November 18, 2021

Four Tips to Demystify Financial Models for Early-Stage Startups

Rachel Star
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Four Tips to Demystify Financial Models for Early-Stage StartupsFour Tips to Demystify Financial Models for Early-Stage Startups
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Editor's note: 

There’s a certain alchemy that goes into creating an early-stage startup’s financial model. It’s equal parts insight, research, aspiration and planning, oftentimes sprinkled with a dash of wishcasting. While there’s no tried and true method for developing a perfect financial model in the early days of a startup’s life, there are plenty of ways to turn that exercise into a valuable tool for teams and investors.

Like our partner and colleague Sarah Leary often says, "You can write fiction in Excel just as easily as you can write it in Word."

Even if there’s not a standard recipe to follow, you don't need a crystal ball to build a good early-stage financial model. Let’s talk through four important factors every founder should think about before starting this task.

1. Highlight unit economics

No matter how idealistic, mission-driven, or disruptive your idea is, there’s a core truth that every founder must own up to in order to make their company viable in the long term: the math needs to work. Unit economics – things like cost per customer, lifetime value (LTV), and the associated margins – provide a constant pulse for a company’s financial health and viability. 

If the basic unit economics tell you that your product and GTM motion is efficiently driving growth, you’re likely onto something. It’s time to double down on those efforts and focus on maintaining great ratios on those core metrics rather than focusing on the full profit and loss sheet. Efficient growth will always win in the end.

A side note: "Economies of scale" is not a magic wand for improving bad unit economics over time. Show how growth will change things for the better, and why.

2. Show growth in terms of levers

Applying a blanket month-over-month growth rate is a great way to have your revenue go up and to the right, but it doesn't actually say much about your business. Aim to dig a level deeper and show what assumptions you’ve made about the levers that impact growth. 

Ask yourself: 

  • What macro trends will impact your startup’s trajectory? 
  • How is your marketing spend going to kickstart user acquisition? 
  • When will referrals become an efficient flywheel for the company?

Growth projections that aren’t grounded in evidence – or at least well-informed assumptions – are hard to rally around.

3. Think in orders of magnitude

One common question investors ask founders is some variation of “How does the business get to $100M in revenue?" 

There’s a simple way to answer this question: Give us a rough order of magnitude of how many customers you'll need. Is it 100 customers paying $1M each? Or a million customers paying $100 each? 

An entrepreneur who thinks about that question in this way is giving us a much more detailed vision of their growth path than one who comes in with a P&L projection that ends at $100M in revenue in month 84.

4. Spell out core assumptions

At the end of the day, your model will include dozens or even hundreds of different assumptions that range from exhaustively researched to pure gut instinct, but there are only a few core assumptions that really move the needle. Identify these, call them out in your model and make them dynamic. Let those assumptions tell the story of how you’re going to turn your great idea into a great business.

For more in-depth guidance and actionable tools for early-stage startup fundraising, check out our comprehensive open source company-building resource, the Unusual Field Guide. We have a whole chapter dedicated to fundraising here. You can also sign up for our newsletter to be the first to know about new startup resources, tools, and exclusive events.

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