Entrepreneurship · Entrepreneurs

How many years do you include in a financial projection?

Nick Cruz CEO at Nick Software Solutions

September 19th, 2016

We are debating if with our CFO if it would make sense to do a 3-year projection or to go as far as 5 years. From your experience, what would you say it makes sense to include if we are looking to raise a Seed round of financing?

Ayelet Ph.D. Co-Founder & CEO Capsoole Inc.; Dr. Hirshfeld; Advisor @ Earn2Learn

September 19th, 2016

between 3&5 you must outline the first 6, 12 & 18 months in detail the rest is projection based [image: Capsoole] *Ayelet Hirshfeld*, PhD - CEO & Co-Founder @AyeletHirshfeld | 408.315.6960 http://www.capsoole.com/

Mitchell Bolnick Business Mentor, Adviser, Consultant for Start-ups, Small Businesses, Growing Businesses

September 19th, 2016

​If you are looking for financing ultimately the source will tell you what they want. I work with my clients on detailed 3 year projections by month that then can easily be extrapolated if someone wants to see 5 years. Typically, but not always, banks want to see 5 years. The 4th and 5th year can be done quarterly or even annually instead of monthly. Most valuation models discount years 4 & 5 so much that adding them does not add a great amount to the valuation. But if you can prove a true hockey stick in those years, it may mean giving up less equity than you may otherwise have to. Many suggest only detailing year 1 monthly, I disagree. The key to people buying off on your projections will be your assumptions and use of constraints in modeling. If you only show detailed assumptions for a single year, and then extrapolate or use some simple inflation factor the risk of the projections increases greatly in my opinion. Therefore, investors are going to place a higher capitalization rate on the valuation and it will mean you give up more equity than you may otherwise have to. ​ I can help if you are interested. I charge $300 to review existing financials if they exist, and then I will sit down with you and discuss what is missing and how to make the projections as risk free as possible. If not, or if what you have is insufficient, I have a process that I walk clients through that costs them between $1500-$2000 if starting from scratch. Less depending on how good what you already have really is. My service includes a complete valuation model, internal rate of return (investors want to know that) and determination of real upfront and

Vanessa CPA Startup CFO Consultant

September 19th, 2016

Here are some common points that you'll want to include in your financial model:

  • 3 Years of Projections. Occasionally investors will ask for more/less, but start with 3 years.  I personally believe that 5 years is way too much / overkill / pointless; but if your investor wants it, then yes, you should do it.
  • 3 Statement Model. Include a Profit & Loss Statement, Balance Sheet, and Statement of Cash Flows.  Each should balance and tie back to each other (this gets tricky).
  • Your KPI's should be your Drivers.  Every company has a dashboard of metrics that they track growth and success by.  A few examples include number of users, customers, margin, customer acquisition cost, Twitter followers, website traffic, etc.  Look to the past and show that there is a correlation between X (could be # of Sales Reps) and Y (could be your revenue), then use this as a driver towards the future projections.
  • Churn.  Customers will leave.  Account for this.
  • Waterfalls. Your financial model should be dynamic.  Waterfalls show how you actually performed against your projection and then resets the future accordingly.
Don't show an investor a financial model that shows smooth growth "up and to the right."  No company's growth is without bumps.  These models take a lot of time to build and are highly personalized, so it really is best to consult with a professional.  If you're planning on raising $3M+ you should come prepared with a well thought out financial model.

Stephen Mitchell

September 19th, 2016

Almost more important is the Use of Funds doc - ensure that the investment is clearly directed to understandable and achievable goals.

Mike Adhikari M&A Advisor, business valuation, and BV Software

September 19th, 2016

I suggest 5. Marginal effort to do 5 is small. 5 is definitely important if first year of revenue is out in the future. You do not have to present 5; you can choose to keep it simple and present 3. If they do ask, just in case, you can say ...Yes, we have 5 years. All you are doing is closing an escape hatch. 

Martin Omansky Independent Venture Capital & Private Equity Professional

September 19th, 2016

We usually want to see 2 years of monthly projections and three years of quarterly or annual projections. The five year estimates give us a sense of the order of magnitude of the venture's revenues. We also like to see a specific list of assumptions that back up the projections. Sent from my iPhone

Martin Omansky Independent Venture Capital & Private Equity Professional

September 19th, 2016

5 years is not silly if there are multiple product launches, R&D expenses and license revenues anticipated. We understand the difference between a projection and a prediction. Getting an order of magnitude projection helps determine longer term capital needs and valuation determination. "Silly" is for amateurs, "prudence" is for pros. Sent from my iPhone

David M

September 19th, 2016

I would make sure you have full financials, which I'm assuming if you have a good CFO he has already advised you to. This includes footnotes addressing each line item. Anyone can post numbers in excel as others have pointed out. Your footnotes show you understand your business. But some of this depends where you are with your startup too I suppose.


I do know people who gained investments with simple pro-formas that were basically one sheets. I never would, but it would be inaccurate to say it never happens. If you are detailing it out you will likely have 100-300 rows in excel just to cover the below.


I would do monthly for 3 years with a year to year summary:


INCOME STATEMENT

Revenues

Cost of Sales

Gross Profit

Gross Profit Margin

Operating Expenses

Salaries, wages, SS, Medicare, Futa, Suta, Insurance, Payroll, rent, utilities, D&O insurance, Depreciation Expense, accounting, legal, telephones, postage & mailing, Internet, travel, meals, supplies...etc as it applies.

STATEMENT OF CASH FLOWS

BALANCE SHEET

Scott McGregor Advisor, co-founder, consultant and part time executive to Tech Start-ups. Based in Silicon Valley.

September 19th, 2016

If you are seed stage and pre-sales your estimates after the first 24 months are extremely speculative. So it is probably not worth a lot of effort to perfect numbers 3-5 years out. At the same time, it is likely that your “exit” is going to be 3-5 years out, and the valuation of the company at that time will be some multiple of revenue (or maybe net earnings). So it is worth having at least some ball park number for volume, revenue, and net earnings for up to 5 years, if only so you can see what you believe a reasonable valuation will be at that time, if you are on target. So calculate at least annual forecasts for years 3-5, but don’t sweat bullets over it.

David M

September 19th, 2016

I agree on the 5 years.  The only way it is silly is if it is a formula drag in excel.  But if you have thought out your plan and the 5 year projection of financials illustrates that plan in detail and with thought and you feel it is valuable, there is nothing silly about it.  In some cases quite the contrary, I believe it could illustrate a true desire to build something great.



A big reason projections often get slighted is because the entrepreneur has not put the needed time into compiling them.   Ex:  If someone has "rent" as an expense, I am going to ask them about location, next price up, next price down, what it gets, who are the surrounding businesses. etc.  Ex: phones..what was the pricing of competitors.  Its not just about the numbers but does the entrepreneur care about the details in building a business.  I have looked at projections where numbers don't even add up...truly unreal.



That is one reason you need accompanying discussion of your financials.  If one is treating them as "silly" regardless if it is 3 or 5 years, chances are they will be poorly compiled and add to the stereotype that they hold little to no value.  No one can predict the future, but one can illustrate competence in approach.