January 19, 2016 | 4-minute read (648 words)
This guest post is from Joe Silver, VP of Finance at Lighter Capital.
Any potential investor worth their salt will want to know where your business is headed and how their investment will help your business get there. It is very important to offer a set of realistic and attractive financial projections when raising capital.
You should approach financial projections like you are telling the growth story of your business. That story will show important numbers and analysis via financial statements. Individual income, investment and expense components combine through financial statements and metrics to show where you are going and what it will take to get there.
When building out your projections, you can use historical data as a baseline. Usually investors like to see two to three years of your historical financials to get started. If you have a shorter operating history, however, use everything you have. These financials are important in that they convey what you have accomplished so far, as well as set the foundation for efficiencies and scale you will can reach in the future. A multi-year track record can indicate how you manage your company and previous investments internally as well as the external market appetite.
Once your historical financials are ready, you can then move to the next part of your growth story - revenue on the P&L statement. Determine your gross revenues by building up from the most basic elements - pricing by channel and units sold. Having a solid grasp on unit economics is vital for planning for the future.
Moving down through your P&L will reveal the related expenses to achieve your revenue growth. Is net margin increasing to align with mature comparable companies within your industry? Is gross margin increasing over time? Are incremental expenses decreasing as you scale? If revenue is projected to triple year over year while your fixed costs only double, you can show a path towards profitability. It’s always nice to show top-line growth, but it is important to show efficiencies further down the P&L in order to demonstrate the long-term sustainability of your business in the long run.
Financing Your Key Investments
The base for your company’s growth story has been put in place thanks to your P&L, but there is still work to be done. Now you must connect the dots through the balance sheet to find out what investment needs to be made to achieve your growth milestones, as well as how that investment will be obtained. Is it time to expand your business development team, add key leadership positions, or build on the back office? Should you invest in infrastructure, significant inventory amounts or fixed assets? Answering these questions goes a long way to determining what investments are needed to fuel your company’s growth.
Determining the required amount of investment capital will help you find the ideal type of capital you need to raise. Does additional equity need to be secured? How about debt financing? Maybe a mix of both to help maintain a strong balance sheet? Whichever you choose, plugging in these proposed investments is an important part of your projections so that potential investors can see what commitment is needed to facilitate growth.
It is also crucial that you show a judicial approach to cash management. This can be shown in your projections via responsible cash burn and controlled spending.
In conclusion, keep in mind that all investors are going to discount your projections. Being too aggressive with your calculations can ultimately damage your credibility. Taking a strong, yet realistic approach is the way to go. Show how your business has significant potential to scale while being profitable, and do so in a manner grounded on realistic fundamentals. Start with a realistic foundation and include an upside case as well showing the potential in a best-case scenario.