Startup Financial Models

There are two ways that startups might want to record equity investments that they get, like venture capital rounds, on their balance sheet.

1) The Official GAAP way - probably overkill for most startups 2) The way investors like to see it

The GAAP way wants your equity section to have three accounts, Common Stock, Preferred Stock, and Additional Paid-in Capital. The hardest part of this is to calculate the Additional Paid in Capital is like the (Issue Price – Par Value) * Basic Shares Outstanding. Financing Costs are netted against this account.

Investors prefer to see each new fundraising round as a new equity account. If you use this method, you’ll have Common Stock, Seed Series Stock, Series A, Series B, etc. You’ll subtract your financing costs against each rounds amount. In this method, if you haven’t really calculated APIC, don’t include it on your Balance Sheet - you don’t want to give the impression that you are doing things on a GAAP basis when you are not. Notice that once fundraising round is closed, new funds aren’t added to it. New funds are placed in a new fundraising Equity account.

Why do venture capitalists prefer to see the Equity section in the non-GAAP, simpler method? Because it’s cost effective (from a cash-burn spent on accountants perspective) and it’s easy for them to understand how much the company has raised at each round of financing.

Here are a few tips for you as you’re building a budget for your startup.

1. Headcount is going to be your primary expense in most cases, so this is the place to focus the most. Understanding why your different team members get hired, and how they help you get to the next milestone, is very important.
2. You should have a really strong opinion on the amount of revenue and the amount of cash burn that you’ll have in the coming years. Don’t ask your department heads what they want to spend - tell them how much is available and ask them to work within the constraints.
3. Match the amount of cash you need with the size opportunity of the company that you’re trying to build. If you are building a company with modest potential, don’t burn millions of dollars!

So you’ve got the great idea, and maybe even have the team put together. Heck, maybe you even have a client or two! Now you want to put together a financial model to figure out if you can raise capital, or how long you can last with your existing investment. How do you start that model? There is no single answer to the best way to get going, but here are a few places to think about at first:

• How big is the market, and if you capture a small amount of it, do you have enough revenue to have a real business? VCs often ask this question - and it’s a good one for you as you try to decide how to formulate your business. Are you looking at a $100 million revenue opportunity in 3, 5 or 7 years? Or if you get a meaningful percent of the addressable market, will you only have a $5 or $10 million business? This will help you size how much venture funding you should think about raising (and how much you should burn in the near term).
• How many people do you need on the team to get to your first milestones? If you need a developer or engineer, is that you or one of the other founders? Or will you need to have cash on the balance sheet to afford to pay a salary for an engineer? You’ll want to model out and project the salary requirements for the business in the first few years pretty carefully, as this is usually the majority of a startup’s cash burn at first.
• Understand your product’s unit economics. How much will your clients pay, and what will your costs to deliver it be at first, then at scale? The goal is to understand when the company has a viable cash flow positive product. It’s totally OK, and normal, for a company to lose money on every sale at first, but you do eventually want to have positive cash contributions from your sales.

SaaS companies have specific financial modeling needs. In particular, a SaaS company wants to have a strong understanding of its user metrics. This includes how many users are acquired, churned, upgraded in a given period (we usually model it monthly.) Secondly, the length of time of contracts, and how your company is paid, matter for SaaS companies. Annual contracts that are paid up front can create deferred revenue, which is great for cash flow but does present some challenges from a modeling perspective. Finally, many SaaS models that we create have different pricing tiers to help the SaaS company understand the influence and impact of different pricing plans on the company’s top line growth and profitability.

What are Customer Acquisition Costs and how do you model them? CAC looks, on a per new unit (i.e. customer basis) how much you pay to get a new customer. So, if you spend $10,000 on sales and marketing and get 100 new customers, your CAC is $10,000 / 100, or $100. The costs that go into CAC usually have two components, fixed costs, and variable costs. Examples of fixed costs would be costs that don’t increase as your company grows. The salary for your demand generation team would be a clear example of a fixed cost - if they are scalable, then you can acquire 1 user or 100 in a period and still have the same salary cost. Some software costs don’t vary much as the company grows, such as the cost of SEO software. Variable costs move up as the company acquires more customers. Clear examples of variable costs include some online marketing costs, such cost per click advertising. The cost of a sales team can also be variable, as you likely need to hire an ever increasingly large sales team to help your company close more and more new clients.

