Kruze Consulting’s clients have raised over $500 million in venture capital in the last 12 months. In our experience, a solid financial model, one that helps convey the assumptions and one that builds excitement, is key to getting VCs to engage in your fundraising. Here are some tips to help you make a financial model that resonates with venture investors.
Startup Financial Model Tips
- Identify KPIs that drive revenue
- Explain your gross margin
- Identify and understand your operating expenses
- Project your balance sheet
- Match the startup model to your actual results
- Understand the model’s trendlines
Startup financial modeling tip #1: Identify KPIs that drive revenue
The most important startup financial modeling tips that you can take away is that you want to align your financial model with your actual business. That means the business goals, or the key performance indicators, otherwise known as KPIs, are what you want to use to drive your model. There are the assumptions, drivers or metrics that will communicate your core business assumptions to the investors.
Many times that can be average selling price per customer, or deal, customer acquisition cost, churn rate, things like that, that all feed into lifetime value of the customer. Those are the big variables that are going to drive your business. Start with your KPIs, write them down, even before you start working in Excel or Google Sheets. Start by writing down your key performance indicators, isolate four or five of them. Don’t do too many, because then it gets too complicated to explain.
Startup financial modeling tip #2: Explain your gross margin
Work downwards from revenue to the gross margin. What costs are required to provide the service? A lot of times Amazon web services, or hosting, things like that, or software that’s built into your product that you always have to pay and subscribe to every month. Investors tend to really focus on your gross margin. Everyone wants to invest in companies that have a higher gross margin because high gross margins allow you to spend more money on operating expenses, like marketing, advertising, headcount, things like that.
Startup financial modeling tip #3: Identify and understand your operating expenses
Then you’re going to work through your operating expenses. This is where you capture all your personnel spend, all your marketing, all your advertising, all that is called G&A or SG&A. (G&A = General and Administrative expenses; SG&A = Sales, General, and Administrative expenses). like rent, healthcare benefits, all that stuff. You’re going to have line items for all that in your financial model so it’s very obvious to you. One of the best parts about doing this on a line-by-line basis, is you really start to understand the costs inherent in the business. We’ve had companies paying way too much in rent and they didn’t realize that was going to materially impact their ability to be profitable. It’s always better for your business to identify these before you start talking to investors.
Bonus modeling tip: Early stage startups need to pay special attention to payroll costs. It is not uncommon for a startup to invest too much in headcount, too early, and all of a sudden their burn will go crazy. Some CEOs don’t realize that until they actually look at the line items and how many people they’re employing, what those salaries were and what the impact is on cash burn. It’s a great exercise to review payroll on a line-by-line basis.
Startup financial modeling tip #4: Project your balance sheet
Now, once you get your income statement done, you’re going to want to feed that into the balance sheet. There’s going to be some working capital changes, which is part of the company’s cash flow that may require special attention. For example, when you invoice a customer you’re probably not going to get paid for 30 days or 60 days. That is a working capital cost and that’s going to be reflected on your balance sheet and cash flow statement. Just be aware of all the changes to working capital, all the prepaid expenses that you have to do, all the accrued expenses. Those are going to all get flushed out on the balance sheet and cash flow statement.
Startup financial modeling tip #5: Match the startup model to your actual results
Now, once you’ve got your three statement model, the incomes statement, balance sheet, cash flow statement, you’ll need to layer in actuals. You’re going to want to show what you budgeted and what you’re actually doing, and do so in a way that explains how the company’s projections will grow over time. This is tremendously valuable to the CEO, because they can see if they’re underperforming financially, if they’re spending too much money, and this is very, very important to see if your runway is getting shortened, if you are materially outperforming your projections. Having the budget actuals is really important.
Startup financial modeling tip #6: Understand the model’s trendlines
Finally, you’re going to want to analyze some of your basic trendlines. You’re going to want to analyze your expenses. You’re going to want to analyze your revenue ramp. You’re going to want to look at how much you’re spending on headcount every month. Some nice charts are really valuable. Those are charts you can show in your board meeting and say, “Look at our revenue ramp. Look at how we’re keeping costs very manageable. Look at how we haven’t ramped headcount too much.” Pay attention to the ramps, make sure they are either smooth, or that you can explain where massive changes happen. For example, if revenue growth is projected to jump, can you explain why that jump will occur?
These are all tips that you can use as you create your startup’s financial model. Using these tips can help you make your financial model a lot more informative for the company, for your board, and also just help you manage the business better. It reduces a ton of stress when you actually have the information at your fingertips. If you are looking for experienced financial modeling help, contact Kruze Consulting today.