In 25 years of reviewing financial projections for startup and growth-oriented companies, some presentation characteristics never change. Entrepreneurs tend to underestimate just about every administrative and marketing cost and the time it will take to secure first customers.
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Guess what entrepreneurs tend to over estimate? Revenue and profits.
The reason why projections tend to be so far off the mark is entrepreneurs try to guess what will impress investors. It is true that startup and early stage investors seek out reasonable opportunities to earn rates of return over 30% to 40%. Still, it's not worth backing into artificial sales and expense numbers just to reach an assumed rate of return, sales growth or profitability goals. More thoughtful approaches to projection development stand up to investor scrutiny.
Here are my insider’s tips to financial projection development:
No. 1: Develop a complete set. Well-prepared projections include a profit and loss statement ('P & L'), a balance sheet, and a cash flow statement. Entrepreneurs should know how long it will take to reach monthly cash flow breakeven and how much capital will be required to reach this crucial milestone of financial safety. It is not necessary for raw startups to prepare more than a 24 month projection. If investors want more detail, they will ask for it.
No. 2: Make it easy for reviewers. Take the time to write up a summary of key projection assumptions. Address areas of likely concern to your targeted funding source. Explain noticeable changes in revenues or costs too. Be ready to describe how you will attract first customers without over-reliance on paid advertising.
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No. 3: Avoid volume discount price breaks. If your widget costs X, don't casually assume that higher production will automatically lower your company's overall costs. Sales growth costs money.
No. 4: Check the math. Too often projections just don't add up – literally. Investors view sloppy work as a potential sign of sloppy management. And finger pointers won't get funding either. Blaming poor presentations on hired bookkeepers doesn’t build confidence in management’s accountability.
No. 5: Know your industry. Funding sources will compare your projected results to industry averages. If your projections show sky high gross profit margins, be prepared to explain why your numbers are reasonable. Similarly, if you tell investors that one day a corporation will pay five times your projected revenues to buy your business, find at least one recent industry transaction to support your valuation estimate.
No. 6: Accept the “haircut.” Experienced investors typically cut projected revenues in half and boost expenses as part of their “what if” analysis of a company’s viability. While this exercise is extremely frustrating to entrepreneurs, the investor’s objective is to test how much money may really be required for a company to comfortably reach cash flow breakeven, complete product development or launch a product successfully into the marketplace
No. 7: It’s ok to be wrong. History usually proves all projections wrong so don’t spend a lot of time debating or insisting that your view is “right.” You won’t win. Rather, agree that problems will occur. Demonstrate that you have an open mind and can handle constructive criticism well.
Beware of the “hockey stick.” In business plans, entrepreneurs frequently present their projected growth in annual revenues and profits in the form of a chart. The graph of a young company's projected revenue growth line typically will be flat for some short period of time, and then rise sharply taking on the appearance of a hockey stick. The steeper the pitch of the hockey stick revenue line, the more investors will question the entrepreneur's business judgment.
Here’s one last tip. Don’t tell investors that your projections are "conservative." It makes us laugh behind closed doors!
Entrepreneurs are ambitious, assertive, innovative, fast-acting and driven to create change in the marketplace. Nothing about successful entrepreneurship is conservative.
Susan Schreter is an advocate for the greater small business community and the “Big Voice for Small Business.” She is a 20-year veteran of the venture finance community and expert on startup viability. She is the founder of www.takecommand.org, a community service organization that offers the largest centralized database of startup and small business funding sources in the U.S. Follow Susan on Twitter @TakeCommand.