When I was an early-stage founder, I bristled at the idea of making a five- or even three-year financial projection of my business. I can promise you one thing: It will be dramatically wrong. But as part of your fundraising, you need to make them anyway, and there are a couple of great reasons for that.
VCs understand as well as you do that you can’t predict the future. Hell, that isn’t just true for companies at the pre-seed stage; if founders could predict the future, there wouldn’t be so much nervousness around IPOs.
But it’s worth keeping in mind that your investors aren’t asking you to predict to the nearest penny how your company is going to perform in 2030. They are looking for two very specific things: Whether you understand how the financial dynamics in your business work and whether you are venture-scale.
To be venture-investable, you need to be “venture-scale.” That means that if an investor puts $1 million into your business, you need to have a very firm grasp of how you’re going to turn that $1 million investment into a $10 million return. Now, not every business is going to do that, of course, and it’s not easy to guess which businesses are going to successfully give investors a 10x return.
I can guarantee you one thing, though: If the financial projections show steady 10% year-on-year growth for the next decade, it may be a good lifestyle business, but it’s never going to give a 10x investment return.
In other words: Yes, your financial projections need to be “realistic,” in the sense that they show that there’s a logical progression from where you are to where you want to be. But you also need to show, in spreadsheets and numbers, that you at least have a fighting chance at being venture-scale. If your most optimistic, most aggressive growth trajectory falls short of this, you’re not going to have a good time as a VC-backed startup founder: It shows that you have fundamentally misunderstood why investors invest.
Understanding the financial mechanics
When you are raising money, you need to show your investors that you have clear plans for why you are raising money. In other words: What are you going to do with the money?
Originally published at techcrunch.com