Angel Investing – Financial Models

“I am a serial entrepreneur with a business idea that will generate $100 million in sales in 3 years!!!!” , sound familiar? As an angel investor, I meet many passionate entrepreneurs who present a very optimistic outlook for the future of their business concept. Building financial projection models is a very difficult process for the CEO of an early-stage company and an even more difficult process for the investor to believe in.

So, is there any real value in financial projections?

In my experience, when an entrepreneur puts together a financial model simply as an insert into a power-point deck to present to investors, that analysis is typically not particularly insightful and is usually overly optimistic. Rather, if the CEO builds a financial model to help them quantitatively understand their own business model, it is more often a more robust tool that can be used by both the CEO and the investor to determine how various assumptions impact not only revenue growth but as important – cash flow. The interplay of revenue and cash flow will determine how long a runway a specific funding will provide.

I like to see a model built on a “bottom-up” (focuses on the details) approach to constructing the near term revenue and expense outlook, based upon the company’s sales pipeline and marketing strategy. Who are the target sales prospects over the next 6-12 months and what does the CEO think they will need in terms of resources to convert that prospect into a paying customer? With this approach to financial modeling,  it is possible for me to better determine if the model makes sense in context with how the entrepreneur is describing their actual business strategy. A model built with the ability to perform sensitivity analysis easily, makes it a more useful tool for the CEO to understand the financial side of their business and for the investor to utilize in trying to determine how much capital will ultimately be required to position the company for an exit.