The financial projections are Essential for any business, but in the case of tech startups, a financial model is one of the most important and overlooked tools available to a founder.
Venture-backed start-ups work on an aggressive and venture capital deployment, often operating at a loss for years as they seek expansion and market dominance. This means the track is a critical KPI that founders need to keep an eye on for every financial decision.
Aggressive spending should translate into aggressive growth: revenue can grow 20% or 30% month over month, making the track estimate a constantly moving target. Being able to expand the team a month sooner can make a big difference in the long run, or cutting expenses quickly can keep the company from running out of money.
When milestones and deadlines are directly driven by your finances, you put yourself in a great position to iterate.
Yet few founders create the tools to help make those decisions. We connect with hundreds of founders each month, and the most common mistakes we see include:
- They created a financial model just to satisfy investors, but they don’t use it for their daily operations.
- They are using a revenue-driven financial model, rather than a driver-based model.
In the fast-paced world of start-ups, quick and informed decisions are essential. Take a look at this example scenario.
A company is looking to raise a $1 million seed round to finish building and launching their product. You can set a consumption rate target of $40,000/month so that the principal will last approximately 24 months.
A safe cushion is to assume that negotiations with new investors will take about six months, so by month 18, the company should be in a position to start submitting proposals to the next round of investors.
Where should the company be when it wants to raise money? How much of the product must be ready? How much income will you have? How many clients? How much will it cost to bring in those customers?
Founders need to make sure their capital deployment takes all of those variables into account. A miscalculation can mean spending too little (and not launching the product on time) or spending too much (and not being able to close the next round before the money runs out). The stakes are high.
The problem is that, in my experience, seed-stage founders rarely think about these goals when defining how much money they want to raise or how they want to spend it.
Creating a model that you actually use
The most common problem I see is that entrepreneurs think of the financial model as a “homework”, so they prepare it to satisfy an investor’s request or to fill out a slide on the pitch deck.
In the pre-seed or early stage, it is impossible for the model to accurately predict revenue. So for an early-stage business, the model should serve two main purposes:
- Monitor the track and enable you to make financial decisions to ensure you reach your next funding milestone.