Should founders invest time on a model/business plan?
Hi all,
In today´s post I want to discuss a couple of things I thought were pretty obvious, when I joined the VC industry 4 months ago, but I am finding they are not: (i) the importance of a good model/business plan; and (ii) how to estimate in a reasonable and sensible way operating KPIs & financials and how to present it to investors. I will show some real examples I have seen so far and provide an operating and financial model everyone interested can use.
The model includes an operating model and a P&L. I will follow up on this post by including a Balance Sheet and Cash Flow. It has been done for an invented company “Chefo Inc.” but you can easily adapt it to your company.
As this is my first post in Medium, I quickly introduce myself. I joined JME VC as an investment associate in September 2016 after 3 years working at UBS in London as a telecom´s equity research analyst (where thanks to my ex-boss and friend Giovanni I learned 99% of what I know about finance and modelling). I have also tasted the flavor of entrepreneurship back at university where I founded 2 companies: favorazo.com and La Fabrica de Camisas.
Enough about me. I would start by saying that:
a) an entrepreneur does not have to worry about building an operating and financial model since day 1;
b) an entrepreneur that is focusing too much on having a perfect model will not be using his/her time in an effective way;
c) no matter how good a Venture Capitalist is on analyzing a spreadsheet his/her success rate will probably be similar to the Venture Capitalist that does not look at numbers when deciding on an investment.
However, I would definitely say that:
a) there is a moment in the life of a start-up (and not very far in time since the foundation of the company) in which having a good operating and financial model does really matter and creates real value to the company and;
b) overtime, focusing on numbers will somehow pay-off Venture Capitalist that do so.
[i] The importance of a model/business plan
For a founder, a model is a way of reflecting where your company can go if certain parameters are met. It helps to plan your budget based on the level of growth you seek and as a result plan the company capital requirements if you successfully or unsuccessfully meet your business plan objectives.
For an investor, a model helps analyzing what the company has been doing since inception and see what the founder thinks about the business in a more quantitative way. It also provides a centralized “data base” for an investor where to look at all the metrics and “play” with them. And last but not least, it provides one of the elements to construct the valuation of the company.
[ii] How to estimate your KPI´s & Financials and how to present it to investors
A common practice among entrepreneurs is sending a spreadsheet to investors without formulas in the cells (neither for KPIs nor financials) ie. there is no trace where the numbers are coming from.
Comment: send all the spreadsheets with links, it will help the investor and will also save time to the entrepreneur as the investor will probably ask for it.
Regarding how to estimate your KPi´s and financials I will comment on the revenue side, for the rest please look into the model where I have put comments in each relevant line. You may find this very basic but I have seen the following in c50% of the business plans I receive.
Firstly, you should have a breakdown of your revenues that correctly represent the different units of your company. If you have a B2B and a B2C units you should indicate the revenues for both units not just the headline number. Last week I was talking to a startup that is doing great but did not know how much revenue was coming from each unit. The company has grown at a very good pace and has focused a lot on product (which is great). But, they are at a point in which they absolutely need to monitor their revenues.
In addition, I have seen plenty of entrepreneurs that estimate the top-line (ie. revenues) by simply putting a month-on-month % increase. When asked, what was the reasoning behind that “x”% mom increase the entrepreneurs answered that this was the growth they wanted for their companies. In addition, I could not find the number of clients/users the company has had nor what they were expecting.
Comment: the topline of every company comes from multiplying Price x Quantity, estimating your revenues by hardcoding a % number does not make any sense. You have to make sensible assumptions on the number of customers/users and the evolution of the price of your product/service over time.
The above can be estimated in many ways. As an example, in the model I attach, I estimate next month new customers for the SMA´s segment by dividing my marketing budget for the next month by my LTM (last twelve months) CAC. For the large accounts segment I multiply the number of salesperson I have by the historical average of customers won per salesperson.
On other occasions, I have seen that both the % increase of clients and revenues where hardcoded. The ARPU implied by doing the latter was totally non-sense and very different vs. the price the product had in the market.
Comment: again, always follow a Price x Quantity approach.
All in all, estimating your company KPI´s and financials is about common sense. In my opinion you should spend time and take sensible assumptions based on your history, your sector benchmark or well grounded assumptions. You should not just put a number to “check the box” to have a business plan done. A good model/business plan helps founders planning where they want to take their companies and the resources they need for this purpose.
That´s all for today, if you want to use my model, feel free to do so and drop me a line at jose@jme.vc. You can also write me if you want to discuss any other issue.
Gracias!
