Why you need a financial model to fundraise

Tl;dr: Why you need to have a financial model when you are fundraising for your startup. Investors want one and they have the cash you want. Good financial models help you to understand what you are doing to give better answers to investors which will encourage them to party with their money.

Do you have to have a financial model?

Yes and sort of.

Let’s be clear unless you are famous, you absolutely need to have a pitch deck. From there, there is a curve of required to ‘nice to have’. A financial model is immediately after your pitch deck in terms of required material.

If you are asked for a financial model and respond you don’t have one, it will be a big red flag. If investors are really interested you’ll be asked when you’ll send it over? You’ll need to be pretty special to get away with getting funded with an answer of “we’re not doing a model“.

Not having a model reflects poorly on you.

Will you still get funded with a bad excel model?

Not everyone is an Excel whiz, that’s fine but you are expected to have access to someone who is at least average. Sucking at Excel is not really an excuse because, well, there’s me and there are a load of consultants who do this financial shizzle.

There is a curve of “what the actual fark’ to ‘holy crap, I can’t even understand this huge thing“. Somewhere in the middle gets you a passing grade, which is really all you need till you are raising beaucoup d’argent.

A dog crap model raises a lot of negative questions around which planet you live on. I mean, do you really think this is acceptable? But equally beyond a certain point, you’re sort of showing off, which isn’t necessarily a bad thing.

I’ve seen models which are missing various things, but they’re sort of good enough and the company isn’t raising $100m, so who cares. Focus is on the business and the founders’ execution.

If an investor wants to fund you, then your model is something they might be willing to give you a pass on, but is this really something you want to risk? I honestly don’t have enough data points to say much more.

How does a good financial model reflect on you?

An amazing financial model like the ones I make will absolutely not get you funded per se. But it makes you look attractive in a number of ways.

Investors like founders who are metric and data-driven. Your model is a tangible illustration of this which also speaks to them
It can show that you are logic and are able to think about complex things in detail and at a holistic level
It reflects that you understand the fundraising game and know how to play it by setting milestones which are that which will get you funded but still being reasonable
I can go on, but you get the point

A good model implies you know what you are doing and can give you some credibility especially when you might not have a lot of traction yet. If you are later stage and don’t have a model, you’re going to look pretty dumb.

Harder to know how much you actually need to raise

If you build a proper financial model and apply the most logical assumptions you can to it, it’s going to spit out useful outputs.

If you’ve modelled a runway calculator (You can get a free runway calculator here, though they are in all of my fundraising models too) you can see either how long your runway will last according to your forecasts, or how many months you can get by with the envisaged fundraise.

A question you will get asked by investors is “how much are you raising?” The next question is typical” why $5m exactly?”, or some variant. “I don’t know, it seems like a nice round number” is a crapppppy answer! The investor is just going to think this is amateur hour.

The reality though is that how much you need to raise is actually a really hard question (which I’m not going to get into now). Having a proper model is a great way to provide a proper answer even if you haven’t thought through all the considerations. You can at least say “We built a really big model and for 18 months runway, this is what our model said“. That’s like C+ answer at best, but it’s still a passing grade.

You won’t be able to build out a proper execution plan

You’re going to be shocked to hear this, but financial models have… numbers in them. So long as those numbers are reasonable they are what they are and you can’t hide from them.

I had a moron of a client once (Who stills owes me £10k) who never thought things through. He told me people were on 6 figure salaries and bonuses, we wanted to do all sorts of marketing activities, you can fill in the blanks. I ran the numbers and he needs 6x the amount of money he was (unreasonably) planning on raising. Suddenly salaries were down to £40k and there were no bonuses. That was sheet one of a reality check for a founder living on Pluto and still baffled as he’s not sure if he is categorised as a planet or not?

Models are the ultimate reality check.

Want to do high-quality customer care? How much will that cost?
Want to offer free returns? Will your economics work?
Churn still high? Unless you plug the leak, how much do you blow on marketing to sustain your growth?
Planning on scaling with sales? How many salespeople will you need?

Investors are going to ask you how you are going to scale and it’s really easy to say ignorant things if you have not done some basic math. An investor who knows your industry can do quick math and figure out that what you are saying does add up. The result is you lose credibility.

You can’t triangulate to funding milestones

If you take the red pill and go down the VC funded startup path then it’s basically a game of pass the parcel at loosely defined milestones. You VC crack-addicted ass typically lives on their sweet funds and needs a hit every 18 months or so.

