StartUp Investing: Do The Numbers Matter?
Photo by Carlos Muza on Unsplash
One of the ways that my firm helps organizations is by forecasting commodity prices. That is, we study specific commodities (e.g. High Density Polyethylene) and, using both quantitative models as well as qualitative analysis, provide a view as to what will happen to the prices of those commodities 6 to 12 months out. It’s not a perfect science but it’s helpful in driving better decision making.
Every so often, I’ll have someone ask us for a detailed 24 month forecast. And every time, my answer is the same: we can do it, but it’s really pretty useless. The underlying trends and drivers analysis can be helpful but the mathematical modeling (and its resulting output) is simply a best guess. 24 months is too far out and too many things can change between now and then. So don’t waste your money.
My point is that no one has a crystal ball and too many variables are at play to be able to develop an accurate point of view. Our time is better spent understanding the underlying trends and, even more important, identifying the actions needed to manage the situation to our benefit. Intuitively, that makes sense, right?
And yet, it’s funny then that that same logic isn’t carried through to areas where we have even less information to work with. Specifically, the emphasis placed on developing deep and detailed business plans when you’re a startup.
Investors and lenders expect fully thought-through, detailed business plans before they agree to put their money into a new business. And, of course, the intent is understandable. They want comfort that the person(s) they’re giving their money to, has done their diligence, has calculated how to best use those funds and will make that business a success (guaranteeing those investors a proper return).
But here’s the thing: the revenue forecasts in those plans are little better than guess work.
When you start a new venture, you literally have no idea how your product or service will be met in the market. You don’t know who will or won’t buy (perhaps beyond a few ‘friendly’ folks who have pre-agreed to give you a try). You don’t even know - beyond that innate sense within you as the entrepreneur - whether what you have to offer is fit for purpose.
So any projections you make about first year sales is guesswork. From outreach to uptake and conversions to customer churn. Educated guesses, perhaps, but guesswork, nevertheless.
To be clear, that doesn’t mean that work isn’t valid. The act of doing the work itself helps to clarify thinking, approach and potential actions to help mitigate any problems. That’s a helpful exercise, for sure.
But as an entrepreneur, it’s important to bear that fact in mind. It should be a point of tension and comfort. Something to strive for but not get caught up in trying to nail down, because you can’t. You won’t know until you get started.
And, as an investor, don’t put more stock into revenue forecasts than is actually appropriate - which means, not a great deal. Because no one has a crystal ball. And those numbers could be off by any order of magnitude, either way.
Instead, bet on what’s in front of you, on the underlying factors that will make the business a real success.
Bet on the management team. Bet on their quality and viability of their vision. Bet on their drive and commitment and their willingness to sacrifice to get there.
If you can get proper comfort there, then that means far more than numbers in a deck. You’ve got something to work with because those elements are far better predictors than any detailed business plan.
