How to Make Your Financial Model Standout to VCs
While it might be true that depending on the investment stage VCs will focus on different aspects of your model, engaging in financial modeling is a critical part of building a sustainable business.
And although each investor has his or her own criteria, expectations, and preferences when assessing investment opportunities, there are ways to build a compelling and useful financial model that will catch the attention of VCs.
Think of it this way. Your financial model is a big piece of your startups puzzle that shapes ongoing conversations about the logic and rationale behind your business. It is inevitable that the structure, content, details and output of your model will change over time, and that’s okay!
Building a clean and fully functional model can be intimidating for small businesses, but it is worthwhile because it sends a positive signal to potential investors.
In this post, we’ll share some best practices and tips on how to make your financial model stand out to VCs!
Make realistic and thoughtful assumptions
Another important factor that VCs evaluate is company valuation. One way to show this is with realistic and thoughtful revenue projections. VCs want to understand your thought process on how you plan to scale your startup.
By creating realistic assumptions based on historical data, industry research, or feedback from beta testing, you can paint a clear picture of what it will take to achieve growth and profitability.
Avoid creating revenue projections that are overoptimistic or overly pessimistic. Like most things in life, it’s a balance!
For example, a model that projects $1M in revenue in 5 years, may not be super exciting to VCs. On the other hand, a projection of $100B in revenue in 5 years could indicate a disconnect from reality and you need to come back down to earth.
Ultimately, what’s going to make your model stand out to VCs is if you’re able to show proof and validation behind your numbers. You want your numbers to be consistent with your vision. By creating properly supported assumptions in your model, you will add credibility to that vision.
Based on your assumptions, how do you grow the business? Show the relationship between your growth expectations and the associated costs in your model. One way to highlight all of your key metrics, assumptions and results is to provide a financial summary. Not only will a summary save VCs time, but also it will make their due diligence process easier overall.
Create multiple scenarios
Another way to build a financial model that’s attractive to VCs is to create different versions. In addition to your default financial plan, or base case scenario, it may be worthwhile to prepare a best case and worst case scenario. By creating different financial plans, you can show investors the potential upside as well as the impacts that a less optimistic outcome would have on your cash flow, funding needs and profitability.
Make your model interactive by walking VCs through your thought process. Use your model to demonstrate contingency planning to show that you can effectively respond to a future situation or event that may or may not happen. Your ability to model the strengths and weaknesses of your business demonstrates to VCs that you know your business inside out.
Creating multiple scenarios within your financial plan allows you to be open, honest, accurate and authentic about your business.
Be clear on your usage of funds
Although it may seem obvious, it is a common pitfall in financial models that founders do not give clarity around their numbers. Make sure to adequately explain and breakdown how you plan to use the funds you are asking for. It’s all in the details!
Including a cost breakdown within your model will surely make your business standout to VCs. Include your capital needs in your model to give VCs a sense of how much cash you’ll need to scale your business.
Although high-level reporting and projections are important, you should also have detailed individual reports on budgets, expenses and operational costs that trace the company’s performance and provide insight into how your funds are allocated.
Have an understanding of KPIs (+ other metrics)
VCs want to see conviction around your business model. Understanding what your top priorities and critical metrics are and how your team will execute and improve upon those metrics will be of interest to investors.
Key performance indicators are important metrics because they show the critical factors or drivers of growth that your company needs to successfully raise your next round of funding. Identifying the KPIs that are essential for the success in your business in your financial model can definitely catch the attention of VCs.
An additional metric that you should know about your business is the cost to acquire a new customer and the customer’s lifetime value. Since CAC directly impacts a company’s cash flow, including CAC in your model will be advantageous to your fundraising efforts because it will give VCs assurance in your startups ability to sustain profitability.
Prove there’s market opportunity
Does a real problem exist in the market? Is there significant demand for a solution? Does your product or service access that demand cost-effectively and at scale? The answers to these questions should be an underlying theme throughout your model.
You can do this by identifying consumer segments and conducting data analysis such as: analyzing changes in the environment, competitors, existing players and comparable products or services in the market. Your data should be clear and show customer traction, the value proposition, and scope of how your business fills the gap that exists in the market.
Remember that your financial model should tell a story that aligns with your overall business plan. Figure out what your goals are, think about how you want to achieve those goals, and provide metrics that showcase the effectiveness of your strategy. A financial model that reflects a business with a meaningful, competitive edge and high growth market opportunity will attract willing investors.
Financial Literacy is Key
There are various unknowns that will almost certainly arise throughout every stage of a startup. VCs don’t expect all founders to be finance experts, but displaying a lack of financial knowledge surrounding your business can be a red flag.
Put yourself in the position of an investor and focus your mindset to be metrics-driven. Your financial model is a chance for you to communicate the value of your business through numbers, so you need to have a sense of the math to immediately connect with VCs.
Ultimately, financial models come in all shapes and sizes, but including these characteristics and metrics within your financial model will allow VCs to take you seriously and have a complete picture of your business from a financial point of view.
Financial models tell so much more than just the financials. VCs want to understand the main drivers of your business and have a conversation with you about what the next year or two looks like for your startup.
Show them you are dedicated, passionate, and pleasant to work with and demonstrate that you know what it takes to reach your goals. Impressing VCs is no easy feat, but adequate preparation, research, and enthusiasm will take you far and make you memorable in the minds of VCs.