Is your business gaining strength and ready for another infusion of cash to either support growth or further your research and development? Are you ready?
There are certain things early angel investors will forgive when investing in a startup. Investors don’t expect you to have fancy systems. They also don’t expect you to have perfect GAAP financials or detailed financial forecasts. Most understand you may have a limited number of staff and cash to work with, so these things are often glazed over in the very beginning, as you are just beginning to prove your idea even works.
Say you get to the point that your idea is gaining strength. You’re either starting to show promise with the product you are developing, or you are already selling it and earning a modest profit. Many businesses need additional funding to get to the next level. Not many have such a surge in revenues that they can fund growth through operational cash flows. Therefore, you have to be ready when it’s time to pull the trigger and raise some serious dough.
It truly depends on who your audience is, i.e. your potential investor, in order to determine what you will need to provide or have in place already when it comes time for due diligence. Some investors in key markets could care less what your financials look like in the past but do care about what your forecast is for the future. Others, especially family office investment companies, will care more about accurate historical financials. All will care about what your detailed plan is for spending the money you raise.
Regardless of who you are raising money from, you’ll need to be prepared when the time comes to have a successful experience. The following are the first three needed prior to fundraising:
1. Cash Forecast
Surprisingly, many companies, even mid-market companies who are well past their Series A funding, don’t utilize a weekly or monthly cash forecast. The risk for a start-up in not having a cash flow forecast is you may pull the trigger and raise money too quickly, or worse being blindsided by running out of money all of a sudden. Also, you may not see trends that could be developing in your business that may be driving a burn on your cash flows. Even a high level estimated forecast is better than having nothing at all.
The key goal of a cash forecast prior to a fundraising event is to see where your cash burn is primarily coming from and to be able to speak to potential investors about how much cash you have left in terms of weeks or months.
When building a cash forecast you need to be conservative on your revenue and collection assumptions, and try to lump your expenses into certain categories (such as payroll, taxes, insurance, and regular vendor payables) based on typical payment timing and method. If things look good on a weekly forecast out to thirteen weeks, then you could shift to a monthly forecast for the later periods to keep it high level.
2. Financial Forecast
Probably the most important item you can have at your fingertips when going to raise money is a three to five-year financial forecast. Year one needs to be more detailed and any dramatic changes from historical trends need to be easily explained. Years 2-5 can be high level, but you will need to take into consideration certain assumptions that investors will ask about, for example:
- Is your ramp on revenues reasonable?
- Where will you spend your marketing dollars?
- How fast will you grow your headcount and overhead spend?
- Has your gross profit margin stabilized or are there still efficiencies to be gained through growth?
In general, your investors want you to have thought about the road ahead and what it will look like. They want to know you have considered the method in which you will get there, and what roadblocks you may run into along the way. Your financial model takes the strategy in your head and quantifies it on paper to prove out that your business model is worth investing in. It needs to be realistic and thoughtful.
3. Historical Financial Statements
In the case your investors want to ensure your historical financial statements are up to par, there are options available on how to go about it. Some consulting firms or your internal accounting team (if available) can do a quality of earnings study. This is where the financials for at least the last 2-3 years are scrubbed to ensure they meet with not only GAAP accounting, but that entries have been recorded timely in the correct periods. If the financials are not accurate on a monthly or annual basis, trends on revenues, spending, and profit margin will not be accurate and can mislead an investor.
Many start-up companies don’t even use GAAP accrual accounting. Instead they keep their books in cash basis accounting. The conversion from cash basis to GAAP basis can be part of this project, but it can range from relatively easy to cumbersome and costly, depending on the industry you are in. For example, software as a service can be relatively complicated but consumer products or restaurants can be very straight-forward.