In my most recent column on the pitch, we examined the pitch from a more macro level, highlighting the importance of crafting a story and the key components around which the story is constructed. This week we are going to zoom in and look the financial model — the numbers that serve as evidence of past and potential future growth, as well as the general financial health of the business. Financial model
The financial model is a detailed examination of your business’ finances. It will display an income statement, balance sheet, cash flow statement, a valuation and the method(s) used to determine said valuation.
The financial model can either be included in the business plan and pitch deck, or as a separate Excel file. I suggest going with a separate Excel file as this allows investors to look at formulas, take a deeper dive, and see if projections make sense. They can also play with your numbers (e.g. see what happens if revenues are reduced by 10%) and look at worst case scenarios. If packaged in an Excel sheet, each component should get its own tab.
The income statement exhibits revenues against expenses and thus the company’s profits or losses. Include as much historical data as possible and include (ambitious but justifiable) projections for a minimum of three years. The more the better. Remember, this information in an important buttress for your valuation so the more evidence you can provide, the better you can justify your proposed valuation and future growth expectations.
The balance sheet is a breakdown of company assets, liabilities, and shareholders’ equity. Your liabilities are any debt the company has or accounts payable (anything you owe), whereas equity is a breakdown of capital received in exchange for equity: the number of shares multiplied by the price per share. Your assets must balance by equaling your combined liabilities and equities, hence the name balance sheet.
Cash flow statement:
The cash flow statement exhibits what happened to your cash over the course of the year — how it was spent. The goal is to show investors that you’ve properly accounted your for your money.
Your company’s valuation is, in short, an estimate of what your company is worth at a given point in time. There are a number of methods that can be used to approximate the value of your business, and most are based on the income statement, balance sheet, cash flow statement.
If your business is established and has historical financial data, then we recommend using the discounted cash flow (DCF) method. When possible, it is preferable to use the comparables method, which compares your data with that of a similar company from a similar industry, however since innovation is the name of the game in entrepreneurship, it is often difficult to find a truly comparable comparison.
The valuation is often one of the most contentious elements of the investment process. Entrepreneurs have a natural tendency to aim for the highest possible valuation, while investors are naturally incentivised to negotiate the valuation down.
My advice to entrepreneurs is to not get caught up with raising at the highest possible valuation, especially early on. At best, this will impede the capitalisation process and limit how quickly you can get the money you need to grow your business. At worst, no one will invest and you could be in trouble.
Offer investors a fair deal that is supported and justified with data and evidence to the best extent possible. As your business continues to grow and you gain more and more traction and historical financial data, you will be able to rapidly scale the value your business. You want it be to growing exponentially, not incrementally, with each fundraising round.
Lesson Seven: Be meticulous when you develop and curate your financial model. At the end of the day, its contents are some of the most important metrics and considerations about the investability of your business.
Read Part 1 – To raise, or not to raise?
Read Part 2 – Who should you raise from?
Read Part 3 – Debt vs Equity Financing
Read Part 4 – When to raise
Read Part 5 – Pitch Psychology
Read Part 6 – Pitch Presentation