Startup Finance: Build an Investor Ready Financial Model
We at Hammock recently hosted an evening workshop to help educate founders and individuals on the fundamentals of crafting a funding strategy and building a financial model from scratch (You can find more info about our event here).
I’ll start by acknowledging that there are plenty of free templates available online at startup communities and sites. Some are decent but most are either too specific to a vertical or too broad. No matter which template you start with, be ready to spend hours tailoring it to make it specific to your business and encompass the key information and metrics that are critical for your company. In the book Venture Deals by Brad Feld (a must-read for anyone going through fundraising), it emphasizes that if there’s one thing to know about model is that it’s always wrong. True, but building a model will help you understand the impact of certain internal decisions and external factors on possible futures. As an adviser to tech start-ups, I consider the financial model as a persuasive tool and logical framework that enables founders to communicate their growth plans to others and tie operational activities to key metrics.
This blog is organized into 4 sections and covers the following
1. Why do I need a financial model?
2. Principles of an investor ready model
3. Basic structure of an excel worksheet
4. Sample excel revenue and cost templates
Why do I need a financial model?
If you’re reading this blog, my guess is that you probably already have a pretty good idea why. Let me give you my reasons. I believe the exercise of building a model is critical when you’re ready to fundraise. It takes the traction you have established in the prior months or years and projects it out over the next 3 to 5 years. Even if you’re pre-revenue, the exercise helps you answer questions with greater detail — which channels will get you traction? How much are you spending on each channel? How will you get users to convert?
A model is even more critical in later fundraising cycles and will have greater implications to valuation. I advise founders to maintain a simple model even for pre-revenue products. During the diligence process, investors will use your model to review your historical data and test assumptions. They’ll look to the model to answer questions such as “How will you capture the market? What are the growth trends across channels? How much value are created to customers across their lifetime?”. It’s important to tie this to the right channels and sales initiatives. While this can become more of an art than a science, the more historical data you have, the more credible your story.
Principles of an investor ready model
What makes a model investor ready? The model should be robust enough to calculate key metrics and answer questions that your investors may have about the assumptions. Regardless of your industry, the model typically covers 4 key areas:
• Growth & Revenue Strategy. Model should demonstrate how the injected capital ties back to your target milestone and illustrate a monetization strategy that indicates a strong path to user growth, revenue growth, or profitability.
• Operating Budget includes a detailed breakdown of marketing & sales and operating spend.
• Resource build-up for the next 12 to 18 mo. (sales, engineers, products) and the time-frame and cost of each resource.
• Cash balance is typically incorporated once the funding is received. This helps founders stay on top of their monthly burn rate.
Basic structure of an excel workbook
The most basic financial model should have at a minimum 3 to 4 tabs. Don’t try to put too much into one tab — its far better to have a consistent structure in one tab than to cover too much. For a basic model, I recommend organizing the excel workbook in this way:
Sample excel revenue templates -> download here
To keep things simple, I’ve only enclosed the revenue and cost models. I suggest starting in excel but Google Sheets works as well for very simple models. The reason I didn’t include any other tabs is because it should be designed to align with your pitch deck and story. Each founder brings his/her own tone to the story and the model should be consistent to that tone.
Templates includes instructions and footnotes on how to complete. The workbook has three sample revenue templates that uses different unit economics:
- SAAS subscription
- Sales team
- Product-based sales
Basic revenue metrics are also incorporates but you should absolutely adjust and incorporate metrics specific to your business (ie.g. user growth, conversion, churn)
Most investors are focused less on cost, but it’s still important to model as it enables you to understand the levers to profitability.
Costs are organized into a larger income statement, but feel free to tailor to your company.
• Team payroll (salary, benefits, and bonus)
• Operating costs (travel, software, overhead)