Managing a company’s burn and the runway is a constant challenge for an early-stage, funded company. Having helped hundreds of companies manage their burn, Kruze Consulting’s view is that the companies who have a well-developed budget are the ones who best manage their runway.

You need to have a vision of what your long-term strategy is and what you need to do to achieve those goals so that you can build a budget to manage your burn and optimize your runway.

Why do you need a budget? Because knowing where you want to spend, and how those choices impact your burn, is critical to managing your runway. Plus, you need something against which to measure your burn - and that’s called your budget!!

Your budget may have money coming in - other than venture capital money, that would be from revenue. Revenue may or may not be an important part of your projections. If you are something like a SaaS company, you’ll likely need a particular set of revenue and revenue growth numbers to raise your next round. Build your budget based on the targets you need to hit - and then you can modify your hiring and other burn based on how closely you hit your spending.

Money goes out of your company’s expenses. Every very early-stage startup spends >80% of their money on 3 things: Payroll, Rent, and Contractors. You may also have some large legal expenses from your recent fundraise, so ask your attorney if you haven’t already. Controlling these expenses give you levers you need to manage your runway.

Payroll: people are expensive. Hire the very best people that you can and pay them well. Always take the quality of people over quantity. As David Barrett highlights in this article, more people does not equal more output, it means more overhead.

Rent: Rent is expensive, so consider having some remote people, using a WeWork or headquartering in a city other than San Francisco or New York.

Contractors: Contractors are expensive… but less so than employees. You don’t have to manage additional rent/desk space, equipment, or training. You will also feel less likely flexing their hours/spend, although, in turn, they may give you less loyalty.

Working Capital is effectively the delta between a startup is paid by its clients and when it needs to pay its vendors. A more technical definition of working capital is the difference between current assets and current liabilities on a company’s balance sheet.

Working capital matters for startup financial models because understanding working capital becomes important for being able to project cash flows. Not all clients will pay immediately. Not all vendors need to be paid immediately (although some may be paid ahead of time).

Critical factors to think through when modeling the impact of working capital in a startup’s financial model include: how long it takes to get paid (especially if selling into the enterprise); if any revenue will be collected up front (creating deferred revenue and putting cash onto the balance sheet); which vendors are being pre-paid; how long the payment will be on other vendors.

If you are modeling a very early stage startup, it’s OK to assume you pay your vendors in the same month and defer your revenue collection 30 to 60 days. Later stage companies will likely need to have a more detailed working capital model built into their balance sheet and cash flow projections.

Silicon Valley-style technology and biotech startups, by their very nature, have extreme financial projections. No venture capitalist wants to invest in a highly-risky company where the management has modest projections! But how should a founding team set up realistic projections that are still aggressive enough to explain the massive opportunity and get VC’s interested in investing?

Step 1: make sure the projections capture the size of the market; bigger markets lend themselves to bigger projections and estimates, higher growth, etc.

Step 2: if you are projecting big growth/big top-line revenue numbers, don’t forget to have big expenses to go along with them. In particular, we see time and time again founders who have projections of reaching $50 million or more in revenue with just a handful of employees. It would be very unusual to not have a lot of headcount growth to reach a huge revenue size. And VCs will doubt your credibility if you show them a company that has 80% pre-tax margins at scale - this is, generally, pretty unrealistic. So scale up your expense projections alongside your revenue growth.

Step 3: Focus on the assumptions behind your unit economics. Make sure these make sense from your target customers’ point of view. The average consumer can’t pay $50,000 per year for a new product; the average small business can’t either. So, understand the customers’ willingness to pay, and then how that impacts your margins and growth.

