Is Your Financial Model Worthless?
“Building a financial model is worthless and a complete waste of time! In building this model, I’m being asked to tell a story that investors already know and have a vision for what it should look like. This is one of those 'qualifying tests' to see if I can manipulate Excel to produce the numbers they want to see.”
COMMON EXPECTATIONS
Leveraging this calculus to provide a roadmap across several different growth scenarios, suddenly Brad had the workings of a tool that would be imminently valuable to him and the rest of his startup. He could come to understand the impact that product delays would have on cash flows and runway. Brad could explore how an accelerated growth trajectory would impact his hiring needs, and to follow, his recruiting capability and cost needs.
On another front, we compared Brad’s growth assumptions against best-in-class benchmarks (I’m a big fan of Bessemer’s Scaling to $100M ARR) This gave us defensible and realistic growth targets, but he had to understand where the growth would come from. Together, we explored separate frictionless and salesperson-led revenue growth targets, which further led to discussions about sales team quota, compensation, and structure, as well as marketing resources and efficiency targets. We considered:
We went on to explore other areas of Brad’s business including various revenue scenarios, cash runway, how much to raise, and efficiency metric assumptions. As a result, Brad is a stronger and better-informed CEO, and his team has an aligned set of plans, and guidepost tools, to help them navigate the business for the next three years.
CONCLUSION
As in many areas of their business, startup founders can choose to “check the box” on their financial model, and “send it in” to satisfy a requirement. Many do just that! However, the ones in it for the long run, the best ones, take the time to lean into the effort, as Brad did, and take the opportunity to learn the lessons that building a business model has to teach them.
Is your financial model worthless? It is if you let it be. On the other hand, if you use it as a map and a compass to guide your startup’s navigation for the next few years, it can be priceless!
These were the lamentations a startup founder recently shared about his views on building a financial model, just before we started working together in preparation for his raising his next equity round. I might have expected this reaction from a founder with limited experience in building financial models. However, this founder had previously led strategy and operations for a publicly traded company and already had deep experience building financial models. Of all people, I thought he’d be in the boat. I was wrong.
In the grand scheme of sizing a market opportunity, identifying the right-fit investors, and keeping the wheels on an existing business, I see why a financial model can seem like a “check the box” exercise, rather than the “strategic blueprint” for your business it is meant to be. It sounds like a somewhat banal and easy enough requirement: if you want venture capital funding, you have to build a three-year financial model that provides three financial statements of information—Profit and Loss, Balance Sheet, and Cash Flows. Build growth expectations that go up and to the right, minimize costs, and collect your equity investment, right? Not so rote, if you're doing it right.
In my 4+ years as a Fractional CFO to venture-backed startups, I’ve built countless financial models. Some have focused on growing recurring revenue streams through top-of-funnel assumptions, while others were for capital-intensive businesses that required deep forethought into equipment and facility investments to be able to deliver on promises of growth and transformative change.
The good ones targeted outcomes that achieve industry best-practice benchmarks and milestones. The best ones marry actual results and trends with aspirational targets, and operational and product plans, and provide a playbook for various growth trajectories. Unfortunately, most financial models shared with investors fail to meet the potential investors’ needs and fail to help the CEOs steer the business.
Some common features in models I’ve seen that indicate the model fell short of its potential include:
I started working with Brad, a startup founder and CEO, when he raised his hand to a community of highly capable business operators, looking for some help in “pressure testing” his seed-stage financial model. What came from this initial “pressure test” conversation has led to work on pricing, product roadmap, sales team compensation, and much more.
What Brad eventually came to realize, is that embedded in the underlying layers of his financial model were the playbooks for how and where his team needed to grow, the milestones and features his product needed to achieve, and the resources available to the team to capture market share. Brad started to see the implications of timing for different roles and needed to consider ramp time to productivity.
In one example, Brad knew he wanted to increase his ACV (“Average Contract Value”) over time, and that to do so, he’d have to move from mid-market to enterprise customers (a common approach for software publishers). To be successful, Brad would need the depth and sophistication of features that that new market would require. For this, he had to have a product roadmap conversation with his CTO, to ensure alignment of product and pricing timing.
As a Product Led Growth (“PLG”) company, the phasing of feature development and release would have an impact on the Go-to-Market (“GTM”) teams that he builds, specifically what skill sets are onboarded, and when, across both Marketing and Sales teams. These functions, Brad knew, would have to evolve from selling to a single team to selling to a full organization.
In the grand scheme of sizing a market opportunity, identifying the right-fit investors, and keeping the wheels on an existing business, I see why a financial model can seem like a “check the box” exercise, rather than the “strategic blueprint” for your business it is meant to be. It sounds like a somewhat banal and easy enough requirement: if you want venture capital funding, you have to build a three-year financial model that provides three financial statements of information—Profit and Loss, Balance Sheet, and Cash Flows. Build growth expectations that go up and to the right, minimize costs, and collect your equity investment, right? Not so rote, if you're doing it right.
