Your startup idea is brilliant. Your pitch deck is almost finished. Now, you just need to get your financial projections in order to present to potential investors. Cue the screaming hair-pulling moment!
Financial projections can feel like the most daunting part of the process. It can also be the very thing that makes or breaks your startup plan. Knowing your numbers, and having confidence in your projections, could be what seals the deal for a potential investor.
I spoke with Paul Hynek about financial projections for startups. He’s worked with hundreds of entrepreneurs to help them develop their plan and their pitch. I’ve never met someone with a more passionate entrepreneurial spirit. He is a Wharton MBA and an adjunct professor of finance at Pepperdine University. In addition to an extensive history in tech, finance and entertainment, he is also the founder of EZ Numbers, the software for easily creating business financial projections.
Duffy: Why do startups struggle with their projections?
Hynek: Because it’s not easy to predict the future. Projections are hard and traditional template business plans are much easier. If you don’t know the basics of accounting and finance, projections look like a cross between Swahili and graffiti.
Often entrepreneurs hire a consultant to do their pro formas, and then when they sit down with a potential investor, they have that deer in the headlight look when asked about this or that assumption.
My approach is to spend next to no time on a business plan, and to contain it to one page. You don’t want to write a 30-page business plan, and believe me, nobody wants to read it. Tell your story quickly, and then use the time you save on making a long business plan on really understanding and articulating the dynamics of how your business could, not will, operate.
Boning up for a few hours on why things go on the P&L and Cash flow, and learning the investor performance metrics of IRR and NPV, which are based on the time value of money, will also help tremendously. It’s ok to not turn a profit for a couple years, but keep a laser focus on cash flow, because, what’s that word for companies that run out of cash? Oh yeah, bankrupt.
Duffy: You’ve helped many startups by creating custom projections for them, what are the most important things to remember/to do when making one’s projections?
Hynek: Projections are meant to be dynamic and flexible tools. There’s a tendency to grant numbers some amount of legitimacy once they’re entered into Excel. You want your projections to be easy to change – so that one key driver will instantly affect all related components, and that you don’t get fossilized into one particular scenario that may have already been obsoleted.
It’s also quite helpful to be able to see the effect on your cash flow and profit instantly from any change you make, so that you have a real time feedback loop. This isn’t always easy to do, but having this kind of summary dashboard can make a big difference.
Duffy: What are investors looking for in a startups’ projections?
Hynek: They aren’t looking for accurate sales projections. Nobody knows what your sales will be. But you can predict your expenses much better, and investors look to see if you’ve spent enough time to think through what $X in sales will require in terms of personnel, equipment, and office expenses.
They also aren’t looking for the dreaded hockey stick – where your revenue goes from $200,000 in Year 2 to $85 million in Year 3. One technique I’ve used to great effect is to model in some wrinkles. Most projections tend to show smooth charts of increasing sales, but in the real world, you have problems – a big customer drops out, you lose your CTO, or you have a patent fight. So, it can be very effective to try to reflect the effects of three real-world incidents. Then your charts will have some hiccups, and if investors ask you about it, they tend to be impressed that you’ve actually incorporated some potential snags.
You probably won’t predict the exact setbacks you’ll endure, but you’re pretty much guaranteed to have some. And if actually incorporated with a less than constantly rosy future, and your model is robust enough to handle them, it can come across really well.
Duffy: How did you come up with the idea for EZ Numbers?
Hynek: I was originally writing a book for entrepreneurs on how to work with factories in China, which is a tricky business indeed. I wound up going to China repeatedly and learning to speak Mandarin. I’d seen so many people lose all their money, and their passion, to those bogus inventor assistance companies that advertise late at night on TV, and I wanted to provide an honest resource with my own experiences.
As part of the overall offering, I thought I’d provide a free template that I had developed on making projections. But then I had what I call an epiphanal pivot. I realized that the market for people wanting help dealing with factories in China is about 5% of the total number of startups, whereas the market for people needing help with projections is about 95%.
I hunkered down and developed EZ Numbers to the point where anyone can use it with no prior experience or knowledge of accounting or Excel, for almost any kind of business, and started selling that. Now with EZ Numbers we even give away a free PDF on how to deal with Chinese factories.
Duffy: What makes your EZ Numbers unique?
Hynek: Most solutions that help you with projections focus more on the business plan, and then kind of limp across the finish line with some last-minute numbers so you can have a couple charts and tables in the fancy plan.
We are the opposite – we give away a free Two Page Plan template. One page is a template for how to summarize any business in one page, and the other page is a financial summary that’s automatically created for you in EZ Numbers.
Many entrepreneurs say “Wait, I need more than a page to say everything about my unique business!” No, you don’t. First, you don’t want to say everything about your business. You don’t even want to say everything important about your business. All you want to do is get the investor to want to know more.
Nobody invests just after reading a business plan – they want to meet with you. So, orient your efforts to intriguing them with only the most important kernels about your startup, and get that next meeting where you can tell them all about how your new router does this and that. Nobody learns about their own business by writing a business plan, but everyone does if they do a decent job on their projections.
Duffy: What is the best advice you have for entrepreneurs and startups?
1. Don’t come up with cool product ideas. Instead, research to discover unmet needs in the market.
For example, Frank has a super cool design for a Bluetooth radio shower cap. He has prototypes made, files some intellectual property, goes to retail trade shows, etc. Betty is in Target one day and sees a crappy thermos for $5, and some amazing Yeti ones for $75. Hmm, she thinks, maybe there’s a need for a thermos priced around $30.
Yes, Frank is the example of the romantic notion of an entrepreneur with a Eureka moment, but Betty is the one who analyzes a gap in the market, and seeks to fill it. Betty will have a much easier time. People talk a lot about the need for passion in entrepreneurs, and it’s true. But not passion for your current product – passion for providing your current and evolving solution.
2. Think broadly about competition. Entrepreneurs all to easily say something like “We’re so unique, we don’t really have any competitors.” Hogwash. Potential customers can stick with doing nothing, or solving their problem in a very different way.
For example, the Jobs to Be Done approach includes as competitors for a mid-range wine company, anything else that people might do on Friday night while watching Netflix besides drinking your wine – like drinking beer, drinking no alcohol, eating at a restaurant, etc.
3. Don’t obsess about your valuation. If your startup goes nowhere, your valuation doesn’t matter. If your startup limps along for a while, your valuation doesn’t matter. And if you have the next tech unicorn, everyone will make plenty of money, and – your valuation doesn’t matter.
Duffy: As a futurist, what do you predict in the way of trends and opportunities for startups in the next few years…what should people keep their eye on?
Hynek: The biggest thing I see is the acceleration of the rate of change. Think back over the roughly ten years of the iPhone. It’s come a long way. But that’s nothing compared to what it will transform into by 2028. The ability to cope with, and even embrace change, is one of the key success factors going forward.
Specific market solutions, aka “products,” may well have shorter life spans than before, so companies will have to innovate even faster. At the same time, that many more disruptions will create far more opportunities for new approaches, so startups with less investment in people and money in current ways will often have an advantage over companies looking to milk their current offerings.
For more information about Paul Hynek and EZ Numbers, visit the website.