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My co-founder at Everywhere Ventures, Jenny Fielding, has a penchant for drumming up debates on Twitter, and her Tweet about financial models was no exception. After seeing such entrenched perspectives on both sides of the aisle, we decided to lay out both a post about why we think it’s necessary, as well as a video module and draft model that we created with our friend Eric Friedman over at Graph Advisors.
Within the 144 quotes and 36 reposts I was caught eye-rolling at how many people still think that a model is about prediction. The reason some dismiss it is because of the knee-jerk, straw-man argument that “it could be wrong,” and therefore “what’s the point.” “If you’re too early, you can’t possibly understand how to model anything accurately enough to warrant the time spent,” or so that argument goes. This is a fundamental misinterpretation of the merits of a financial model.
A model allows you to map out conditions, and sensitivities. If you change one input, what would that do hypothetically to an output. This gives you an ability not to predict, but to prepare. Models are about preparedness, not about prediction.
A model is a logical articulation of the levers that drive your business, and perhaps the highest value a model has is in the actual creation of it, the process. The outcome of what’s created, or what it predicts, isn’t the point. The point is thinking through your entire business from the bottom up and top down, and pulling out all of the business drivers and levers, and then the assumptions within the assumptions. Your model is a map of the conditional arguments of your business, and the sensitivities. If this then that, across every assumption in your business. Moreover a model allows you to map out some of the hypotheticals, or sensitivities. If you change one input, what would that do hypothetically to an output. This gives you an ability not to predict, but to prepare. Models are about preparedness, not about predicting the future.
For example, we recently invested in a cyber security company that sells through managed security service providers (MSSP), a channel partnership. This is a pre-seed company, and we invested because when we pointed at a multi-billion dollar market figure in a slide and asked about their go-to-market, how that number broke down, the founder could articulately logic his way through the various levers, and pathways to scale. We weren’t looking for an answer, but rather structured thinking, thoughtfulness, preparedness, the fact that he had been rigorous. He was fluent.
We weren’t interested in what the model forecast in year 3 or 5, but rather questions like: 1) Across the ~$100 billion market, what was the distribution of companies across employee ranges, 2) was there a market segment that was easier to sell into, or that most worked with these MSSPs, 3) how many MSSPs were there, 4) how many SMBs did each MSSP sell into, and at what average order value (AOV), 5) based on that AOV what was a reasonable price point he could layer on that wouldn’t change demand, or lead to customer attrition, 6) based on the total market size of MSSPs, at a very conservative to reasonable level of market penetration could we see a path to $1M in annualized revenue run rate (ARR), then to $5M, and to $10M?
Of course beyond a certain horizon our belief (and reality) is that the business will certainly change, layer on new components, expand its own scope, move into market adjacencies, etc. So I do agree that trying to build a model to hypothesizes out 10 years is less useful, but what’s not is performing the logical exercise of building a model to become fluent in your business, and understand all of the levers in a mutually exclusive, collectively exhaustive (MECE) way so you can speak about it fluently. Building a model helps you gain fluency with your own assumptions.
Models are about preparedness, not prediction.
As with most things, if you can go one or two layers deep, so can most other people. So can your investors. But if you’re probed and you can go three, four, five, or fifteen levels deep, that is the vocabulary of logic and levers that a model provides you. Your investor has not modeled it out, so if you haven’t either you have no advantage in understanding your business better than they might. Investing time in building a model yourself (not outsourcing it), is exactly what gives you the firepower to speak directly to any investor, and be able to go ten levels deeper than they can. This will not only impress them that you’ve “done your homework,” this is why they’ll write you a check. You’ve demonstrated an exhaustive, gritty, informed way of thinking that’s indicative not only of how you build a model, but how you’ll run a business.
The process of how you share your vision, how you frame your pitch, how you think through your model, is a direct view into how you will run your company. Fundraising isn’t in isolation; it’s a lens into who you are and how you lead.
As with all things signals matter. Signal that you’ve done your homework by thinking through your business in a comprehensive way by building a model. This will give you the vocabulary and depth of understanding your own business that will, on its own, supercharge your ability to defend positions, spot errors, and raise money.
We’re firm believers not only in models, but in the process of building them. Download our sample model, and then make it your own. Add to it, tinker, have fun. This is an arrow in your quiver, a tool in your belt, and is as powerful as you think through it.