A startup looking to raise capital usually provides financial projections. These projections are shared with investors to help evaluate the investment opportunity.

Investors use the financial projections to understand the numerical drivers behind the investment, risk assessment, valuation and structuring the investment.

1) Understand key drivers

Most financial projections include several assumptions. However, there are certain assumptions that are the main driving force behind the financial projections of future years. These key assumptions usually include metrics such as volumes, pricing, Gross Margins, and other such parameters. The investors are then able to evaluate what are the key metrics that the business is targeting. As an example, is an ecommerce company going to chase revenues only from electronic gadgets or from clothing as well?

2) Building internal forecasts

Most investors then evaluate what assumptions are credible given the past performance and the market dynamics. The investors then plug in their own values for the key assumptions and build a view on the financials the company will likely have. Most investors generally consider forecasts provided by the company as aggressive and therefore taper them down.

3) Scenario analysis and risk assessment

The investors use the forecast they built in step 2 above to evaluate scenarios depending on different outcomes. Scenario analysis reveals what are situations that the company is vulnerable to. It particularly helps investors in understanding what happens in economic downturns.’

4) Valuation

Investors use their internal model to analyze the valuation of the company. Their internal model makes forecasts for future years.  These forecasts give investors an idea what the company can be worth at the time of the investor’s exit after four or five years. Understanding what a likely exit is for these investors helps the investor better understand what they can pay today.

5) Unit economics

Financial forecasts give investors some visibility into the unit level economics of the target company. As an example, in a logistics company the investors will get some idea into what happens per square foot of the company. In a restaurant chain business, the investor can understand the economics per restaurant. These unit economics give important insights to the investor.

6) Validating the investment thesis

The financial plan puts numbers around the investment case from the investor’s perspective. The investor is able to better understand the numbers around specific trends and metrics that will contribute to the performance of the investment.

7) Structuring the investment

The financial model will provide insights into the important metrics that will need to be achieved in future years. The investor may consider putting these into the valuation structure. For example, the investor might use an incentive structure of his ownership where if the company achieves higher sales then the ownership stake of the investor becomes lower. The numbers for this structure will be derived by analyzing the financial model.

8) Structuring incentives for employees

Employee incentives are a key component of an investment plan. The financial plan is used by the investor to develop numbers behind the incentive structure.

 

 

Disclaimer: Vitspan does not provide any investment related, tax related or financial advice. The information presented is done so without considering the investment objectives, risk profile, or economic circumstances of any reader or investor. The information presented may not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the potential loss of principal. Please consult your financial advisor prior to making investment related decisions.