When I was as a fledgling founder, I came up with the idea of making a five or even three year financial projection of my company. I can promise you one thing: it will be dramatic wrong. But as part of your fundraising, you should make them anyway, and there are a number of good reasons for that.
VCs understand as well as you do that you can’t predict the future. Hell, that doesn’t just apply to companies in the pre-seed phase; if founders could predict the future, there wouldn’t be so much nervousness around IPOs.
But it’s worth bearing in mind that your investors aren’t asking you to predict to the nearest cent how your company will perform in 2030. They are looking for two very specific things: Whether you understand how the financial dynamics in your company work and whether you are at an enterprise scale.
Being on an enterprise scale
To be venture-investing, you need to be ‘enterprise scale’. That means if an investor puts $1 million into your business, you need to know very well how you’re going to turn that $1 million investment into a $10 million return. Now, of course, not every company is going to do that, and it’s not easy to guess which companies are going to successfully give investors 10x returns.
However, I can guarantee you one thing: if the financial forecast shows a steady 10% year-over-year growth for the next decade, it may be a good lifestyle venture, but it will never deliver a 10x return on investment.
In other words: Yes, your financial projections need to be ‘realistic’ in the sense that they show that there is a logical progression from where you are to where you want to be. But you also need to show, in spreadsheets and numbers, that you have at least a fighting chance to be at the enterprise level. If your most optimistic, most aggressive growth trajectory falls short on this, you’re not going to have a good time as the founder of a VC-backed startup: It shows you’ve fundamentally misunderstood why investors invest.
Understanding the financial mechanics
When you’re raising money, you need to show your investors that you have clear plans for why you’re raising money. In other words, what are you going to do with the money?