Step 4: Research similar companies’ business models and financial statements. For example, if you are in the social media space, look at Facebook and Twitter - see how their financial statements changed over time. The same is true if you are an eCommerce business - plenty of eCommerce companies have gone public and shared their data.

Step 5: Don’t model yourself out of a deal! If you are truly focusing on a huge market opportunity with tons of potential customers willing to pay for your product, don’t be so conservative that your projections don’t look interesting to potential investors, co-founders and employees.

There are two types of standard financials that are needed in a VC pitch deck. and they can usually be shared in the same summary slide.

The first is for companies that already have real operations, so a pure “startup” with no operating history doesn’t really need this. But if your company is in business, you’ll want to show the historical financials in a summary format. And these should “roll” into the projections, which is the second thing you’ll need to show. Note that it makes sense to do this either quarterly or yearly - too much detail isn’t helpful in a deck.

The second is that the best pitch decks also have financial projections. Again, you’ll want to integrate these into the historical projections, and in most cases show them all on one slide. Keep in mind that the VC is trying to understand 1) what the company will look like when it raises the next round of funding; 2) how “big” the founders think the business can get; 3) how much capital the business will need; and 4) do the founders have a good grasp of the financial implications of their business model.

Yes, startups need to have a coherent financial model. Not only can a financial model help keep a startup from prematurely running out of cash, it is a useful device for managing an early-stage company’s cash, burn and progress against important KPIs. If your startup is going to raise venture capital funding - or even seed financing - you need a financial model to explain to the investors how much capital you’ll need, what you will spend the investment on, and the position that the company will be in at its next fundraise.

1. Determine model’s primary goal (fundraising, managing cash, etc) 2. Determine the KPIs for your company 3. Grab a template off the internet, like ours 4. Merge actual results into the template 5. Start with revenue 6. Project headcount needs 7. Estimate other expenses 8. Model working capital 9. Review your projections

Looking for free financial models for your startup? Look no further - we’ve got free model templates available above for your download. Look for files that do the bulk for the infrastructure work for you - you don’t need to spend time building fancy formulas, let the template do that for you.

Zero-based budgeting can be a useful tool for organizations that are looking to improve their financial performance and increase their efficiency. It can help them to identify and eliminate waste, and to allocate their resources in the most effective manner. 

Zero-based budgeting is a method of budgeting that starts from a “zero base” and involves analyzing the needs and costs of every function within an organization. One key advantage of zero-based budgeting is that it can help to identify and eliminate waste. By thoroughly reviewing all activities and expenses, an organization can identify areas where resources are being used inefficiently and take steps to reduce or eliminate these expenses. This can help to improve the organization’s financial performance and increase its efficiency. 

This makes it a particularly useful tool for startups experiencing a difficult economic environment. 

A key issue we’ve seen multiple times (and maybe even made once or twice early in our career) is when a founder simply asks the department leaders “what will you do next year” - essentially, giving them an open book to request huge hiring and expenses and now dictating what the company needs to do to survive. Establishing clear boundaries for cash burn rates and revenue objectives are critical starting points that should be communicated to all departments before a budgeting process begins.

A common pitfall occurs when CEOs consult each department—be it sales, marketing, or R&D—about their respective needs and plans without first setting financial limits. Summing up these requirements often leads to unsustainable cash burn rates, placing the company at risk.

The smarter approach is to begin with clearly defined financial parameters. This allows your go-to-market teams to know precisely what their revenue goals are and the budget they have to achieve them. Similarly, rather than granting your R&D department an open budget, allocate a specific annual spend to help them reach their milestones.

Basically, the CEO should know what revenue targets need to be for the startup to remain default fundable. And the CEO should also know how much capital the company can burn comfortably. Giving these constraints to the teams helps avoid painful rebudgeting exercises. 

By initiating the planning phase with financial constraints, startups are better positioned to create a strategy that minimizes cash burn and maximizes the likelihood of hitting revenue targets.