At each stage, there are approximate milestones which are expected of you (SaaS info is shared more, but you need to have conversations with investors to ascertain what they are looking for). When you raise your series-A you need to be thinking what do I need to achieve to hit our series-B? That’s how much money you need + a buffer.

Let’s go with the SaaS thing and assume you are at seed stage. You’re at $300k ARR now and you think you need to be at $1.5m ARR to be Kool and the Gang for your series-A. Ignore all the other metrics that investors care about here to make this simpler.

You need to add $1.2m ARR to get funded. If you run a proper model you might realise that that $1m fundraise might only get you to $800k. Fark, that’s game over for you unless you can pivot to profitability (which has its own associated issues). You need to raise more.

I invented a methodology called the future fundraising model to help you forecast your funding needs to exit by working backwards so you know what you need to raise now.

Being able to tell investors that you’re raising a defined amount because that’s what’s needed to reach your next stage of funding illustrates you get ow the game is played.

As an aside, it’s useful to understand how investing works when pitching. I find that if investors know that you get it, how they will communicate with you is different. You can “cut the shite” a bit and some are more willing to be more frank and honest which is crazily valuable to you for learnings.

Investors expect one

If the primary reason you are making or filling in a financial model is for fundraising, then I could have made this blog one sentence. Investors expect a financial model so give it to them. It’s just pointless to fight me or them on this point. But let me explain a little for posterity.

When you are early stage you have not earned an iota of credibility. Like the streets, you need to earn respect. For early-stage founders (who aren’t famous) then investors will draw insights and conclusions from little things.

Do you turn up on time?
Are you nice to the secretary?
Do you order expensive food if you go to lunch?
Are you confident?
Are you thoughtful in responding to questions?
What does your pitch deck look like?
Do you have a financial model…?

The earlier you are the less traction you have. So as a proxy, investors will rely on your plans and ability to communicate them. Solid financial models show investors that you understand your business and have a defensible plan that won’t keep investors up at night.

Everything gets more complicated and nuanced the later stage you are at. If you have crazy growth then you can get away with a lot. Even if investors don’t really like you, they might still fund you. The type of investor you raise from does change as you raise larger amounts of money.

Look at KPBC. Mary Meeker and co left because culturally they were just different. Growth and early-stage are different games. To simplify things, the later the stage you are the more predictably you can forecast. Growth stage investors have the ability and interest to ‘run the numbers’. What do you think they are going to forecast with or use as assumptions? Your model.

Your model is also just going to be a small part of their due diligence. They’re more than likely going to ask for all sorts of cohorts to start with.

Finally, understand that 98% of investors have a boss which are termed Limited Partners. Institutional funds can in no way act without impunity. They need to be able to communicate to their LPs that they do proper due diligence. Let’s say your startup blows up (which it statistically will) and there are dodgy things involved. Well, the GPs would look like tits if they didn’t even look at a financial model, right? I clatching on straws a bit here, but you get what I mean.

You won’t be able to answer investor questions well

Let’s close it out here.

Your pitch deck, financial model and all the other fundraising material you need will not get you funded by an investor. They help you get meetings, build confidence, and to close rounds.

Investors invest in teams, but let’s stick with you as the CEO and founder. You need to get a meeting, pitch, get another meeting, pitch, and so on till you hopefully get investment. What exactly do you think happens when you are pitching. You’re explaining answers to the things that investors want to know.

I know you just want me (the investor) for my money so it would be pretty reasonable to assume you’ll say whatever to get my money. Why should I believe anything that you say? No, really?

Numbers are harder to argue with as they are imbued with logic, if in fact, they came from a financial model!

The investor can say your year 2 revenue forecast is really high! You can either say:

Are they? Well, we think we are onto something great!
Actually, they are in line with top quartile SaaS companies in our industry according to research. The key drivers of our revenue growth are driven by increasing our ARPA by adding new features starting Q2, move to annual pricing and retargeting our demographic will lead to less churn, and our partnership with an integrator will lead to lower acquisition costs reducing our CAC and enabling us to recycle our marketing to accelerate growth. Taking all these levers together will enable us to have higher growth.

I just made that up without thinking, just wanted to get my meaning across (and the blog done). It would have been more powerful if I had actually done numbers and inserted them everywhere. There is no way you could give an answer like that (with or without aforementioned numbers) if you hadn’t built a proper model.

The thing with models (the earlier you are) is that your actual forecasts are total and utter BS and investors know that. They want to know if you know what you are doing and get a sense you’ve got the confidence to work on big stuff.

Here’s some blogs worth reading on financial models. And if you want one of my pro models to make you look like a pro, click in the menu under Premium Models.