I own a website that I've been working on for the last couple years, and I'm now at a point where I need to try and raise money from venture capitalists. I am wondering what the best way to formulate some projections of how many users I will have in the next few years after I launch as well as any other projections I may need. Any suggestions? Thanks.
The most important thing to keep in mind when building your financial model is credibility. The financial outcomes of the model must be in line with the business plan and what is happening in your industry.
The model should provide the details of the big picture that the company is pitching. The key assumptions that are the drivers of the financial model are critical to understand thoroughly as well as communicate to potential investors. In addition, if you key drivers don’t make sense to investors then your pitch will not be deemed credible. In order to ensure that your pitch is credible and in essence your financial model makes sense, make sure to test the following items when your model has been completed BEFORE sending to anyone externally.
First Test: Make sure cash flow makes sense
In your cash flow model, you must make sure to account for when cash from sales is actually received rather than when earned and when money is actually paid out for expenses. Many models assume that when a sale occurs the business receives the money at the same time. However, this may be the scenario for a consumer-oriented brick and mortar retail store but not the case for an online retail store using a 3rd party sales portal to hock its products. The 3rd party may wait for 30-days or more to pay out monies for sales. In the meantime while you are waiting for those funds, employees need to get paid and other bills are arriving in the mail. Your your cash flow statement and balance sheet must take these in and out flows of cash into account. By including this information you show potential investors that you understand cash flow and are not a complete idiot.
Second Test: You don’t account for income taxes
Most models for early stage or startup companies show significant losses during the first years of business operations. For the years there were losses, there is no tax liability. However, when you start making a profit, there may or may not be a tax liability for the first several years due to the earlier losses. Make sure to take into account your net operating losses from the early years when calculating future tax liabilities in the profitable years.
Taxes can be complicated so make sure to talk to a tax professional to get an understanding of your state and federal tax liabilities as well as the standard tax rate for your industry.
Third Test: Sales forecasts are based on reliable data not a percent of the market
From a investor presentation standpoint, it makes sense to present your business as achieving a certain percent of the market over a specified time period in order for the investor to understand the size of the opportunity. However, you should not build your business model on a percentage of the market assumption.
Sales should be calculated from a bottoms-up approach. This means calculating your sales based on your sales process and cycle. If you have done a good job building out your key drivers (i.e. assumptions) of your business model, this should not be difficult to do. (Note: If you are in an industry with publicly traded competitors or competitors that have filed for an IPO you can get some good information on number of users and their user behavior as a basis of some of your model assumptions.) Examples of key drivers include how long does it take to close a sale? What is the percentage of leads/users that turn to sales? What percentage of online referrals convert to paying customers? The list can on and on but is dependent on knowing your sales process and cycle to make it credible. At the end of the day it is you who is selling yourself and company to investors. You need to understand the key drivers of your business model and explain them both strategically and financially. If you need help with the financial part, then get help. You want to be credible to potential investors.
If you expect a significant amount of users from search engines, use SEO (Search Engine Optimization) to see what people have searched for recently and if your business could do well for initial hits based on that.
Projections are a figment of your imagination, which is why people get in trouble using them. You have probably heard the phrase "Past results are not an indication of future performance." It is the disclaimer on ever prospectus you are likely to read. Start with whatever number you think you can reasonably generate.
That being said, now you have to back it up, so your investors don't think you're hallucinating. Just like going to the bank for a loan, investors want to see your business plan. The quality and reality of the numbers is proportional to the amount of money you are requesting. So where can you get the information to back it up?
First, how many "beta" users do you currently have using the site? How fast did your user base grow as you began advertising your service?
As a test of growth, offer to allow your beta users to invite 10 other people. Not only will you see how many referrals you get (and how happy they are with the product), but if they all use up all of their referrals, you might have something good going... Remember that Facebook was free until past 1 million users.
Second, research the competition. How many users do they have? How fast are they growing? Adjust your numbers based on a comparative analysis of your feature sets and pricing models. Again, this is an educated guess, so if you are analytical about it, you'll get a better response from the investor.
Finally, the more demonstrable that you are able to succeed without financial assistance the more likely you will get it. While you are seeking investors, make sure you've built a decent business model that can generate revenue, either by charging for your services directly, or by exploiting your user base (e.g. advertising revenue).