As a startup, making a financial model is hard. My former boss had a saying in reference to startup models: "Half these assumptions are wrong, we just don't know which half yet". In reality, if a startup got half of their assumptions right, they would be in pretty good shape. Let's take a look at some of the mistakes that startups make in their assumptions and some things that can be done to de-risk them.
You Can't Win the Race if You Aren't on the Right Starting Line
The biggest mistake I see startups make in their assumptions is that they don't truly understand their market. I wrote an earlier blog post about this (Go check it out), but if you don't understand your market, then your assumptions won't make any sense. Going back to the example in that post, if your company sells soccer cleats, you need to start with people that play soccer and not people with feet. Then you need to further restrict your market by geography, price point, competition, etc. to get a realistic Serviceable Obtainable Market (SOM) as a starting point. Even the best assumptions will make your financial model look ridiculous if you aren't starting from the right place. It's ok if you don't have a Billion Dollar business, but it isn't ok to embellish your financial projections with an unrealistic market. Investors will sniff this out immediately, and your odds of getting funding will surely go down.
Wait, Who is Driving this Thing?
After unrealistic markets, the next biggest assumption mistake I see is that startups don't understand what is actually going to be driving their revenue. Do you have a direct sales strategy? Targeted Marketing? Revenue Split with Channel Partners? Understanding HOW you plan to make your money will help you identify which assumptions are most important. For example, if you have a direct sales strategy (Sales people calling potential clients) then your important assumptions might be the number of sales people you have, the amount of deals they can close in a month, and the average price point of those closed deals. If on the other hand you have a channel partner strategy your important assumptions might change to the number of channel partners, the amount of business they refer in a month, and what percentage your are going to split revenue with them. If you don't have a good concept of your revenue drivers then it signals to investors you don't understand your business.
Getting the Important Half of Assumptions Right
Understanding your market and your revenue drivers will give you a better financial model than 99% of startups out there. It will help you narrow down to the right starting point and identify the 2 or 3 KEY assumptions that will drive your financial model. Once you have these identified it's time to get as much data as you can to de-risk them. Market research, customer surveys, hiring schedules, whatever it takes to ground these assumptions more in reality. If you have a price point in mind, what evidence do you have to show people are willing to pay that price? If you want to assume a certain number of sales people, where will you get them from and what compensation will you give them between salary and commission? Even if your other half of assumptions are wrong, you can go a long way into make sure that the important ones are RIGHT.
Summary
Assumptions can be tricky, especially for startups. Make sure you are starting in the right place and understand the 2 or 3 key variables that will drive your success. If you have any questions on this or need help building your financial model, reach out to us at InfleXion Point. We are happy to help!
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