Part I of a five-part series on founder finance.
Why Founder Finance?
Financial modeling is a tool for communication and analysis. A financial model cannot fix fundamental business problems or drive growth. Alone, it cannot raise capital or attract employees.
At its very best, modeling can support communication, understanding and analysis. But, in this role it thrives.
For capital raising, it can help tell your story and demonstrate a deep understanding of the industry dynamics. It can serve as the common language between yourself and a financial investor.
For management, it can support an ongoing financial and strategic planning process. A strong grasp of the financials can uncover important KPIs, identify inefficient use of capital and provide insights into the scalability of a business.
Understanding Your Needs
Perhaps the most important part of the financial modeling process is understanding what your needs are.
The more detailed a model is, the more time consuming its construction and management will be. The more assumptions a model contains, the higher the probability that the model will contain mistakes. A model that is unnecessarily complicated is a waste of time. And, for the early stage startup, time is precious. Detail does not equate to usefulness.
Through the three example cases below, it is easy to see how needs can vary.
Case 1: A startup with multiple employees and moderate revenue. The founder needs a tool for analysing historical spending and predicting forward results to appropriately allocate capital.
Insight: The founder will need a monthly model that is easy to update with actual results at the end of each month.
Case 2: An early stage startup with valuable technology that is looking to raise an initial round of capital.
Insight: The founder will need something to present to investors. The model must be relatively easy to adjust for different assumptions. Assuming a successful raise, the founder may want to convert this model into an operating model.
Case 3: A solo entrepreneur is building a side project while working a day job.
Insight: The founder likely needs a quick, back-of-the-envelope calculation to understand the market opportunity and perform general product validation (e.g. market sizing and unit metrics). The details of a full model may be too time consuming to justify.
The answer to two key questions can help guide the development of financial tools.
- What do you hope to achieve through your financial tools?
- Who is the audience of your financial analysis?
Throughout the process of developing financial tools, keep your answers in mind.
Who Are These Tools For?
In this series, we address two general scenarios, but a founder should use judgement to determine their unique needs.
- Side Business Scenario: A small side-business, run by one person, that only needs a general sense of market size and product validation. This business will likely be funded by internal resources (e.g. friends and family, or founder capital)
- Early But Scalable Scenario: A multi-person startup, seeking meaningful external funding. The product will still likely be early in development but may have traits that suggest fundraising should be possible (traction, exciting tech, strong team). This business will likely need a model to serve as an ongoing financial planning and strategic decision-making tool. The founders may also wish to share projections with potential investors.
For the Side Business Scenario we assume the founder, with very limited time, will perform only a high level analysis. Until scaling or seeking to raise capital, the founder may want to avoid the monthly model we discuss in later installments.
For the Early But Scalable Scenario it remains important to consider high-level analysis. These techniques can highlight the key factors driving the business and lay the foundation for more detailed analysis. But, it may also be necessary to build a monthly financial model.
The tools we discuss through this series are designed to serve one or both of these imagined scenarios.
Tools for Every Business
There are a few important exercises that should be done for both business scenarios: a market size analysis and a unit-economics breakdown.
We will complete the exercise from the perspective of a Side Business Scenario company, The Little Cookie Business.
But, before any modeling we need to ask our imagined founder the two key questions presented above.
Question: What do you hope to achieve through your financial tools?
Founder Answer: To try to understand if I have a scalable business and determine if I can justify working full-time on the project or hiring a full-time manager.
Question: Who is the audience of your financial analysis?
Founder Answer: Myself.
In the Founder’s answers we observe two key questions he or she hopes to answer:
- Is there a large enough market for my product to justify working on it?
- Can I make a sufficient profit pursuing this business?
These questions cannot be answered through finance alone but two tools -- a market size analysis and a unit-economics breakdown -- can help.
Tools for Scalable Businesses
In future posts in this series we will build out a model specifically for the Early But Scalable Scenario. A founder of an Early But Scalable business might answer the two key questions presented above as follows.
Question: What do you hope to achieve with your financial tools?
Founder Answer: We need a financial model to share with potential investors. We would also like to have a model to help analyze performance as we move forward.
Question: Who is the audience of your financial analysis?
Founder Answer: Potential investors and the internal leadership team.
For this founder, it will be necessary to build out a true financial model. And, in future posts we will help this imagined founder build his or her first detailed financial model.
Once you begin operation it will be necessary to keep track of your ongoing financial position.
A part-time bookkeeper should be able to work through an online business accounting tool such as QuickBooks. If you go the outsourced route (as some startups on StackList appear to do), the best way to find a bookkeeper may be to reach out to people you trust in your local community.
Additionally, you should review your financial position regularly. Depending on the nature and status of your business, the frequency should vary. But, even for a side business with little activity, monthly reviews may be appropriate.
As a Side Business grows, a more traditional financial model may be necessary to understand the flow of funds.
But, for early stage exploration, a very simple analysis like the one presented in the next post in this series for The Little Cookie Business may be sufficient. It will be possible to analyze the flow of capital with a small business accounting tool.
Before You Start
This series of articles guides founders through exercises and calculations that will aid with idea and business model validation, and communication with investors. These models can be applied to a range of early stage businesses. There are limits to their utility, however, as they are not appropriate for larger startups or public companies. The focus of the analysis is on cash flow, and the models do not adhere to GAAP. The goal is to provide early-stage founders with a tool that they can use to assess the potential viability of their ventures.
The models are built for founders who have limited experience in finance. The purpose is to provide a quick framework that founders can use to assess different areas of their business without having to have an MBA or degree in finance. As your startup grows, you will likely bring on a team member who has deeper experience with financial management. You are solely responsible for determining the accuracy and quality of any work in or derived from this series.