Ask an Investor: do early-stage VCs care about financial models?

financial model

Long story short: YES! Don’t act like you’re surprised. We know you knew.

While it’s true that depending on the investment stage VCs will tend to focus on different aspects of the model, most VCs will ask you for a financial model at the end of your first date.

The forecasted numbers will most likely be wrong, but your thinking into how your business works, how you grow users/clients, revenues, and staff is invaluable to us.

As much as I agree it is (after all, it is the whole purpose of this post), I don’t like to think about financial modelling as a fundraising exercise. My strong personal belief is that it’s a must-have at any time during the life of a startup. A proper financial model is a crucial tool for founders to rationally think about the business they are building, as it translates the vision into an actionable plan. It also improves and supports planning and management decisions, such as hiring plans, fundraising targets, or product launch. Sure the content, the structure, the level of details, and—more than anything else—the outputs will change over time, as you’ll be wrong! Your plan will turn out to be false, and it’s okay, we know that!

So why bother?

Why do we care?

Going through a financial model and analyzing the form as well as the substance will help us gain a better understanding of the opportunity, your knowledge of the market as well as the solution you’re selling, growth expectations, and some of your personality traits. This will complete the ongoing conversations we have and help us to rationally answer the following 3 questions:

  • Is there a path to a big opportunity?
  • If this path does exist, is the plan the right one?
  • What is the likelihood of a successful execution of this plan?
  • The form

    VCs will fully expect this spreadsheet to be part of your management toolbox. The way your model is built will tell us a lot about your personality and can be extrapolated to help us understand the way you manage and lead the business.

    A clean (colour and formula consistency) and fully functional model will send a strong and positive signal to potential investors by demonstrating a logical, organized, and rational mode of thinking. When messy, a model will reflect poorly on you and your company. Clearly, you don’t want that.

    The substance

    As mentioned earlier,the forecasted numbers will most likely be wrong, but your thinking into how your business works, how you grow users/clients, revenues and staff is invaluable to us.

    We want to get a sense for the order of magnitude of the opportunity, what drives the growth, if the path to the opportunity is plausible and what it takes to get there:

    Opportunity sizing: During the first meeting or within your deck, it is very likely that you’ve shared your high-level revenue projections. We need to make sure that the number you’ve discussed with us are the numbers generated by your model. Numbers need to be consistent with your vision. The assumptions you use in your model will help us gauge if your analysis of the opportunity is realistic.

    What drives the growth: A model will help us validate your knowledge of the industry and show that you clearly understand your business and levers that drive it. Your model, properly constructed, will lend credibility to your vision. If your assumptions are well supported, it will be easier to buy into your vision.

    Plausible plan: Analyzing the model will help us understand the founders’ ambition and approach. Our review of the model will allow us to examine the founders modelling assumptions in order to assess their level of conservativeness or realism. A founder must strike the right balance between demonstrating the size of the opportunity and the conservativeness necessary to comfort investors that the opportunity is within the company’s grasp. A properly constructed model also provides the management with a tool that takes into account safety factors since, for startups, things rarely go as expected.

    A well-designed and developed model will help us identify a clear timeline and get a sense of the targets and milestones you need to hit each month and quarter.

    What is takes to get there: In the model, we expect a reflection of your understanding of how long and how much you need to get there. A well-designed and developed model will help us identify a clear timeline and get a sense of the targets and milestones you need to hit each month and quarter. The best models translate into sequenced and actionable targets. We want the founders to be aware of this. One of the key outputs we look at is the expected burn rate, as it will help us validate the ideal amount of capital you need to raise with this current round, as well as the ideal timing before your next round.

    What we are looking for, and how to build a great plan

    Now that you know what kind of information we’ll look for from a basic spreadsheet, let’s have a look at a couple of key points to think about when building or refreshing your model.

    At Impression Ventures, we review hundreds of models per year. Based on this experience, here is some guidance on what we believe are importants elements in building an excellent model:

    Format – Don’t use a template: While it’s easy to search around and find a template to use, those templates were built by someone with a particular business in mind. Since your model should reflect the specificities of your company, you are better off building it from scratch.

    Our recommendation is for you to review multiple financial models and formats and pick the ones best suited for your business. Once you’ve seen enough, build your own model from the ground up. It is absolutely critical to understand every column, cell, and formula. Remember, you are building a real management tool that will guide your actions for many years to come; you want to make sure you master it and that it’s adapted to your needs.

    Assumptions – Drivers: A great model should clearly disclose which are the most important levers of your business. Again here, every business is different and we should be able to identify which drivers have the biggest impact on yours. Bear in mind that while it might be tempting to list dozens of assumptions, as it is often the case, only a handful will have a very significant impact on your business. Therefore, identifying them clearly will provide us with clear confirmation that you understand what drives your business, and that you are likely to focus your scarce startup resources on the few items that really matter to the success of the business.

    Logic – Growth expectations: Based on the assumptions you defined, how do you grow the business? What impacts them? Is this about marketing, increasing the business development team? Ideally, the model clearly displays the growth rate of assumptions. It will also clearly show the relationship between the growth and the associated costs. i.e. to get to this revenue estimation, do you need more customer service employees? Credit analysts? Your biggest expense line will most likely be your staff. This will help you highlighting any bottleneck issue when scaling the business, as well as budgeting more precisely how much dollars out will allow X amount of dollars in.

    Outputs: As much as financial statements can be useful for accounting purposes, it is not likely to be the case from a VC or strategy perspective. In the startup world, “cash is king,” and everything beyond the EBITDA line doesn’t interest us. Ideally, the model will have a three year horizon: monthly for the first year and annually or quarterly thereafter. If the company has some history already, than past performance is important as well, we need to see how much money has been spent/earned, at what pace, what’s left in the bank.

    Key takeaway

    Financial models provide us with a lot more information than just the financials. Regardless if you are fundraising or not, we strongly encourage you to follow the guidelines above and to build a financial model that informs not just potential investors but, perhaps more importantly, you!


    Pauline Brunel

    Pauline is an Analyst at Impression Ventures, a venture capital firm focused on investing and leading deals in FinTech companies raising late seed to early Series A rounds across North America. Pauline started her career in M&A focusing on growth companies in Paris. She then switched to the Capital market side working for JPMorgan in London as an Associate, before joining the Luxembourg regulator’s alternative investments team as a Senior Officer. You can follow Pauline on twitter at @paulinejbrunel

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