As an angel investor, I see lots of financial models, which range from the very simple to the extremely complex. I am often asked why I insist on seeing the actual model ( yes the excel not the pdf version) as it all based on layers of assumptions. In response, the financial model is nothing more than a quantitative expression of the business model and in fact what is most important to me are the assumptions that underlie the numbers.
Overly optimistic revenue projections combined with an understatement of the expenses which will be required to fuel the business, result in higher cash burns for the company. If the company runs out of cash more quickly than anticipated or before certain milestones can be achieved, the CEO will be faced with raising additional capital more quickly than anticipated and potentially at a lower valuation – not a great outcome for either investors or the CEO.
When I look at the monetization assumptions, I want to understand if they as based on:
- Industry practices
- A Beta test/pilot by the company
- A first guess
All three of the above are valid ways to attempt to model revenue, but at a minimum I want to make sure that the CEO understands the pricing models of the competitors in the space. If the company has done a pilot/initial roll-out and then plans to expand that to a broader market, that provides me with a specific datapoint to analyze. If the monetization is a first guess, I will probably discount that more heavily as it is an untested assumption.
On the expense side, I find that entrepreneurs underestimate the costs associated with bringing on critical team members as well as marketing expenses as well as the cost of client acquisition. I need to understand which expense items are variable and can be managed if revenues come on stream more slowly than anticipated versus those costs that are fixed and will not be able to be reduced to save cash.
Borrowing from a line in an episode of The Simpsons, “In the money game, cash is king“.