The entrepreneurial mindset can be wildly different from that of an investor’s mindset. I have joked with colleagues from the buyside that if the private equity professional version of myself could interview the entrepreneur version of myself, the former would be disappointed in the latter. The metrics I previously considered critical in evaluating a business are eclipsed by new metrics that I track to evaluate ASM’s progress and momentum.
Note: I wrote about this mindset shift in 2017, and it was republished by Inc. and Forbes. You can find the article on ASM’s blog should you be interested.
Pitching investors on your startup idea requires combining these two mindsets. You must both sell the vision, which comes naturally to entrepreneurs, and explain the success story with details and structure that are important to investors.
In that context, I thought it would be interesting to discuss a few of the financial topics that I frequently find are missing in an early-stage investor deck.
Path to Profitability
Most investors want to see the potential path to a return of capital. Startups and businesses that are not presently profitable cannot return capital without additional capital raises or without being purchased. Demonstrating a path to profitability eliminates the urgency that would otherwise be associated with these two potential outcomes.
As part of this exercise, I would encourage including historical data and details to support projected revenue. Depending on the business, historical revenue can be broken out by product type, service, or customer, and then this data can be used for the projected period. At a minimum the projection should extend through the first profitable month.
There are also plenty of startups that do not focus on profitability for an extended duration. If this is the objective, I think it helps to communicate that operating at a loss for the projected period is a choice (e.g., high spend on customer acquisition to scale quickly).
I created a video series that documents how I tracked ASimpleModel.com through its first profitable month. You can learn more about this as part of the Business Development series.
For many asset-light businesses, an income statement might be sufficient to communicate a path to profitability. But businesses that require working capital to scale will rely heavily on the balance sheet for growth, and this will consume cash. As the business grows and adds new products, the inventory balance that carried it up to a certain point may not be sufficient for the additional SKUs required to maintain revenue growth.
It may seem counterintuitive, but even a profitable business with positive working capital can experience liquidity issues (or risk bankruptcy) if it scales too quickly. A business that sells a manufactured product, for example, should carefully evaluate the cash required to support projected revenue, and the best way to do this is with a detailed operating model or three-statement model. Note: For an example of a detailed three-statement model please see the tab titled “Operating Model” in the Excel workbook for this LBO Case Study.
If a detailed operating model is not available, then a projection of working capital accounts and any required capital expenditures will help communicate the amount of cash required to support revenue growth.
Related Video: See how working capital trends can have a drastic impact on the amount of cash required to scale a business.
The amount of capital raised is frequently included in most investment decks I review, but the detail surrounding how it is structured is occasionally omitted. An entrepreneur should consider the pros and cons of popular fund-raising options including equity, SAFE (Simple Agreement for Future Equity) notes and convertible notes, to name a few.
If the security has a current component (e.g., interest payments on convertible notes), a financial projection is once again helpful because it will demonstrate how the entity will service this debt.
Uses of Cash
How much detail has gone into the uses of the capital being raised? As an entrepreneur you might be raising capital to expand the team, expand the marketing budget or fund inventory purchases. The more detail you provide on this front, the better.
Invitation to Review Subscription Documents
In addition to encouraging follow up, this also communicates a degree of professionalism that imparts confidence. If subscription documents are available, it suggests that legal counsel has been engaged and that the entrepreneur is spending time and money to works towards a successful raise.
Responding to Silence
I have had many entrepreneurs tell me that they have pitched their idea to multiple investors without ever receiving a response. Most active investors are carefully evaluating multiple opportunities simultaneously. If something about a particular investment does not appeal to them, they are more likely to focus their attention on opportunities that are more attractively structured. This may be a matter of perspective, but if the idea is struggling to gain momentum with investors, my advice is to follow up with investors and ask them to present terms that they would find attractive.
It’s important not to be offended by the response, because a response is a better starting point. Now you have engagement.
Note: Start with investors that have the potential to complete the round. If one such investor finds it attractive, it is likely that others will follow.