Founders, Always Forecast Cash

This is a guest post from Brett Calhoun, Managing Director and Partner at Redbud VC.

Reach out to Brett Calhoun, Managing Director & GP at Redbud VC, at brett@redbud.vc to learn about Redbud, and subscribe to our newsletter here.

TLDR

Before launching a product or service, founders must have a thoughtful financial plan to navigate operational needs. I crafted a plug-and-play financial model for founders, whether a product or SaaS-based business. A 24-month plan is possible in under 30 minutes using the Pre-Seed & Seed 24-Month Financial Model template HERE

When the economy is booming for an extended period, people can become incautious, irrational, and overconfident. We had the longest market euphoria in history between 2010 to 2021, where the market’s price-to-earnings multiple (i.e., what each dollar of earnings cost) more than doubled, and SaaS multiples quadrupled — including a 69% increase between Q1 2020 to 2021. Venture capital investments nearly doubled in 2021, with average early-stage valuations tripling between 2020 and 2022. For over a decade, capital was nearly free, with the federal fund rate at or below 2.5% between 2009 and 2022. Everyone talks about the rise in the consumer price index (i.e., inflation), but the price of a home more than doubled in the US between 2011 and 2022 (an understatement for large metro areas). As a society, we needed a downturn, similar to burning down an overgrown forest so it could regrow with fresh vegetation.

The last decade has been great to dip your toes in entrepreneurship, but bad habits were taught or allowed over the previous few years. One of the most dreadful habits is that a thoughtful financial plan, or any financial plan, is NOT needed at the Pre-Seed or Seed stage. For years, some investors have pontificated on the ideology that startups must grow as fast as possible and defer any focus on cash flows. These investors crave the game of passing the hot potato (i.e., grow revenue fast and then raise at erroneous multiples from the next investor), which is a short-term strategy for fund managers to raise their next fund. Unfortunately, those pioneered this investing method have influenced the general investing community. Now, the industry is in an awkward limbo where funds have a record level of dry powder but are incredibly cautious to deploy.

In 2022, capital is still abundant, but generally, investors are patient to find founders who have obtained traction (e.g., $5k-$10k monthly recurring revenue) and have a path to scalability (i.e., increasing margins and/or profitability). For pre-revenue founders, especially first-time or non-technical founders, it seems like a fruitless time to start a tech company. At Redbud VC, we see capital constraints as power because they can force founders to lean into first principles, unlock creativity, and be resilient. With constraints, good operators grow a business’s top line, but great operators grow the top and bottom line, and there is evidence of this in the public markets. Spending hours on a financial model is the last priority for those who need to be financially savvy. At Redbud VC, we built an intuitive input-driven model that any founder can use to plan for the next 1–2 years (here).

At the Pre-Seed and Seed stage, an 18–24 month cash burn forecast is all that is needed. After finishing the initial customer and product discovery, it’s the perfect time to build a financial plan, so you are not flying blind when going to market. What goes into the model is much more than forecasting expenses but thinking deeply about your distribution strategy (e.g., inbound vs. outbound and hiring sales reps vs. focusing on organic content). The distribution strategy will drive your revenue targets and the costs to execute. The financial model helps to understand how the customer acquisition cost (CAC) vs. the average order value (AOV) or customer lifetime value (LTV) scales over time. Below you will find a detailed instructions manual for how to build your Pre-Seed or Seed financial plan in 30 minutes or less.

The Financial Model Instructions Manual for SaaS or Product Pre-Seed & Seed Founders

Step 1: The Mechanics and Logistics

There are five spreadsheets (you might only need two or three)

i. Financial Projections: Automatically populates the monthly, quarterly, and annual income statement, balance sheet, cash flow statement, and financial graphs. The only cells to alter are the dates from 1(b) above and the investment amount and common stock in the cash flow statement.

ii. Drivers: This is the brain of the model. You can input the revenue and expense assumptions here, which include hires, pricing, and website traffic.

iii. Historical Financials: Manually input the historical financials, but this is optional if you use the model only for projections.

iv. Depreciation Schedule: Used to depreciate fixed assets (e.g., automobiles, equipment, etc.).

v. Loan Amortization: Plan out lines of credit, assets financed, or business loans.

1. Every cell highlighted and with the royal blue font is an input cell that needs to be changed or updated. Any black and white cell is a formula — do NOT change.

2. Start here: The model is driven by the dates chosen at the beginning. The selected dates will flow through each spreadsheet and populate numbers based on the tagged dates from the Driver spreadsheet.

