The startup forecasting dilemma
When you’re preparing to raise money you need 3 things: a presentation, executive summary, and financial forecasts. Even brand new, pre-revenue companies need to forecast numbers. I have prepared many forecasts for many early stage companies over the years.
Even though, there is very high likelihood that the forecasted numbers won’t be hit, I still feel it is an important exercise. Done right, forecasts give management and investors a clear sense for the drivers and levers of the business, as well as clear milestones, spending and runway (how long your cash will last) targets.
But the only thing I can say confidently about early stage forecasts when I see them is that I can’t rely on them. Its hard to see 3 months ahead, let alone 3 years (this is the standard period you need to forecast for). How can you accurately say what your revenues will be 3 years from now?
In addition to lack of visibility, the other dynamic at play is real pressure to show investors BIG numbers. Don’t show what’s probable, show what’s possible (and often beyond). Investors are complicit in this. I know of many situations where investors have told entrepreneurs to go back and increase their forecasts. The investors then assume the company will hit 1/2 of those forecasts on steroids and use that assumption to make their decision.
Despite the lack of visibility and pressure to pump up numbers, investors continue to be disappointed when numbers are not hit. This is true for existing investors who invested based on your pumped up forecasts and new potential follow on investors (especially if they had your original forecasts and are comparing where you are now with where you said you would be).
If you pitched VCs in your 1st financing and go back to the VC community for more, they will all have your original forecasts and will dust them off to see what you were saying back then.
Why would these intelligent, experienced investors fool themselves? Why do they expect that you had a crystal ball and that your business opportunity was sufficiently derisked that you knew what was achievable? If it’s worth investing in, then it is hard to forecast. Occasionally, a product or service takes off and the actual results surpass anything you expected. More often than not though, things take longer than planned. Success is rarely a straight line.
So, what’s the answer? I don’t advocate coming in with conservative easy to hit forecasts for two reasons. i.) Investors are expecting big numbers; and ii.) you should always be thinking big. But I do think that entrepreneurs increase their credibility when they can talk about how hard it is to hit their most optimistic targets.
If you have thought through, from a bottom-up perspective, how you will goto market and distribute your product or service, then you will produce more accurate forecasts and you will be able to speak intelligently about customer acquisition costs, channels, partners, hiring, etc. All of that gives the investor a lot of comfort that while the global targets are ambitious, the entrepreneur has a clear sense of what needs to happen to achieve them. Hope is not a strategy. Clear tactics and a clear direction are needed.
And if you need to defend your track record and account for why you missed old targets, don’t blame it on external factors, take the time to understand exactly what happened. Did you release products late? Did you know how to acquire customers at scale? Be honest. And show clearly that you understand what happened. That will get the conversation moving forward to the future and the next set of wildly optimistic targets!