All too often companies approach us to analyze the market feasibility of a product. Usually, the product is already in process, and they’ve hit a snag; the CTO has bailed, the tech team is lackluster, the costs have overrun a tight budget. They are asking for our help in a crisis. They want us to get things back on track or at a minimum understand what it’ll take to get things back on track. They are doubling back on something that should have been one of the first points of analysis. They are asking “Is this even worth it?”
We like playing the hero, so usually, we’re game. Not every product should be taken to market – no matter how much has been invested so far. Good money can go after bad sometimes, just not very often. One thing that is almost as common as bad ideas are the lack of market analysis and financial projections.
Good financial projections include a realistic addressable market and a feasible plan (with associated costs) of addressing a realistic market share of that market. The words “realistic” and “addressable” aren’t exactly concrete. So what does a good financial projection look like?
I’ve seen 4000 financial models of companies at varying levels of maturity. There are a few telltale items the scream out:
1) Lack of Fully loaded salaries
If your model has a peanut butter spread of salaries – vague numbers, a ballpark, it isn’t a good model.
Fully loaded salaries are a good sign of what is realistic both regarding running an operation but also regarding valuation. If your leadership is “working for (unrealized) equity” – that can’t go on for long, and it won’t float in the open market. It is more than fine for everyone to contribute sweat but if you are relying on what amounts to free labor you aren’t profitable. You can only claim profitability if your salaries are fully loaded according to the open market. Fully loaded means taxes, health benefits, paid vacation and whatever else needs to happen to attract talent. Anything less and you are raising the risk factor. What happens when your CTO get sick or gets sick of working for free and gets lured away for a real paycheck? If you can’t afford it now then when? There needs to be an answer and if you don’t know the answer – even regarding “when we reach X and Y is the path” then you need to keep looking and analyzing until you can get to a realistic answer.
So you are just starting out, and you aren’t trying to establish a valuation, and you aren’t profitable yet anyway – so why does it matter? Your model needs to be realistic from the beginning. You don’t want surprises, and if you don’t have a grasp of such fundamentals from the beginning, you are likely to find yourself behind the 8-ball moving forward.
2) Lack of on-boarding or Hire dates
If your model just shows your outlook as “fully staffed” or doesn’t take into account the productivity hit of new hires you are missing a pretty big drain on your resources.
The presence of hire dates implies an understanding of workflow, volumes and cycles. You don’t need everyone on board at the beginning – but you do need to know when you need them, how long it will take a sales associate to get up to snuff, how much onboarding is going to be needed to get a new engineering team productive, etc. Don’t make the mistake of phoning this in.
3) No Marketing Budget
If you build it, they will not come. Bet on that.
In the early days when we’d take time out of our lives to go to entrepreneurship breakfasts, we watched a lot of pitches, gave a lot of pitches honestly. The rooms were full of entrepreneurs and lawyers – nearly no actual investors. It was considered a privilege to be there – at least until you concluded that it was a complete waste of time. It was truly astonishing how many pitches lacked any marketing or sales budget, much less plan, at all. No awareness of what it was going to take to get the tech (it was usually tech) into the market, adopted and used.
Do you have a sense of your weighted return? Your adoption rates? Attrition? Much of that learning will come later, with real numbers, but if you don’t ask the question and try hard to find the answers, you risk getting bitten hard by some mysterious and surprising results.
4) No Support costs
When the tech is done, will it be done? Hint: It won’t is.
I saw a post to a founder network list the other day. The poster asked, “how much should I budget for development after we launch.” The poster went on to say that “there’s no reason to need a developer at all once they were launched” but nonetheless they wanted to budget for it anyway. This is probably better than thinking your technology is done, period and then being shocked when there’s a bug or need or even demand to improve, extend, evolve the product. Like buying a house and assuming you’ll never have to put money into it.
Knowing how exactly things are going to fall apart is always hard to predict, but you should develop a matrix that allows you to predict the staffing needs against certain models. There are accepted algorithms that can get you an approximation based on your market, the level of user and volume but nothing can substitute for road testing with users, beta acceptance, on-boarding, and a complete operational review of integration. Eventually, you support costs will factor into their model and you’ll develop a sense of volumes and impact that can translate into scale and cost but until you start to think about those factors you may be caught unaware.
5) Unrealistic Build
Are you going to take the market by storm? Is the demand pent up and on the verge of explosion? Don’t be a fool – this is serious.
When I craft financial models, I build the revenue with a mind towards the length of the sales cycle and size of the deal. Seasonal implications are also a real influence. It depends on the size of your market and your access to it, the cost of acquiring customers, the attrition, start up costs, etc. All this needs to be factored into a good financial model. Ideally, your margins will be good enough that a little wiggle here or there can be accommodated but if you are operating on a thin return or are early in the process, you’ll want to know the difference a few weeks makes. By crafting a realistic build, you can often spot your errors in the assumption – will you have six high-dollar customers in month 2? It pays to questions all your assumptions.
6) Cash Flow
We’re on track to do great things …
If you don’t consider cash flow, directly, in your financial model, we should all get-together and lock you in a room for your safety. You can have millions in receivables at 90% margins and still go under if you can’t make payroll. I recently consulted an old friend who I’ve known for 20-some years. His goal was to reach $10 million in revenues before cashing out. He’d worked out a complex rationale for his valuation and the growth he’d need to achieve to reach that point. We talked for hours. When I asked him about his payables and what kept him up at night, he confessed to needing to drive around all day and shake trees for money just to keep the lights on.
Potential means nothing without a healthy cash flow. Even the best (and biggest) of companies suffer cashflow-related disruptions, but you should be doing everything you can to avoid it. Focus less on the revenues and more on the cash flow – you’ll get a lot more sleep that way.
A realistic model is more than these size items, but without these, you run the risk of having your head in the sand – in a bad way.