Why do VCs Really Want to See Your Financial Model?
Hint: It’s not about the numbers.
I recently tweeted about the importance of financial models in evaluating seed-stage pitches:
And I want to share a few notes about how and why they’re so helpful and illuminating.
💳 Capital Needs
Some businesses are just more capital efficient. While this is obvious in many cases, it’s not always so. Founders often have a sense for how much cash they’ll need to really prove things out and scale. At @fcollective we like capital efficiency.
💸 Capital Timing
Understanding when inflows and outlays hit the balance sheet is critically important. Too many founders just do cash models and disregard the impact of lagging collections for example, which has a cascading effect on the rest of their decisions.
🚪 Data Access
A model is only as good as the data/assumptions that underlie it. I find it helpful to be able to review a data room that documents historical financials and other quantitative data.
🔬 Detail Orientation
I don’t like to see models that count cost down to paper clips, but evidence of detail is nice. For example, the way a founder accounts for seasonality or churn is a helpful insight into their attention to detail or lack thereof. 1–2 sheets is usually enough.
A compelling founder can handwave away a lot of objections to their business in a pitch, but all is revealed in a Google Docs workbook. E.g. It’s worrying when a founder doesn’t know the going rate for an engineering hire or realistic CAC costs.
Being able to model the strengths, and weaknesses of your business demonstrate that you understand it completely.
🔀 Contingency Planning
The best models are interactive. Entrepreneurs can walk you through their thought processes and use their models to demonstrate how adding a dozen new reps, or a product extension will alter their future.
🌊 Business Dynamics
Is this a “cash business” or a rapidly appreciating “asset?” The former will show linear revenue growth, the latter, at least the potential for algorithmic expansion. FYI, “businesses” are still investable, but require different conversations.
It’s always encouraging to hear a founder talk about their financial model in a way that makes it clear it’s actually a tool they use to manage their business. Too often, it’s an exercise meant to appease VCs rather than the heartbeat of their business.
🎰 Financial Literacy
We don’t expect most founders to be quants, but a lack of sophisticated financial knowledge on the founding team is worrying (though not disqualifying). We’re not looking for expertise on spreadsheet macros, but a sense for the math behind the biz.
👻 Respect for Unknowns
There are always some unanswered questions at any stage of a startup. Decks allow you to tell stories, but models force decision making. Those decisions, while almost certainly wrong, are revealing and produce useful data for discussion.
Beyond their value in helping secure venture capital, models should be eye-opening for most entrepreneurs. Often, the startup idea that seemed promising becomes more or less attractive once you actually crunch the numbers.
It’s one thing to say “We only need to get 1% of the population for this to work” and another to model out how much it will cost to get each new customer, the burden of supporting them, etc.
So what does one do if they haven’t built, or been exposed to a financial model before? Here are a few tips and links:
🐛 Start Small
If you’ve never made a financial model before, start by simply modeling the basic unit economics of your core offering.
⏬ Download some samples
There’s no shortage of templates you can study. Here’s one from an MIT Sloan prof:
Prof. Robert H. Hacker's Author Channel
Prof. Robert H. Hacker, Entrepreneurship Professor at FIU & MIT Sloan Business School, is sharing quality business…
And this post links to a half dozen decent starting points:
How to Create a Basic Financial Model: An Entrepreneur's Guide
Creating a Financial Model forces an entrepreneur to plan very specifically how their business will work, how users and…
👑 Learn from the pros
A great resource is “MBA Mondays” a blog series by @FredWilson which is a great crash course in understanding entrepreneurial finance.
👥 Learn from your peers: If you’re in a startup rich community and have friends who are building companies, ask them to walk you through their model. It’s a great audience to ask stupid questions :)
Above all else, focus on your product and team, but it’s never too early to start modeling. Your model should be the heartbeat of your business, not homework done in advance of an investor pitch. I promise you’ll see returns on this investment in time.
Our wise LP @PatrickKearns pointed out that this is the same reason consultants ask “how many cokes are sold per day” or why an investment memo matters — not for the answer but for how you think.
Managing Partner Micah Rosenbloom recently shared this as a tweetstorm. We collected the tweets as a post for your convenience. Please share it with any entrepreneurs you know who aren’t yet excelling with Excel.