. Having well thought out financial projections will go a long way towards demonstrating that you do.
