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 startups work on a risky and aggressive capital deployment, often operating at a loss for years as they pursue expansion and market dominance. This means that the track is a key KPI that founders need to keep an eye on for every single financial decision.
Aggressive spending is expected to translate into aggressive growth: Revenue could increase by 20% or 30% month-over-month, which makes track estimation an ever-changing target. Being able to expand your team a month early can make a huge difference in the long run, or quickly reducing expenses can prevent the company from running out of money.
When milestones and deadlines are driven directly by your finances, you put yourself in a great position to repeat.
However, few founders build the tools themselves to help make those decisions. We connect with hundreds of founders every month and the most common mistakes we see include:
- They’ve created a financial model just to please investors, but they don’t use it for their day-to-day operations.
- They are using a revenue-based financial model rather than a driver-based model.
In the fast-paced world of startups, quick and informed decisions are key. Check out this example scenario.
A company is looking to raise a $ 1 million seed round to complete the build and launch of its product. It can set a burn rate goal of $ 40,000 per month so that the capital lasts around 24 months.
A safe cushion is to assume that new negotiations with investors will take around six months, so by 18 month the company should be able to start launching into the next round of investors.
Where should the company be when it wants to raise money? How much of the product should be ready? How much income will it have? How many customers? How much will it cost to bring those customers?
Founders need to ensure that their investment takes into account all of these variables. A miscalculation can result in spending too little (and not being able to launch the product in 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 template that you actually use
The most common problem I see is that entrepreneurs view the financial model as a “homework”, so they prepare it to meet an investor’s request or to fill a slide in the pitch deck.
In the pre-seed or seed stage, it is impossible for the model to accurately predict revenue. So, for an early-stage company, the model should serve two main purposes:
- Track oversight and empowering you to make financial decisions to ensure you hit your next funding milestone.