In my 4+ years as a Fractional CFO to venture-backed startups, I’ve built countless financial models. Some have focused on growing recurring revenue streams through top-of-funnel assumptions, while others were for capital-intensive businesses that required deep forethought into equipment and facility investments to be able to deliver on promises of growth and transformative change.
The good ones targeted outcomes that achieve industry best-practice benchmarks and milestones. The best ones marry actual results and trends with aspirational targets, and operational and product plans, and provide a playbook for various growth trajectories. Unfortunately, most financial models shared with investors fail to meet the potential investors’ needs and fail to help the CEOs steer the business.
Some common features in models I’ve seen that indicate the model fell short of its potential include:
- Quarterly reporting: This level of reporting is not granular enough to understand what’s happening. It also suggests, to me, that the model was built by someone more familiar with larger, public-market companies, where quarterly reporting is the standard, rather than agile startups where monthly metrics matter.
- Overly precise: The model author was unable to make simplifying assumptions, which suggests to me they couldn’t tell what’s really important and what’s not. This gets down to a question of Precision vs. Accuracy. My friend, Evan, wrote a great post on that, here.
- Not having any cost assumptions (headcount, G&A, or other) that throttle as revenue and customers change.
I started working with Brad, a startup founder and CEO, when he raised his hand to a community of highly capable business operators, looking for some help in “pressure testing” his seed-stage financial model. What came from this initial “pressure test” conversation has led to work on pricing, product roadmap, sales team compensation, and much more.
What Brad eventually came to realize, is that embedded in the underlying layers of his financial model were the playbooks for how and where his team needed to grow, the milestones and features his product needed to achieve, and the resources available to the team to capture market share. Brad started to see the implications of timing for different roles and needed to consider ramp time to productivity.
In one example, Brad knew he wanted to increase his ACV (“Average Contract Value”) over time, and that to do so, he’d have to move from mid-market to enterprise customers (a common approach for software publishers). To be successful, Brad would need the depth and sophistication of features that that new market would require. For this, he had to have a product roadmap conversation with his CTO, to ensure alignment of product and pricing timing.
As a Product Led Growth (“PLG”) company, the phasing of feature development and release would have an impact on the Go-to-Market (“GTM”) teams that he builds, specifically what skill sets are onboarded, and when, across both Marketing and Sales teams. These functions, Brad knew, would have to evolve from selling to a single team to selling to a full organization.
Leveraging this calculus to provide a roadmap across several different growth scenarios, suddenly Brad had the workings of a tool that would be imminently valuable to him and the rest of his startup. He could come to understand the impact that product delays would have on cash flows and runway. Brad could explore how an accelerated growth trajectory would impact his hiring needs, and to follow, his recruiting capability and cost needs.
On another front, we compared Brad’s growth assumptions against best-in-class benchmarks (I’m a big fan of Bessemer’s Scaling to $100M ARR) This gave us defensible and realistic growth targets, but he had to understand where the growth would come from. Together, we explored separate frictionless and salesperson-led revenue growth targets, which further led to discussions about sales team quota, compensation, and structure, as well as marketing resources and efficiency targets. We considered:
- What is the right quota for a sales leader in the earlier stages of a company’s growth?
- What’s the right OTE selling to mid-market (“on-target earnings” read: full cash compensation package)?
- OTE selling to Enterprise?
- What are the right ratios of sales support team members to have at these different stages?
We went on to explore other areas of Brad’s business including various revenue scenarios, cash runway, how much to raise, and efficiency metric assumptions. As a result, Brad is a stronger and better-informed CEO, and his team has an aligned set of plans, and guidepost tools, to help them navigate the business for the next three years.
CONCLUSION
As in many areas of their business, startup founders can choose to “check the box” on their financial model, and “send it in” to satisfy a requirement. Many do just that! However, the ones in it for the long run, the best ones, take the time to lean into the effort, as Brad did, and take the opportunity to learn the lessons that building a business model has to teach them.
Is your financial model worthless? It is if you let it be. On the other hand, if you use it as a map and a compass to guide your startup’s navigation for the next few years, it can be priceless!
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Agree with Jim's observations. I have created many models for fund raising and for them to be credible they need to be bottoms- up with reasonable assumptions regarding the go to market and product strategy. Investors need to be able to take the model and stress test the assumptions which means that you need to identify the key drivers and make them variables that can be changed (and that they can easily operate the model). This is also important for the CEO to understand how the cash runway is affected when running different scenarios.
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