According to the results of a recently published study by a highly credible research organization, 0.00 percent of financial projections issued by startup companies end up being accurate one year after they are issued. While the research organization and the study can be fictitious, I have no reason to doubt the veracity of the conclusion. In my experience, financial projections issued by startups not only end up being inaccurate, but the actual and projected figures often bear no resemblance to each other whatsoever.
Then why do most venture capital investors require accurate financial projections from startups when seeking investment? Just as the eyes are the window to the soul, financial projections are the window to a company’s soul. Financial projections give investors deep insights into how the company’s principals think about their business.
When you break it down, financial projections are a set of assumptions based (often loosely) on historical company and industry results. Investors understand that the projections will never be accurate, but we can assess how realistic we believe the assumptions are and try to understand the thinking that went into preparing them to understand the path the company intends to take.
“Financial projections are the window to a company’s soul. Financial projections give investors deep insights into how the company’s principals think about their business”
If financial projections are prepared thoroughly and thoughtfully, investors who review them will learn the answers to some key questions about a company.
These include, what will drive future growth? What will the product and revenue channel mix be? Which marketing channels will the company utilize? How much will it charge for its products? How many employees will the company need, in which roles, and how much will they be compensated? How much will the company pay to acquire customers, at what rate will customers churn and what will be their lifetime value? How much money is the company planning to rise, and how much will it burn each month and how much runway will that result in?
After gaining these insights, investors will reflect on whether the assumptions used to build the model are realistic and achievable. This assessment is naturally based on two pillars: the company’s performance till date and the investors’ experience with other similarly situated companies, or use of average industry metrics. Questioning the assumptions and understanding the rationale behind them is another important step following this.
After the process of analysis, reflection, and questioning is complete, investors get a comprehensive perspective about the company, its principals, and if the investment is a good fit for them. The value and importance of financial projections to an investor, therefore, cannot be overstated.
Based on this understanding, a final word to founders would be not to prepare financial projections for the sole purpose of securing financing. The process of preparing them can be a particularly enlightening and meaningful exercise, aligning the principals’ varying goals and visions for the company. It also helps clarify roles and responsibilities and identify areas of misalignment that cannot be mended. Even then, there is a fine line between financial projections that are thorough and those that are overly complex. Be sure your projections can be understood by an investor and that the impacts of changes made to assumptions can be easily tracked.
Developing and maintaining financial projections will serve as an indispensable planning tool and can aid in self-reflecting the company’s growth drivers, assumptions, and capital needs. In this way, the time and effort you invest in analyzing and preparing thorough financial projections can mean the difference between your company’s success and failure.
