Know Your Numbers

A classic concern expressed by high-potential startup investors is ensuring that someone with business acumen is at the helm of the startup. How do you demonstrate that you are someone that investors can trust with their funds?

Investors putting their resources at risk on the potential future success of a startup want to be sure that its leaders know how to build a business successfully. While most high-potential startups have exciting technology innovations at their core, leading-edge tech is not enough to build success. Translating that technical innovation into the foundation of a multi-faceted business requires knowing how to create and scale the scaffolding of all the interconnected pieces of a business. That means that while there are usually brilliant engineers, scientists, and other technologists who are doing their inventing magic to build a set of durable technological innovations that will create that fantastic customer value, expertise in the other elements of the business are equally important. Business disciplines like product management, product launch and commercialization, and operating the business at scale are essential. Furthermore, gathering, deploying, and managing the necessary resources via fundraising, hiring, and managing all business dimensions are critical to success.

Since business skills and experience are essential, one of the most crucial skill sets that a startup leader must demonstrate is a solid grasp of the business fundamentals that make up the structure of a successful business venture. Experience with managing an operating business unit or company comes with the requirement of managing the core business drivers, often known as managing the P&L.  P&L stands for profit and loss, and means the work that business leaders do to monitor and manage the increases and decreases in the revenues and costs in a business that ultimately generate a net operating profit for the business.  For a startup, achieving cash-flow breakeven and profitability often involves raising money and investing that money to develop innovative products, commercially launch them, and grow the business to profitability.

The common theme you might notice here is that managing the business side means understanding and knowing how to manage the money flows of a business. A strong business leader with the right experience will have a firm understanding of managing funds to accomplish business objectives. One of the key indicators that a startup leader has those requisite business skills is whether they can demonstrate that they “know the numbers” and can fluently talk through the drivers that generate revenue, influence expenses, and how planned investments will translate into future financial performance. Earning investors’ trust does not require that you have an accounting degree. However, a business leader should be conversant in reading core financial statements and understanding their interactions since that understanding is essential to making wise business decisions. This is why finance and accounting are part of the core coursework in earning a business degree and why business leaders are often asked about their experience managing a P&L.

Once a potential investor has been intrigued by the business concept, expect that part of due diligence will be testing the expertise of the core team members. One of those skills a startup CEO is expected to have is a strong grasp on the finances, so in addition to being able to pitch your high-level financial forecast model and answer questions about your financial statements, your assumptions, and other financial matters, here are some example questions you should be able to field from investors confidently:

• Can you share your 5-year forecasted financial statements (income statement, balance sheet, and statement of cash flows), with at least the first year broken out monthly?
• Can you share more about the target market size, the industry’s sales cycle, and other purchasing patterns?
• Can you explain your revenue assumptions, including pricing model, average anticipated annual volume of purchases per customer, and revenue ramp justifications?
• Can you describe your gross margin now and as you scale? What is changing and why?
• Can you outline your planned product development investment plans, including the funding required to achieve each milestone (broad brush strokes, please!)?
• Can you please share your trailing 12 months of revenue and forward-looking monthly forecasts?
• What is your monthly burn? How does it vary under different hiring and sales scenarios?
• Can you share where your milestones are at now with your current raise and how those milestones would change if you raised materially more or less?
• When do you anticipate raising additional funds? How much will you need to raise, and what milestones would you achieve with that funding?
• How did you handle taxes in your financial model – sales tax, income tax, franchise tax, payroll taxes, and so on?
• Can you please provide your historical financial statements since the company’s inception? What was your revenue, number of customers, and total expenses for ___ year?
• Are your financial statements prepared consistent with GAAP?
• Can you share your pro forma cap table? What will be the impact on the cap table if you raise less than you anticipate?
• And so on…

As a startup leader, your goal is to demonstrate a strong understanding of the financial levers that make up your business. This is fundamental to being able to be a careful financial steward with an eye towards capital efficiency as well as being able and willing to knowledgeably and, under conditions of uncertainty, make the essential financial bets that could make the difference between a startup’s success or failure. These are critical skills that the CEO, as the ultimately responsible executive, and at the appropriate point, the startup’s lead financial executive, must demonstrate appropriate competence in.

More than once, I have found that having a robust and detailed financial model and the ability to talk through and explain it gives essential comfort to investors that their funds will be deployed and managed wisely. Know your numbers so you can inspire their trust!