Building Financial Projections That Withstand Investor Scrutiny

Investor due diligence is a process by which investors assess a potential opportunity before fully committing capital to it. Throughout this process, investors verify the accuracy of the information that startups provide, identify any potential risks and liabilities and aim to gain a better understanding of startup viability and potential investment returns.

Due diligence can take several weeks to even months, depending on factors such as the stage of the investment, the startup’s preparedness, the complexity of the investment, and the investor’s overall process.

That’s from the investor’s perspective. From the startup’s perspective, the goal is to create investor-ready financial projections to help them navigate the due diligence process and successfully plan for raising capital — balancing growth assumptions with credible projections is crucial.

Think of this post as a comprehensive guide for venture-backed startups to streamline fundraising success. Read on to learn more about how Graphite Financial can help create investor-ready projections that are more than aspirational, but reliable and credible.

What Investors Really Scrutinize in Your Projections

So what are investors really looking for in your financial projections? It largely depends on the fundraising stage that your startup is in. Here’s a look at the various stages of fundraising and what investors are really on the lookout for:

• Seed: In pre-seed and seed funding rounds, investors are basically just looking for potential. In pre-seed funding, investors want to see a strong founding team, understand the market opportunity at hand, and get a general idea of potential revenue. In seed funding rounds, they’re looking to see more evidence of market validation and how your product or service solves a problem. They also often want to see scalability potential and a go-to-market strategy.
• Series A: Once your startup gets to the Series A fundraising stage, expect investors to want to see evidence of success in meeting market demands. They also want to see proof of revenue growth and strong engagement metrics. While pre-seed and seed funding rounds are largely based on early potential, investors in Series A funding rounds want to see a well-defined business model that proves your startup has the ability to grow and scale.
• Later rounds: In Series B and later rounds, investors are likely to consist of venture capitalists and private equity firms. To ensure success, you must show consistent revenue growth, predictable revenue streams and a solid market expansion strategy. Investors may also consider assessing expansion potential.

Clean Data as Your Credibility Foundation

Clean and accurate data is the fundamental building block for creating reliable and defensible financial projections. It can help identify trends and patterns, improve the accuracy of your predictions, and enhance startup decision-making and strategic planning.

Yet, early-stage startups lack a significant amount of historical data, which can create difficulties with forecasting. So, how can you combat the lack of historical data to make informed decisions, predict future performance and secure investor funding? Market research and strategic data collection are the keys. Conduct competitive analysis to better understand your startup’s target audience and identify opportunities. Strategically collecting data includes getting user feedback and beginning to track various KPIs.

Best practices startups should follow to maintain clean data from day one include:

• Implement robust data governance and policies.
• Implement data validation rules and checks at every stage to prevent inputting incomplete or inaccurate information.
• Regularly clean your data to identify and correct errors.
• Implement strong security measures to safeguard your startup from data loss.
• Audit data trails and logs, and educate your employees on data integrity.
• Seek accounting support to establish a strong data foundation.

Revenue Projections That Pass the Stress Test

Building revenue projections that can withstand investor questioning and market reality is easier said than done. There’s a methodology involved, and it’s important to incorporate realistic customer acquisition costs, conversion rates and churn assumptions into your revenue modeling.

Investors tend to prefer bottom-up revenue models, as this approach starts at the smallest, most granular level of a startup and then builds upwards to generate a total revenue projection. When done correctly, bottom-up revenue models help provide a detailed and insightful understanding of your startup’s financial performance and ensure your realistic financial projections are credible and defensible.

Revenue projections should also include multiple scenarios. It’s best practice to build conservative, best-case and optimistic scenarios that showcase the wide range of possibilities to present to investors.

Bottom-Up vs Top-Down Revenue Modeling

Bottom-up tends to be the preferred method of revenue modeling that investors want to see in startups. This is especially true with more sophisticated investors in later stages of fundraising, largely due to their level of detail, which can deliver more realistic and accurate forecasts.

Top-down models are better used for providing a high-level overview and validating revenue potential, while bottom-up revenue modeling provides more granular insights into the factors driving your startup’s revenue to permit better decision-making.

