Financial projections are, on the surface, a futile exercise. Nobody believes them. Studies prove that 98% of actual business results of start-up companies are less than projected and take twice the time, compared to the projections in the business plans. Yet investors insist on seeing them, and complain if you leave them out of your presentation. Why?
Because financial projections serve two functions.
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?
Two, they are the beginning of a dialogue about the underlying assumptions of the model. Actually there’s a third: if the projected revenues are way too high or way too low, that could be a reason the investors lose interest immediately.
Where do aim in your projections. High, low, middle? (No, the solution is not to show all three high/low/middle cases in a presentation.) Don’t make them low and NEVER utter the word “conservative.” You won’t get credit for being conservative, and investors will discount the numbers anyway. Don’t make them crazy high, divorced from reality, or you’ll lose credibility.
It’s best to use what I call “Goldilocks numbers.” Not too hot, not too cold, but just 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 sometimes in the Q&A of a private first meeting–that drills down into your assumptions and the business strategies that drive the assumptions. “How will you deploy your sales force to reach 75 customers, and are the costs realistic?” The investors get a truer picture of you and your model. At the very least, you get feedback you can use to make the model tighter. Or a dose of reality that leads to strategic course corrections. At best you get validation and win the confidence of the investors, a firm basis for going the next step.
Steve, this is great. I never even thought of having three models. I’m adding it to our slide deck ASAP.
Jameson, Yes you should be modeling all kinds of scenarios in your spreadsheets. But I hope I didn’t give the impression that you should show all three in your presentation or summary materials (the executive summary). In a first meeting you only show the middle one, the Goldilocks numbers. Or, as I tried to show in the example, a high middle, the highest you can go with the projections and still be grounded in defensible reality based on your research and understanding of your customers and market.
I just made a small edit to the post to avoid any further confusion.