Monday 27 May 2019

Start up diary: Pitching yourself into business model forces you to face reality

Start up diary

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Richard Rodger - Founder of voxgig

I haven't built a single slide of my pitch deck yet.

Last week I told you that we were raising money, and that we needed to built that most iconic of startup collateral: the pitch deck.

If you were expecting an article listing each slide and describing it's content this week, you'll be disappointed.

No, this week we concentrate on only one slide, one that comes near the very end. That slide is the business model.

The term business model means everything and nothing, but here I do mean it in the more traditional sense: the numbers from the projected company accounts that show you how the business will perform over the next three years.

That means very abbreviated versions of the cashflow statement, the profit and loss statement, and the balance sheet.

You can spice things up a little with a chart. I like to show four things: cash in the bank, revenue, expenses, and monthly active users.

Hopefully your cash in the bank never goes below zero, your revenue line eventually rises above your expenditure line, and your monthly active users look like a hockey stick (growing rapidly up and to the right).

Why is this my first slide? Because you need to model the numbers in your business to know that you have a business.

All of the market assumptions, competitive strategies, hiring plans, and technical innovations, are all ultimately measured by how they affect the bottom line of the business.

You should be able to understand how spending six months of technical work on your version 1.0 (built after your Minimum Viable Product), versus spending 12 months, will affect the amount of money you need to raise.

You need to understand how converting 1pc of visitors to your site versus 2pc will affect your revenue growth, and thus how many developers you can hire. You need to know if your plan calls for execution skills that you don't have - such as Software-as-a-Service marketing (that's the case for my company, voxgig).

By building a numerical model of your business, you bring all these assumptions to light. You are forced to face reality.

It is of course easy to 'fix' the numbers and get the projections you want. Even if you start out wanting to be brutally honest with yourself, human psychology dictates that you'll have biases towards your preferred view of the future.

Entrepreneurs are by definition overoptimistic. And entrepreneurs that are also software engineers (like me)? They have a bad case of optimism.

One way to deal with this bias is to use multiple sets of projections. Yes, that's a lot more work in Excel, but it is worth it. You need to be able to see the worst-case scenarios as well as the best.

Let's get practical - how do you start?

You have to start with your assumptions, and turn them into numbers. In our case, we assume that a certain percentage of the readership of our newsletter will convert into users of our system (once it goes live next January). That conversion rate might be 1pc, or 2pc, or 5pc (they are a highly-qualified audience, after all).

Open Excel, create a new spreadsheet and start writing down your assumptions: Newsletter Conversions: 2pc.

This is the first of many input cells that you can change to see how it affects your business.

Don't forget the end goal - after much blood, sweat and broken cell references, you'll be able to change that conversation rate and directly see what it does to profit and loss in year two, say.

There are many assumptions in the plan for your startup. It doesn't make sense to try to capture them all, or indeed to model their effects in fine-grained detail.

For example, your estimate of staff costs might be 20k too low on an annual basis, but this is swamped by the fact that if you can make that viral invitation loop work, you'll be at a million dollars of ARR by the end of year.

ARR stands for Annual Recurring Revenue, and the word on the street is that venture capitalists like to see you earning at least a million dollars in recurring revenue when it's time to invest in your 'Series A' (that's the big investment about 18-24 months after the 'seed' round from your first outside investors).

Since some items will be easy to forecast, and others extremely difficult, don't expend energy on accuracy that is not material. You want to find the assumptions that really move the needle. You can only do this with a proper numbers-based business model. That's why this is the slide you start with.

Once you have those assumptions listed, you can start building the model. You want to feed those assumptions into a revenue projection. It's best to work monthly, projecting out over the next three years. Some investors might ask for five years - I'm really not sure that's useful, as any five-year period is bound to contain so-called 'Black Swan' events that are impossible to predict and can radically alter your business plans.

In our case, if I charge $20 per user per month, and I have 1,000 newsletter readers, and I convert 1pc of them a month to paying customers, I earn $200 more dollars each month.

The price, $20, I can control directly. The conversion rate, 1pc, is something I'm going to have to track assiduously, as it will prove or disprove my forecast.

And the newsletter readership is something I already know, and can project into the future with reasonable confidence. Of such things are models made, and all it takes is a few formulas in Excel.

You absolutely cannot outsource this work to your accountant. People do, but it's a mistake (definitely get your accountant to check it though).

You should understand just enough accounting to build the basic model. You should know just enough Excel to build the formulas. And you should put in the mental effort to understand how the parts of your own business work together.

I'm sure you can come up with many examples of founders who did not have these skills and still prevailed. To which I say, survivorship bias.

Even if you get lucky and succeed despite your lack of attention to detail, you'll eventually have to learn all this stuff anyway - you do have to sign off on the yearly accounts as a CEO and board member, and that's kind of a big deal, legally.

With the monthly revenue projection you can then build a cash-flow forecast, and with that you can build the profit and loss and balance sheets, and the nice chart I described above.

I've written previously about cash-flow projection, and provided a sample cash-flow spreadsheet. I've updated this sheet and added a business model sheet too.

You can download them from richardrodger.com/business-model. Although these examples are very much simplified, I am modelling my own startup using this approach, and you might find them useful too. One slide down.

(Newsletter update: 3,849 subscribers, and an open rate of 12pc)

 

Richard Rodger is the founder of voxgig. He is a former co-founder of Nearform, a Waterford-based technology consultancy

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