Financial projections are, on the surface, a futile exercise. Nobody believes them. Studies prove that 98% of the actual business results of start-up companies, compared to estimates in the business plan, fall significantly short of projections and take twice the time.
Yet investors insist on seeing financials and complain if you leave a summary out of your presentation. Why? Because financial projections serve two essential roles.
One, they offer a model of how the entrepreneur sees the financial future of the company, and key data for evaluating the feasibility of the investment. Are revenues a few years out anywhere near big enough to suggest a payout proportionate to the needed capital investment? How big is revenue as a percentage of addressable market? Emphasis is on the word “model.” It’s a modeling exercise.
Two, they are the beginning of a dialogue about the underlying assumptions of the model. Rather than dwell on one big guess—the bottom line of financial projections—it’s more productive to examine and debate the little guesses, the assumptions, that feed the model.
Actually there’s a third: if the projected revenues are extremely high or extremely low they supply investors with an an excuse to pass on your company.
Note: Don't confuse the role of financial projections in a start-up pitch with the role they play in more mature businesses with reliable performance histories. They're very different.
High, low, middle?
Where do aim in your projections. High, low, middle? And No, the solution is not to show all three high/low/middle cases in a presentation.
Don’t go low. You won’t get credit for being conservative, and investors will discount the numbers anyway. And while we’re at it, the word “conservative” should NEVER pass your lips.
Don’t go high either, crazy high and divorced from reality. You'll lose credibility.
The solution? Use “Goldilocks numbers.” Not too hot, not too cold, but juuussst right. Show only the Goldilocks case in your initial presentation and executive summary.
More to the point, feed your model with assumptions that are as favorable as possible but still defensible. How many customers can you add in Year Two? Don’t say 100 if that’s an impossible number. Can you make a reasonable case for 75 if everything goes well? Then use 75. Don’t be conservative and use 50 and think it’s going to help your cause in any way.
I heard an investor say to an audience once, “You’re entrepreneurs. We expect you to be optimistic. If you’re not optimistic, we aren’t interested in you.”
The real goal is an intensive discussion–-usually at a second meeting, or in the Q&A of a private first meeting–-that drills down into your assumptions and the business strategies driving those assumptions. “How will you deploy your sales force to reach as many as 75 customers, and are the costs realistic?” In the process, investors get a truer picture of you and your model.
Just as importantly, they become engaged. You've “tricked” them into thinking carefully about your business. That’s good. You have their attention, they’re involved, focused on the details. You’ve just achieved the first goal of the first investor meeting.
It's a win for you. At worst, you get feedback you can use to make the model tighter or, in extreme cases, a dose of reality that leads to a strategic course correction.
At best you get validation. The investors begin to believe you know what you’re talking about.