Explaining your business model

Most investor pitches I see claim year 5 revenues of $50m to $100m, so putting in just that piece of information is not going to convince investors, you just sound like everyone else. What you need to make believable is why you are going to hit that target. Showing an incredibly complicated Excel model (”look, we did our homework”) is not going to get you there either. So the top line number is not convincing, nor is the detailed model, what works? The napkin.

When a modeling economics, I usually go brought a cycle. Start with a very simple calculation that gets to a ballpark answer, and is easy to follow and verify. Then, go I to incredible detail in an Excel model, understanding why I do, or do not get close to my initial ballpark. After the rock solid model is finished and bug free, it is time to simplify down to the level, of that very first ballpark number.

Simplification is not simple. You need to pick which drivers of your business are the most important, you need to decide which factors to show, which ones to hide. Your challenge is to stay close to values that are linked to everyday reality, not accounting. Messages per user per month, price per message instead of $m depreciation.

With all this preparation, you are now able to let your potential investor write her own ballpark or napkin calculation of the company's potential. You provide her with the basic framework, what are the 6 numbers you need to multiply in order to get to your $75m in year 5. She might not agree with all the numbers, but you gave her a framework to which to apply her own estimates. Getting the point estimate right is not important, agreeing on the order of magnitude, and the way how to get there, is.

There is also psychology involved here. Your numbers are likely to be outrageous, but can you defend them using more or less realistic inputs? Are you open to input and change your calculation? Again, discussing the financials is another way to figure you out as a CEO. Are you a sane person to work with on a day–to–day basis?

Everyone understands that you basically made up the numbers for your business forecast and their credibility might not be as high as an investment analyst forecasting next quarter’s earnings of IBM. Still there is something that will completely kill the credibility of your analysis: lack of consistency.

If you use 2 different sales numbers on 2 different pages it is a red flag that you might not be on top of your material. Even if the footnote says that the number on page 34 includes VAT and the number on page 22 does not.

Calculation errors are the same, if an investor starts checking your math on every page in the presentation, she will not be paying attention to what you have to say. When the final version of the presentation is ready, take out the calculator and check every page carefully, even if you copied data straight from Excel. Look for typos, or funny rounding errors and correct them manually.

You probably noticed that we have not discussed data from market research agencies to support your financial forecast. I consider them a data point, but not the most important input for your business plan. Almost all markets discussed by IDC or Gartner are a $billion, and most of the time have a far too broad scope for a new startup. There is one useful thing about these forecasts though, they provide a good categorization for technology markets. So now you can say “where a in the so and so business”. On the other hand, I have seen startups that had great difficulty explaining what they do because a VC could not put them in an IDC box.

So in short, explain your business’ economics in a simple human language.