How to build a financial model for investors?

A financial model can be a critical part of starting a business and many of the steps that come with building and growing one. So, how do you do it? What do you need to know to nail it?

Financial Modeling For Startups

What is a financial model, and what is it used for by startup businesses?

The primary function of a financial model is to forecast a potential future picture of the finances of a company. It lays out what-ifs, what’s possible, and the goals being shot for. 

Financial modeling can become a big thing when it is time to start pitching investors and raising money for a business. Yet, it really starts its role much earlier. Financial modeling begins when you first have your business idea. It helps map out your direction, gives you steps to focus on, and validates that there is a true business there while highlighting any potential strengths and weaknesses.

In the early days of a startup, your financial model may play a role in your business plan, bootstrapping your financing, managing your cash flow, recruiting employees and even advisors. 

As your business evolves and progresses financial models can be used to continue to forecast the next stage, as well as to evaluate the potential outcomes of various moves you might make. That can cover everything from adapting to unexpected crises to acquiring other companies. 

Of course, from pre-revenue up to your IPO or M&A exit, financial models will play a big part in your interactions with investors and potential investors.

Why Investors Want Financial Models

When thinking about how to build a financial model for investors, keep in mind that investors know how to run their own financial models, and may have teams to do it for them. They probably have their own theses on the potential and financial mechanics of this venture. They probably even expect the real financials to end up looking nothing like your financial projections in the near future. So, why do investors want to see your financial models?

The most obvious use case for your financial models is in pitching potential investors during a startup fundraising process. This can equally apply to your seed all the way through your Series D round. Of course, later in the game, you’ll have a much bigger team and more existing data. In the earliest stages you may still be mostly riding on vision and assumptions. You have no hard data to show your current financials, you can only project out. Those are the only numbers to present.

The most obvious reason for financial models may seem to be to wow investors with the revenues, profits, and ROI they can expect when investing in your company with their capital. It is a way to quickly show that this investment is right for them. That it is in their ballpark and has the potential to deliver the types of multiples they are demanding from their money.

Experienced entrepreneurs and investors know that things change a lot and fast as you race along your journey. Your startup may even have far greater reach and revenue potential than you realize. You might even go off on an unexpected tangent in three months. So, more important than the numbers themselves is what their preparation tells them about you.

Investors will instantly be able to tell if you’ve bothered to invest an appropriate amount of time in market research, know your industry, and have enough business fundamentals to have created a business model that works and scales and are being realistic enough to account for working out the quirks as you get started.

As you move into additional rounds of fundraising and are updating existing investors, financial models demonstrate the advantages and outcomes of pivoting, adding new lines of business and products, addressing new customer groups, scaling teams, responses to crises, new investments you may make. It shows how you frame your decisions, and how you will approach many other things in your business.

When it comes down to fundraising keep in mind that it is all about storytelling. For a winning deck, take a look at the template created by Silicon Valley legend, Peter Thiel (see it here) that I recently covered. Thiel was the first angel investor in Facebook with a $500K check that turned into more than $1 billion in cash.

Remember to unlock the pitch deck template that is being used by founders around the world to raise millions below.

What Should Be In Your Financial Model

Now that you are able to put yourself in your investors’ shoes, you can much more effectively create financial models that win them over and deliver on their expectations. This is critical when figuring out how to build a financial model for investors.

If you’ve been in business for a while, have revenues and existing data, then you should have all of the information ready in a data room for qualified investors and their due diligence after they give you an appealing term sheet.

If you’re not there yet, then this is all about forecasting. Note that this doesn’t just mean it is all made up of numbers. There should be some real basis behind it. 

However, pitching investors at this stage is mostly about the idea, the vision you cast, and showing you have the team strength to deliver on it.

Especially when pitching and delivering a pitch deck you still need to keep it simple. The financial slide will be one of the most looked at. Investors spend more time looking at this slide than any others in a deck. Just remember, that is still only a matter of seconds.

Get in the basics. You’ll be saving time to fill in during the Q&A time anyway.

Key data to put in your financial model may include:

  • Revenues
  • Profits
  • Profit margins
  • Number of sales
  • Customer acquisition volume

The other three main parts of how to build a financial model are:

  1. Making sure you are using reliable sources for your benchmarks and data
  2. Choosing efficient tools (i.e. modern financial modeling software versus Excel)
  3. Presenting it in a visual way that is easy to understand, and raises the fewest questions

Then it is all in the presentation and pitch. On the video below I cover in detail how to create a pitch deck which you may find interesting.

Hopefully, this post provided some guidance as you are tackling how to build a financial model for investors.

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