A financial model is an important step for most venture capital fundraises - however, the level of complexity and importance vary by the company’s stage. Very early stage companies can usually get by with a simple operating plan that says what the company will spend, how it expects revenue to grow and what it will look like at the two next fundraises. Later stage companies - starting with the Series B, but sometimes at an A if the round is large enough, will require more detail projections that have information on expected customer count, CAC, and headcount projections and more.

NO! A 409A valuation is an essential part of a startup’s financial framework. This valuation, provided by a third-party accredited valuation provider, establishes the strike price for employees’ stock options. It is crucial to maintain a conservative 409A financial model to prevent overpricing and to ensure employees are motivated by fair stock option pricing. Founders often use the same financial models for their 409A valuation as they do for their venture capital pitches, which can lead to problems as these models are typically more aggressive and optimistic to attract investors. However, third-party 409A providers cannot discount these optimistic projections, resulting in potentially inflated valuations. Therefore, founders should develop realistic financial projections for their 409A valuations to avoid overvaluing their company and overpricing employee stock options. Use a more conservative, easier to attain set of projections for your 409A projections. 

If you are a SaaS business, download the free startup revenue model template on this page! What typically goes into a revenue model depends on the stage of the company that you are modeling. Companies already generating meaningful revenue, with multiple clients, can start to get pretty sophisticated with their pricing projections, average revenue per client and client retention, reorder, basket size, etc. Pre-revenue startups, or early-stage companies that don’t yet have a deep understanding of how they will charge clients, what pricing will be, retention/basket sizes, etc. should typically opt to be more extrapolated in their revenue modeling. For example, instead of having multiple features that result in dozens of possible pricing permutations, go higher level and estimate the number of clients you expect to have at one or two average price points.

We highly recommend you start with a financial model template instead of starting from scratch. While it can be tempting to start with a blank slate, most founders will benefit from using a model that already flows correctly and that doesn’t require a lot of basic infrastructure to get up and running.

As a founder, you have a million things to do - making a balance sheet balance, or changing a gross profit margin cell to a percentage format isn’t one of them. Many, many of the startup founders we work with can easily build their projections starting from a blank spreadsheet. But the best don’t, because they know that they get no ‘points’ for starting from scratch. Save the time, and use an existing financial model template like the ones we have for free on this page!

When choosing a startup financial model template, there are a few key elements that founders should keep in mind:

1. Free Financial Model Templates: The internet offers a plethora of free startup financial model templates. Don’t feel compelled to pay for one when there are high-quality, free options available. Ensure to choose a template from a reliable source to ensure accuracy.
2. Excel and Google Sheets Based Templates: Excel and Google Sheets are universally used and recognized software. Choosing a financial model template compatible with these platforms ensures accessibility and ease of use for you and potential investors. VCs really expect to be able to play with your assumptions and model, and are likely to want to copy paste your numbers into their own template or into a section on their investment memo. So make it easy for them by providing a file format that they are familiar with.
3. Income Statement and Cash Position Focused Templates: Select a template that emphasizes the income statement and projected cash position. These elements are critical for investors to understand the potential profitability and liquidity of your startup. The income statement shows how you’ll generate revenue and what your expenses will be, and then a simplified cash position will let the investor know when you need to fundraise again. In the earliest stages of companies, so pre-seed, seed, and even Series A, the balance sheet and cash flow statement often introduce unnecessary complexity, so we advise founders that are DIY’ing their startup’s financial model to just focus on the income statement and cash projection. 
4. Customizable Financial Model Templates: Each startup is unique. Ensure the template you choose is easily customizable to reflect your startup’s specific circumstances and business model. But, it’s ideal if you can start with one that is focused around your specific business model - check out our SaaS financial model template, for example. 
5. Easy to Get to Startup KPIs and Metrics: Look for a template that makes it easy to track key KPIs. The template may not actually produce these metrics, but it should make it easy for you to either add them in or let a VC back into them on their own. Remember, if you put in metrics that you can’t actually measure/track, it’s going to be hard to keep the model updated!

Some other tips for getting the most out of a startup financial model template include picking one that is easy to update - ideally, you can simply copy and paste you historical results into the template to update it.