by Alejandro Cremades
Republished from Entrepreneur, October 7, 2018
How do you forecast revenue and growth rates for a startup business?
Creating revenue and growth forecasts can be one of trickiest parts of business planning and fundraising for startup entrepreneurs. These numbers are likely to change dramatically once you get going, but they are still needed and expected. Below is a quick guide outlining methods of generating financial projections and key growth factors.
Why & Who
Why you are creating these projections, who you need them for, and what they are supposed to do for you, may be significant factors in how you put together these numbers.
As described in my book, The Art of Startup Fundraising, all entrepreneurs need some form of budget and business and marketing plan. Revenue and growth calculations are going to be vital for determining what you can afford to do, and showing you what you need to do to get where you want to be. As well as for skillfully navigating potential cash flow shortages which can sink your startup fast.
If you are trying to go to a traditional bank for a business loan, then they’ll be expecting pretty standard 1-5 year financial projections. Big growth claims might scare them off.
If you might at any point try to raising funding from angels or VCs, then these are key numbers that will determine whether your startup is an attractive or viable investment for them or not. If you are not intentionally thinking about this, you probably won’t even be in the right ballpark.
In the event angels or VCs are the way to go for you, you will need to incorporate these numbers in your pitch deck. As an example, I recently covered the pitch deck template that was created by Silicon Valley legend and VC, Peter Thiel (see it here), where the most critical slides are highlighted including the financial forecast and growth drivers. Moreover, I also provided a commentary on a pitch deck from an Uber competitor that has raised over $400M (see it here)
4 Keys to Success
For entrepreneurs considering raising money, these four elements will be vital for success:
- Keep it super simple: you’ll need to show this on pitch deck slides
- Throttle growth projections: you need to maintain growth rates to get new funding
- Use this data to show investors a path to 10x plus returns
- Be aggressive, but realistic
If you aren’t realistic with your projections, no one will take you seriously. Yet, you also need to show enough revenue and growth to be exciting to potential investors. Via the Huffington Post, CEO of Startup Professionals, Marty Zwilling says to be fundable, by year 5 revenue projections should be at least $20M, with an average growth rate of 100% per year.
Expenses: Bottom Up Projections
When it comes to financial projections CEO of Covestor Asheesh Advani recommends “focusing more on your upcoming expenses than on upcoming cash flow. What is your overhead (or fixed costs)?
As a young startup, and especially a pre-revenue startup, it can be hard to predict sales and profits. You can far more accurately assess and control your spending. So, calculate what you are spending and the costs to be in business and to generate sales. Then figure out how much your pricing and sales volume needs to be to make a profit and hit your growth needs.
Your startup expenses may include:
- Technology expenses
- Insurances and licensing
- Communications costs
- A budget for fundraising efforts
- Cost of goods sold (and delivery)
A smart rule of thumb is to double or triple your forecasts for marketing and legal expenses, as they will always cost more than you think.
Revenues & Growth: Top Down Forecasting
For fundraising, entrepreneurs need to make sure they are projecting big enough revenues and growth to draw in investors. It also needs to match up with your market size data that is included in your pitch deck. Keep in mind there is a thin line between being optimistic and lying to investors which may be considered a fraud. Always operate with integrity and deliver on your word.
For this reason many choose a top down approach. Starting with market size, potential market share, and then what costs and investment it will take to hit those numbers. For more detail on this and calculating your TAM (Total Addressable Market), see my recent Forbes article How To Effectively Determine Your Market Size.
Benchmarking Your Financial Data
Being realistic in your projections is crucial. Many passionate entrepreneurs like to roll in with big claims to try and excite potential investors. Pause and think for a moment. Anyone that has been smart enough to amass that amount of free investable capital probably has the intelligence and experience to instantly spot hype from reality. Don’t instantly get your startup kicked to the spam folder for this.
One way to backup your big claims is to benchmark your numbers against data from others. This can be by industry, business size and stage, fundraising round and location. Venturebeat has data from Equidam on financial projections from 15,000 startups from around the world, with graphs to match.
Three more key sets of data to focus on in this process include:
- Break even point (including the time you need to be able to spend on this venture)
- Maintaining profit margins as you scale (watching out for discounts given and new overhead)
- Revenue per employee
Richard Branson’s VirginStartup.org says to watch headcount in these financial forecasts. Remember that you can only service so many clients and accounts effectively yourself. At some point you’ll need to hire to facilitate growth. In fact, number of new hires will be one of the key questions you get from investors every time you enter a new funding round.
Investors will expect you to hire to grow. Yet, they will also want to be careful that you are hiring in a scalable fashion, and that it doesn’t mean diluting equity and returns in the company.
Try to keep in mind that while running these numbers may not be your favorite part of launching and running your own business, they are one of those foundational factors that will allow you to get the resources needed to really make it happen. The sooner you champion them, the sooner you can get back to the activities you are most passionate about.
You’re not going to get far as a startup entrepreneur without revenue and growth forecasts. When preparing them make sure you know who they are for and why you are creating them. Things will change. Yet, having these numbers laid out, and knowing how to present them well will help you get through to the next stage and gain the resources you need to succeed.