Strategic Expense Modeling for Growth

How can your startup balance expense projections in your budgeting that balance fiscal discipline and aggressive growth? Here’s a look at some best practices:

• Categorize expenses accordingly: Make sure you’re identifying and budgeting for fixed-cost expenses that remain consistent while projecting variable expenses that ebb and flow with sales or production. To accurately model these costs, your startup has to understand more than just the basics, but also how they each impact operating expenses and overall business expenses.
• Outside of fixed and variable costs, startups are also likely to encounter various one-time expenses they’ll need to allocate. It’s best practice to clearly categorize and separate one-time expenses from other expenses. You should also be sure to justify these expenses and how they can translate into startup growth.
• Navigate headcount responsibly. As your startup grows, so too will your staff. But it’s imperative to strike a delicate balance between expansion and taking on new financial commitments.

Ultimately, startups should strive for disciplined expense management. This can help facilitate more sustainable growth, help avoid running out of capital and attract investors to secure funding.

Cash Flow Projections Beyond Revenue Minus Expenses

Cash flow projections are about more than subtracting expenses from total revenue. There’s a big difference between overall profit and cash flow, especially for eComm and SaaS startups with more complex payment timing.

Cash flow projections estimate your startup’s expected future cash inflows and outflows to help forecast how much it expects to have on hand at certain defined points in the future. These projections are important for identifying potential shortfalls, making better decisions and planning for future growth. A properly prepared cash flow statement is essential for this process and should be aligned with your other financial statements to provide a comprehensive view of your startup’s financial health.

Proper modeling of accounts receivable (AR) and accounts payable (AP) is essential to ensuring accuracy in your projections. To forecast AR, rely on historical data and patterns you can glean. Increases in AR signify decreased short-term cash flow, while decreases in AR mean money is being collected from sales, which helps cash flow.

AP is a debt that your startup owes its suppliers or partners for goods and services. You can forecast AP by projecting future purchases and payment terms. Increasing AP can help boost cash flow by helping your startup retain its funds for longer, while decreased AP signifies that you’re paying your debts.

Your startup should also work to build cash flow cushions to help promote financial stability and create a safeguard against unexpected events. Proper cash flow management can be the difference between sustainability and failure, so be sure to take financial discipline into account when forming your business plan.

Working Capital Dynamics by Business Model

Different startups require different working capital considerations.

For instance, SaaS startups will initially have negative cash flow and high upfront CAC. However, as they begin selling their service and earning recurring revenue through subscriptions, cash flow will improve.

eComm startups link cash flow directly to sales volume. Cash is often tied up in inventory, representing early negative cash flow, but improves with sales and can be impacted by seasonal volume.

Service-based startups link cash flow to delivery. There tends to be less upfront investment in inventory or infrastructure, but cash flow needs to be managed properly in service-based startups to manage money between projects.

Scenario Analysis and Sensitivity Testing

Scenario planning can help demonstrate management capability and risk awareness to investors, thereby building trust and confidence.

As you build scenario analyses, avoid focusing on arbitrary percentage changes. Instead, focus more on key assumptions and their plausible ranges to generate more insightful results. In doing so, move beyond fixed percentages to consider justifiable ranges for each variable.

Aim to frame any downsides as risk management and preparedness, emphasizing that pitfalls allow for developing strategies and contingency plans.

To model the impact of any external factors in scenario analyses, start by defining and identifying them, then work to quantify the impact of each factor.

Industry-Specific Projection Considerations

The quality of your projects largely depends on how well you understand and incorporate industry-specific metrics and dynamics. Some of the key financial metrics that matter most to SaaS, HealthTech, eComm and Fintech startups include:

• MRR/ARR
• Churn rate
• LTV
• CAC
• LTV/CAC ratio
• Burn rate
• Cash runway

You may also want to compare your projections to competitors to help strengthen their credibility. When doing so, choose your competitors carefully and consider a range of benchmark points. You can use these benchmarks to set performance targets.

