The ongoing market downturn and layoffs at tech companies have caused a great deal of alarm across the startup and venture capital worlds, but growth-stage startups are expected to bear the brunt of the impact.
Early-stage startups have an opportunity to capitalize, as investors with dry powder will eventually need to deploy it to secure their management fees. Investors are moving focus toward earlier deals, which may be less risky in the short term compared to investing in growth-stage companies at larger average check sizes during a downturn. This is because the closer a company is to an IPO, the more investors establish its worth as a function of public company valuations.
Even when times are bad, good businesses will get funding. The key to proving your business is solid to an investor is to adopt a data-backed approach when telling your company’s story.
To start off, founders first need to figure out how much capital they need to hit business goals.
As many funding rounds reach eight or nine figures, the details that go into those deals can seem abstract to new founders or sound like companies are playing with Monopoly money. For many founders, especially those from nontraditional or under-resourced backgrounds, it can be daunting to even say, “I’m looking to raise $20 million,” out loud and feel like you’ll be taken seriously.
Although simplistic, you can think of pitching as simply getting an investor to buy into your model.
A solid financial model is critical to bridging the expectation gap between founders and investors, and it will allow both parties to cut through the hype and focus on the fundamentals.
Here are eight steps to developing a financial model to accurately project your fundraising needs:
Understanding your magic number
Before we build a financial model to find the magic number your business needs to raise, we first need to understand what a good model looks like.
Your model should project your needs two years in the future and include a 2x margin of safety.
A two-year time frame puts enough pressure on the startup team to execute, but not so much that they can’t be thoughtful and strategic. If your business is not making significant progress in driving up your valuation or revenue every two years, it’s likely that there are problems with the business model.
It’s hard to establish projections beyond two years with rigor, and you risk going down an analytical rabbit hole. Founders should avoid doing so for investor presentations. That said, founders should also make a long-term model (10-plus years) to think about overall strategy.
The human brain is notoriously inaccurate when planning, and a margin of safety is a great tool to account for this. Additionally, we live in uncertain times, which makes it critical to account for unexpected future macroeconomic shifts. Building a buffer into your model helps provide a cushion that you can use to get over any unforeseen roadblocks between rounds.
Once you find the amount you need to operate for the next two years, multiply that number by at least 1.5 (2 to be extra safe) to get your magic fundraising goal number.
Building the model
The data points we’ll use to determine overall fundraising needs are: