How much weight do angel investors place on projections? Are there minimum targets for revenues and profitability that should be met in order to raise money successfully?
Here’s a phrase to know: “hockey stick projections.” Hockey stick projections have become synonymous in the venture community with overly optimistic, some might say wildly fantastic, revenue projections.
Here’s how it looks to investors. Within business plans, entrepreneurs often summarize the growth in annual revenues and profits in the form of a graph or chart. The graph of a young company’s projected revenue growth line typically will be flat for some short period of time, and then rise sharply taking on the appearance of a hockey stick. Usually the growth line starts right after entrepreneurs’ project that will close their first round of funding from outsiders.
The fast growth rate looks impressive, but the entrepreneur’s lack of restraint leaves the opposite impression. The steeper the pitch of the hockey stick revenue line, the more investors will question the entrepreneur’s grasp of the real world of business. It takes a lot of cash to fund hyper growth
The upshot is that most investors don’t believe the hockey stick is credible because it happens so rarely…and the individual investors probably weren’t in on the action. They also know that it takes a lot of cash to fund hyper growth—usually much more than the dollar amount of the current investment round.
So what else do investors think when they review business plan projections?
- Set realistic targets.
No, investors are not looking for specific revenue numbers or profit margin benchmarks. What they are looking for is a business strategy that makes good, practical sense. Angels would rather invest in a business with a reasonable shot of generating $20 million in sustainable revenues than the $100 million fantasy.
- Check for bad math.
Too often projections just don’t add up—literally. Investors view sloppy work as a sign of sloppy management. Finger pointers won’t get funding either. Blaming poor presentations on hired bookkeepers says the CEO is not accountable for the company’s books and records.
- Test for slower results.
Seed-stage and early-stage investors don’t really count on a company’s projections to materialize, but they still will pay a lot of attention to them. They know startups will take much longer to achieve key operating goals than entrepreneurs ever imagine.
When I work with startup entrepreneurs I usually cut projections in half or more and then see what the company’s funding requirements really look like. Entrepreneurs that take the time to consider how much extra cash might be needed when operating milestones aren’t met are more likely to gain investor attention than entrepreneurs who are oblivious to venture adversity.
- Reconsider needless spending.
Projections reveal how entrepreneurs approach problems and how they anticipate the costs of commercializing their products. Most important, projections tell investors how their money will be spent. Here, investors are looking for a productive return on investment. They’d rather see money go into product development than a trendy, expensive office space.
- Do them right.
Well-prepared projections include a profit and loss statement (“P & L”), a balance sheet and a “cash flow” statement. I’m a fan of cash flow statements because it gives founders a real world understanding of how much cash it will take to succeed as well as when a company is likely to run out of cash.
I know this is trite, but investors all say that they “invest in management, not the hockey stick.” This means that the people managing the day-to-day numbers of a growing business matter much more than numbers on a page. Your job is to know your numbers well. You can do it!