Hi guys,
This week in After the Cap Raise, I want to discuss one of the dark arts of building a high-growth venture: Financial Forecasting. Every founder will encounter the need to create a financial forecast along the startup journey, but few truly nail it on their first go.
Let’s rewind to 2018. I was raising a seed round for my company. The company had experienced great growth, getting real traction with customers, and we wanted to raise capital to put the foot on the accelerator.
One of the sticking points we kept coming across was our forecast. As young founders it was something we had limited experience in creating and we felt it was important to get right to give investors confidence in where we were heading.
What better way to do this then engaging a Big 4 consultant to help build out a Financial Model. This turned out to be one of our many early mistakes.
For what I now realise was an exorbitant price of $24k, we received a detailed five-year forecast model. The model was a thing of beauty (if that’s what you’re into!), with dozens of tabs all formula driven showing the hockey stick growth we were hoping to achieve.
The problem? I didn’t understand it. Not to the level I needed to anyway.
I spent hours in the lead up to investor meetings studying this thing and trying to get my head around how I’d go about explaining it. That all fell down during one of our first meetings when I was asked about what growth would look like if a few things didn’t go our way. I fumbled through an answer but I knew deep down it wasn’t great.
The issue was I didn’t know the assumptions that sat behind the model, which is ultimately the most important thing. Despite doing my best, the complexity of the model made it harder to explain, and that’s what investors actually want to see - do you get it.
And the worst answer you can possibly give to a question about your model is “I don’t know, my accountant built it”.
Which leads us to how you should be thinking about Financial Forecasting.
At KC Ventures, we work with 50+ Founders and the cream of that crop truly understand the ins and outs of their forecast and the assumptions behind it. They get that if their pipeline numbers at top of funnel dry up in January, this is likely to impact on revenue in April or May as that flows through to the P&L.
The best way to get to this level is treating your Forecast as a living document that you engage with on a regular basis. Too many Founders think a model is something which needs to be built for a cap raise, but then is rarely looked at again. You need a model which gives you data and insights every month to action. If things are going well in a startup (and even if they’re not), a good financial model should be your roadmap helping articulate how everything is coming together.
The other area I see a lot of confusion in startup land is the difference between a forecast and a budget. People use the terms interchangeably, but they are very different things:
The “budget” is what we want to happen. Targets we set ourselves at the start of the year. The budget should be circulated, agreed with everyone and then crystallised. The budget should not change throughout the year.
The “forecast” is what we actually think is going to happen. As things change throughout the year, both good and bad, the forecast should evolve alongside it. Lost a big deal in the pipeline to a competitor? The forecast should reflect it. Made a whole ton of senior hires? Again, get reflected in the forecast. This should be updated at least monthly alongside actuals so you can see where you’re at under a range of scenarios.
Too often I see Founders who tell me “we hit our forecast this month”, however that forecast was updated only last month, and is actually 40% lower than the targets we had budgeted at the start of the year. Hitting a one month budget is not an earth-shattering achievement.
So what should you take away from this?
KCV Key Lessons:
✅ It’s often more difficult to build a simple model than a complex one. Simplify your model and make sure that you as a Founder both understand it . And how the numbers will change if something goes off script (which it inevitably will).
✅ Investors don’t believe your numbers. Every single pitch deck shows a revenue profile going up to the right - no one forecasts things to go down. But the reality is this simply doesn’t happen for every, or even most, startups. Investors know this so take the raw revenue numbers itself with a grain of salt, which makes the assumptions the key thing they dig into anyway.
✅ As a Founder you should think about your forecast as a tool for you rather than as a tool for investors. If you approach it from this lens it becomes a useful resource for a cap raise, but more importantly post-raise. And as an aside, five-year forecasts in a startup are a useful as a screen door on a submarine - it is simply impossible to predict.
As to what happened to that fancy Big 4 model? We closed the round, but the model quickly went into the top draw, never to be looked at again. Paying that invoice didn’t fill me with joy…!
Until next time,
Luke Rix and the KC Ventures team
P.S. If you’re a Founder looking for support with your forecasting, or any finance needs, hit me up at [email protected]. I promise it will be more affordable than $24k!