3. Also, on the projections tab, choose whether you are selling a subscription, product, or both, and if the subscription is chosen, you must select whether it is annual or quarterly. For accounting purposes, revenue is only booked as earned, meaning if someone pays upfront for an annual subscription, that revenue is earned each month the subscription is owned.

4. The annual financial statements along with key metrics will automatically populate, but the period end dates do have to be updated at the top.

5. The model automatically populates three of the most important monthly metrics to track i) revenue, ii) cash flow from operations, and customer acquisition cost (CAC) to average order value (AOV).

Step 2: Input Drivers

Revenue

1. After inputting the actual and projection dates, begin forecasting your growth inputs.
2. Start inputting revenue drivers in Table 1. For example, the weekly website traffic growth rates drive the website traffic, and the conversion rate drives the actual paying users coming inbound to the website.
3. There is flexibility to go from one-time product purchases or subscriptions. For subscriptions, there are tiered prices and breakdown options for the allocation of tiers, monthly, annual, or quarterly subscriptions.

Expenses

1. Next, Table 2 is where all the expense drivers are housed. There is a section for cost of goods sold or cost of revenue (COGs), marketing, hires, employee benefits, recruiting expenses, professional services, and other expenses.
2. With COGs, there is an option to include R&D, which includes engineering hires, or for hardware businesses, there is an option to have the COGs margin.
3. The marketing section is to estimate the cost of users clicking on the website from ad spend. Another cost is SEO spending.
4. Next are hires needed with their respective salaries, benefits, tools, and recruiting expenses.

Other Revenue & Expenses

1. After expenses, you will input your start date for having website traffic and what that monthly traffic was or will be. Next, there is an input to choose the source of the traffic coming inbound. The website traffic drives inbound customers.

2. Table 5 includes the forecasted growth for outbound sales. The table consists of forecasted monthly sales targets for the CEO and hired representatives. If the company has an existing waitlist before launching, there are inputs to predict the conversion of the waitlist. Next are partnership referrals. Strategic partnerships can be a massive driver of growth for products. The model forecasts the predicted partnerships and then the leads each of those partners sends on a monthly basis.

3. The last input is choosing the timing of the hires by selecting 1+ for when individuals are hired.

Income Statement

1. The revenue and expense assumptions are flowed through to the income statement below, which also flows to the balance sheet and cash flow statement. There is a sales cycle delay of one month, meaning all forecasted sales are delayed by a month.

Note: The income statement shows the profits and losses over a period of time. The income statement offers insights into margins, net income, revenue growth, etc.

2. The annual or quarterly subscription revenue is amortized automatically within the projections spreadsheet.

Balance Sheet

1. The logistics of the balance sheet are all automated.

i. Cash comes from the cash flow statement

ii. Long-term assets come from the depreciation schedule

iii. Unearned revenue comes from the annual or quarterly revenue amortization table

iv. Notes payable come from the loan amortization tab

v. Equity comes from the cash flow and income statement.

Note: A balance sheet displays the state of the company’s assets, liabilities, and equity at a point in time. The balance sheet is good for understanding a company’s book net worth and the business’s health (e.g., debt vs. equity).

Cash Flow Statement

1. The cash flow statement auto-populates the operating and investing activities, but the financing activities must be manually entered for common and preferred stock investments.

Note: The cash flow statement gives insight into the business’s cash flow, which is different from the net income. In addition, it offers insight into the cash flow from operations.

Depreciation Schedule

1. The depreciation schedule is used to input assets purchased for cash and/or financing. The schedule automatically forecasts the depreciation expense for the assets. The financed assets automatically go to the loan amortization schedule. The last input is to choose the years to depreciate the assets.

Loan Amortization

1. The loan amortization schedule forecasts debt requirements for financing assets or operations. The assets financed flow from the depreciation schedule spreadsheet, and the general financing is manually input. The other inputs are to choose the term and interest rate of the loan. For simplicity, this model is limited to general loan amortization instead of creative amortization (e.g., deferred payments, balloon payments, etc.). In addition, the model auto-populates the interest and principal payments.

Closing Thoughts

A financial model gives founders a compass for navigating a thoughtful plan (e.g., hiring, fundraising, distribution strategy, etc.) over 18–24 months. In addition, a thoughtful financial plan displays the high level of detail a founder thinks about their business. Good operators focus on short-term growth, but great operators concentrate on long-term cash flow.

For any questions, reach out to me anytime at brett@redbud.vc

Reach out to Brett Calhoun, Managing Director & GP at Redbud VC, at brett@redbud.vc to learn about Redbud, and subscribe to our newsletter here.