SaaS vs eComm Projection Differences

SaaS and eComm startups differ in their revenue models, so they’ll also differ in their projections. SaaS startups focus on software performance and usage, while eComm projections center more on sales and transactions.

SaaS startups rely on a recurring revenue model, while eComm startups rely more on inventory-based projections. Key metrics to track in SaaS include MRR, ARR, LTV and churn. In eComm, metrics to track include sales revenue, conversion rates and CAC.

Presenting Projections That Tell Your Growth Story

To really resonate with your investors, strive to use your financial data to tell a compelling story. Some best practices include:

• Use a series of charts and graphics to help with visualization, and try not to make things too high-level.
• Know your audience and tailor your approach to the investors accordingly.
• Make special note of key metrics that are most relevant to your stakeholders’ interests.
• Be upfront and honest about any limitations.
• Connect your financial projections to operational milestones and other strategic initiatives to provide a more holistic view of your startup, tying your income statement to overall growth performance and decision-making.

Common Projection Mistakes That Derail Fundraising

If you want to connect with investors, avoid these common projection mistakes:

• Presenting metrics that are either overly optimistic or unrealistic.
• Ignoring any historical data and trends.
• Not separating fixed and variable costs.
• Poor cash flow projections.
• Overlooking external factors that could play a role in your projections.
• Inconsistencies between projections and operational costs.

Building Your Financial Projection Infrastructure

While you can create financial projections in-house, it can make sense to work with an external service provider or fractional CFO to help with your modeling and projection development. Fractional CFOs are experienced professionals who have access to a robust technology stack and other financial systems that can help support these initiatives and avoid many of the common mistakes that can derail fundraising.

Consider working with a fractional CFO on projections if your startup is in growth mode, prior to fundraising rounds or if your financial management has become too complex for your in-house staff to handle.

Partner with Graphite for Investor-Grade Financial Excellence

If you’re ready to create investor-ready projections but don’t think you can handle it in-house, consider working with Graphite. As an experienced financial services firm that specializes in working with startups, we can help build relationships with investors and increase fundraising success. When you work with Graphite, you’ll have access to expert financial professionals at a fraction of the cost of hiring an in-house CFO.

Contact us today to learn more about our unique value proposition and how we can take your startup’s investor-grade financial projections to new heights.

FAQs

How far into the future should financial projections extend for investor presentations?

Financial projections should aim to extend anywhere from three to five years into the future when giving an investor presentation. For early-stage startups, three years is generally sufficient. More established startups in later stages of funding should provide financial projections of five years or longer.

What level of detail do Series A investors expect compared to seed-stage projections?

In Series A fundraising, investors want to see evidence of a startup’s ability to scale. They typically want detailed financial models, proof of stability as evidenced by metrics and a path to profitability. Compared to seed funding, Series A investors want to see a granular, data-driven approach to financial projections.

How should startups handle projections when they have limited historical data?

Market research and strategic data collection are key when there’s limited data to draw from. Consider conducting competitor analysis to better understand your startup’s target audience and identify opportunities. Also, work to begin strategically collecting data to track various KPIs. Set data governance best practices to keep your startup on track.

What’s the difference between financial projections and financial forecasts for fundraising purposes?

In fundraising, financial forecasts are designed to present a realistic view of your startup’s financial performance. These forecasts tend to be based on historical data and reasonable assumptions. Conversely, projections are more intended to consider the potential scenarios and outcomes based on market conditions and other factors. Think of it this way: Forecasts are more grounded in reality, while projections are more about potential.

How often should projections be updated during an active fundraising process?

Financial projections are an ongoing process, not a one-time event. However, how often they should be updated largely depends on the stage of fundraising your startup is in. For instance, pre-Series A startups should consider updating projections on a monthly basis. Projections should also be updated to coincide with major events, business model changes or market volatility. Regular updates are key to ensuring your data is always relevant.

Should startups include multiple scenarios in their investor presentations?

Absolutely! This can help demonstrate startup preparedness and understanding of the market, and provide a realistic range of potential outcomes. Presenting multiple scenarios is a key strategy for startups that can help build trust and confidence with investors.