Category: Investing

Persuasively Projecting Revenue and Profit

Predicting the future is never easy. But by following these dos and don’ts for financial services projections, you can avoid some common mistakes

It doesn’t matter whether you’re applying for your first bank loan or your fifth, or whether you’re seeking venture capital or debt financing. Sooner or later, you’ll have to prepare a set of financial projections. Lenders will look for a strong likelihood of repayment; investors will calculate what they think is the value of your company.

In my past 10 years both as a banker and as a financial consultant, I’ve seen many entrepreneurs — despite the best intentions — make mistakes on their projections. The good news is that the most common mistakes are easily preventable if you know what to look for. Here are my top dos and don’ts:

Don’t provide only an income statement; include a balance sheet and a cash-flow statement, too. It’s understandable that you’re focused on sales and net income, but your banker or investors will also want to know how much money you intend to leave in the business as retained earnings and how much additional debt or equity financing you’ll need — if any — to grow your company.

Do provide monthly data for the upcoming year and annual data for succeeding years. Many entrepreneurs prepare projections using only monthly data or only annual data for the entire three- or five-year period. Don’t. Use monthly data for the first year. After that, use annual data. The financial results of your first year will probably end up being different from your projections, so there’s no point in thinking that you can accurately forecast monthly results for the years after that. This is an instance where less is more.
Don’t provide more than three years’ worth of projections unless your lender or investor has asked for them. This is an extension of the less-is-more concept. Let’s face it: it’s a stretch to accurately forecast your company’s sales or net income for even three years out. Only in cases in which you’re looking for long-term financing for equipment or real estate is it likely that your banker will want longer-term projections.

Don’t provide more than two scenarios in your projections. Loan officers and investors are already drowning in paperwork, so do what you can to make their lives simpler. We’ve all seen projections with the following three scenarios: base (or likely) case, worst case, and best case. I’ve also seen super case and break-even case. My advice is to prepare just the base case and the break-even case. The base case should show what you realistically expect the business to do; the break-even case should show how low sales could go before the business begins to lose money.

Do ensure that the numbers reconcile. Everybody knows that assets must equal liabilities plus equity. But all too often entrepreneurs will simply plug a figure into the equity slot to make things settle up. That’s wrong. If your bank is doing its homework, your banker will check the math. If the equity numbers don’t add up from one period to the next, you’ll be asked to explain. Even though everyone makes mistakes, that’s one you want to avoid because it makes you look sloppy. Also, if after the mistake is corrected your company has a smaller net worth than you originally presented, your banker or investor may think you were being intentionally misleading. Not good.

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Don’t be too optimistic about sales growth or gross and operating profit margins. All bankers and investors want to do business with ambitious entrepreneurs, but there’s a big difference between a realistic business plan and fantasy. While it’s true that companies that have low revenues can grow their sales quickly in percentage terms, it may not be realistic to assume, for example, that your business can double in size every year. That rate of growth would turn a $500,000 company into a nearly $16-million business in only five years. And although that can happen, it is definitely not the norm. Also, entrepreneurs often try to convince lenders that as their company grows it will achieve economies of scale, and gross and operating profit margins will improve. In fact, as the business grows and increases its fixed costs, its operating profit margins are likely to suffer in the short run. If you insist that the economies can be achieved quickly, you will need to explain your position.

Classic Secrets to Getting Startup Funding

Getting Startup Funding

BELLEVUE, WASH. — Roxanne Benton Darling toyed with starting a business for two years. “I’ve started and stopped a couple of times, but for whatever reason, it wasn’t happening.” Now it’s happening, and her fledgling business, Health Options Coach, is a health and stress management consulting business that will use the Internet to connect with clients. “I’m ready to ride the wave,” says Darling, a resident of Santa Fe, N.M. And that is why she has enrolled in Bootcamp for Start-Ups, Garage.com’s two-day event where entrepreneurs learn the ins and outs of raising capital for high-tech companies. Garage.com is a company that connects high-tech start-ups with investors.
This week’s start-up event has drawn a crowd of more than 1,000 attendees, packing to capacity the Meydenbauer Center, located here. Like Darling, many entrepreneurs have come to immerse themselves in the world of high-tech start-ups and to find seed capital. “I’m here to be exposed to intellectual capital as well as the financial capital,” Darling says. And when it comes to attracting capital, boot camp panelists have plenty of advice. Here are four of their key fund-raising insights.

Keep your business plan short.

The market is hot, and business plans for the next big Internet thing abound. Zack Herlick, a partner at the Seattle-based venture capital firm Maveron LLC, says his firm considers 3,500 business plans a year, of which it funds only 10 to 15. Peter Hartigan, a development officer at Softbank Venture Capital, says he looks at 50 business plans a week — but his company funds only about 50 a year.

How can you increase your plan’s odds of standing out in a crowd? Be brief. Hartigan of Softbank recommends that your business plan be 10 pages, with a two-page executive summary. “We’ve got a lot to look at,” says Dennis Weston, senior managing director of Fluke Capital Management LP, a venture capital firm focused on investments in the Pacific Northwest. He advises entrepreneurs to create a plan that is concise, direct, and compelling.

Although business plans have gotten shorter, the essential elements remain the same. Greg Bailes, technology partner at PricewaterhouseCoopers, stresses the importance of a well-thought-out plan. The executive summary should be no longer than three or four pages, and the plan should have information such as the market you’re pursuing, the problem you’re trying to solve, your proposed solution, a strategy for attacking the market, financials, and an exit strategy.

Get a referral.

“It’s really a networked world,” says Guy Kawasaki, CEO of Garage.com and the conference’s moderator. To get a venture capitalist’s attention, you need to know the right people, who can make the right introductions. “Finding a referral source that is credible is probably the most important thing to do,” says Weston from Fluke Capital. Make use of your board of advisers, board of directors, professional services team, or anyone you know who has connections to the venture capital world. That’s because many firms look to people they know and trust to find them investment leads.

It is possible to get a plan considered without an introduction — but it’s not easy. Two boot camp panelists say they consider all plans that come across their desks, while others say they occasionally consider plans without referrals. Still, it’s clear that introductions help entrepreneurs get noticed. When asked how many deals he’s made without a referral, Hartigan of Softbank estimates only one out of 50. Warren Packard, a partner at Silicon Valley venture capital firm Draper Fisher Jurvetson, says one or two companies out of a portfolio of 80 weren’t introduced by a referral.

Have the right CEO.

Doug Brown, partner of Paladin Partners, a firm that offers strategic consulting to early-stage companies, encourages entrepreneurs to consider the CEO question early on. “Understand the role of the CEO, and make a decision as to whether or not you’re that person,” he says. Your CEO will be instrumental in getting capital. The right CEO will be influential in attracting investors as well as creating the vision, mission, and company values, he says.

Develop a great “elevator pitch.”

If the person standing next you in the elevator wanted to know about your business, what would you say? Bill Joos, vice president of business development at Garage.com, offers advice on creating an “elevator pitch” — a 30-second spiel designed to pique an investor’s interest in your business. By limiting yourself to 30 seconds, you are forced to focus on what really matters, what Joos calls “the distilled essence of your dreams.”

Passion is important to the success of an elevator pitch. According to Joos, a good pitch must change the investor’s pulse rate. “If you can’t talk about your business in a passionate way, you can’t be an entrepreneur,” he declares.