How to make Financial Projections in a startup?

Financial Projections for a startup: We had a phrase during the initial stages — FIA approach — finger in the air approach. Financial projections were ever so difficult with a lot of conjecture and calculated guesses. There are some very nice models available — Internal rate of return — IRR, weighted net revenue etc which is a well-accepted financial modelling principle in the investment world.

The follow on steps were about making these numbers sober. We will talk through market capture, potential future valuation rounds to develop your financial model. I’m tempted to draw motivation from a beautiful quote by Jason Fried,

Projections are just bullshit. They’re just guesses.”

-Jason Fried, Founder, 37Signals.

How are financial projections made for a startup?

For an early stage startup, valuation is very difficult. The best way to do this is to find a competitor or a similar business. Make an assumption about a % of market capture to give you an idea for initial valuation. Ultimately your startup value is based on

• Quality of your product, its IP, difficulty in reproduction by someone else
• Number of customers you already have
• Potential market size

The above gives you a high level view of the accessible market. Beyond that you need to do additional work on individual areas.

Market capture and accessible market

The accessible market is a subset of the market segment you focus on. Following that you’ll separate it further based on various profiles that separate your customer base. For some, it is age, gender, business segment etc. Your job as a founder is to define your market clearly to show your focus to investors.

Your market segment can’t be too broad. If it is, narrow it down to the area that impacts your product the most. Once you have this- split it further to start building your financial projections.

Costs of running your startup

Most of us tend to underestimate the cost of running a startup. You may start with bootstrapping resources, but as the startup grows — your expenses increase. You’ll need to think about scaling up your operations, building processes etc. (Read more — Difference between small business and startup)

Running your startup has multiple expenses. Some areas to think about are:

• Developing your product — including in-house resources, outsourced options, project management etc
• Marketing and branding costs — you’ll need to consider paid options as your startup grows
• Services costs including legal, accounting, consultancy along with any payouts for your board members etc

As you can see, your costs mount up. Make sure that you start building these costs and a variable amount into your startup financial projections.

Time and Opportunity Cost

Most entrepreneurs and founders tend to miss this in their financial projections. Although you can’t add a goodwill cost into your business model, you must find a way to make your losses tangible. Identify what your opportunity costs are.

Anyone joining your startup will sacrifice their initial position. This sacrifice is usually paid out in the form of employee stock options. Make sure that you keep a separate segment of employee stock options while considering your financial valuations. Most investors will expect you to build this into your financial model. ( How to hire in a startup?)

Future fundraising rounds

As a founder, you must constantly look into the future. Usually most startups go through multiple rounds of funding. An early stage startup might get some seed funding to develop the product. However, future stages are for increasing the size of your market capture. Remember, most investors will be interested in a payout as company grows. They will be keen on exponential growth for bearing risk of investing with you. ( Series A, B and C fundraising)

To achieve this growth, although you can depend on organic growth, the process is slow. If you’re considering this for your business idea, make sure that you consider that the stock options for your investors will reduce with time. If you start with a low valuation, it will hurt your future projections. However, if it is too high, then you might need to dilute your shares.

Originally published at https://inspire99.com on September 18, 2022.