Any time you are talking to an investor, whether in a pitch deck or during due diligence, they expect you to show financial projections. Many founders run into trouble with this when the company is mostly or entirely pre-revenue. You might wonder what you can show with no track-record. Even so, financial projections are still essential both to the investor and to your strategy.

This article is part of our series on Fundraising as well as one on Running your Business.

Short term vs. Long term

Right off the bat, let's be honest. Angels know that your numbers are going to be wrong. That is the only thing they can be sure of. You are lucky to come in within a factor of two at the end of year one. Years 3-5 are pure fantasy. It is useful to consider these two time frames separately.

Your projections for the next twelve months can be grounded in the present reality. You know your expenses and burn rate. If you are a very early stage business, you should probably assume little or no revenue. Short term financials show that you can deliver on the milestones required for your next funding without running out of money. They are all about cash management and planned development or growth expenses.

Projections about the out years show strategy and business model. They demonstrate the theoretical viability of the company. They also provide information about how you plan to grow and your achievable market penetration.

The not impossible story.

Angel investors are an idiosyncratic bunch; we all have different things we are looking for in a business and in financial projections. I want to see the founder tell a not impossible story about their company’s success. We all know that it is likely that you will need to pivot at some point. You might want to check out our blog on pivots if you have not read it yet. You still need to show that your initial plan could work and produce substantial returns on my investment.

Of course, that means you will have a chart showing hockey-stick growth. But don't just make up the numbers, show that they are plausible, or better yet likely.

Your projections should demonstrate that there is a big enough market to achieve those numbers. I see many plans that say: “If we get just 1% or 10% of this market…”. Is that plausible? Are there examples of other startups achieving that against the incumbents? Also, make sure that you are talking about your actual market, not the entire space. If you are making brakes for cars, don't tell me about the market size of the automobile industry.

You may find that you need to tune some of your numbers, be honest about that. I helped a founder with a viral business model to develop their initial projections. Without any actual data on customer referrals, we had to make a best guess. It turned out that our first guess produced outrageous numbers, so we had to carefully tune the virality coefficient to produce healthy, but not absurd, growth. When presenting the model, we always made that process clear. Check out our blog on virality to understand how the numbers can run away.

Demonstrate the Business Model

Your financials show how, and whether, the business will operate. One key element to demonstrate is that the unit economics makes sense. Show that your costs for providing each device or account are (or will be) less than the cost to offer it plus some profit margin. It will also need to cover any fixed costs like headcount, office space, etc. Investors know that failure is a real possibility in any startup, but we need to know that it not assured.

Your projections need to be motivated by some robust assumptions. I get very skeptical when a model projects 500% annual growth as an assumption. Show me why you will grow at that rate. Where are those new customers coming from, and what did it cost in effort and treasure to get them? Every input to the model should be justified in some way. Even when you guess, it needs to be an educated guess. Know your expected salary, marketing, sales, support, hosting, SAAS, and every other cost you can think of. Clearly show a viable cost of acquisition for customers and a plausible estimate of their lifetime value.

Some of these inputs can come from doing simple experiments. Read the blog on testing assumptions if you have not seen it already. You can also take numbers from comparable companies either through public reports or by asking them or advisors.

Where will this round take you?

One of the biggest questions for investors is, "where will the company be after spending this money?" We need to know how long this funding will last, what you will have achieved, when you will need more, and how much. Before investing, you must convince me that it will be possible to raise that next round based on those achievements.

You also need to demonstrate that this funding will be enough to achieve your planned goals. Running out of cash before you clear the next hurdle can kill the company. When modeling your company, develop some scenarios where things don't go according to plan. If growth is slower than planned, or it takes much longer than expected to raise your A round, can you adapt? Are there options to adjust your burn rate to allow the business to survive? Could you potentially bootstrap the company for an extended time if the investment market dries up? These "worst-case" models show the durability and robustness of your model. It is no good having a company with a perfect plan that shatters at the first sign of trouble.

Focus on the purpose

Good financials show that you have thought through your business. Like when you were in school, you need to "show your work." Give the investor insight into how you see the company working. Your financials don't need to be absurdly detailed. Particularly when you are pre-revenue, you don't need to have monthly information, quarterly is fine. "Marketing" is an acceptable expense category. You don't need to get down to what kind of creative on which online platform.

Seeing how you created your financials tells investors as much as the result. We know that your numbers are wrong. We know that you are making guesses. We just want to make sure that it all makes sense, that it can work, and that your business has a good chance of succeeding at a level to bring lucrative returns to the investors.

For some other perspectives, you might take a look at this comparison of 12 financial model templates from OpenVC, or this free template from Slidebean.

Next you might want to read about how investors calculate valuations for very early-stage startups.