8 Secrets To Credible Startup Financial Projections

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Monday, September 7, 2015

 

8 Secrets To Credible Startup Financial Projections

Alexis Ohanian
Entrepreneurs often ask me why investors expect financial projections for a new startup even before the product is built and while the market is still being defined. I tell them that the projection process and results are most important for you the founder, to evaluate if there really is a business that can be built from the idea. You shouldn’t invest in an undefined business.  Investors can’t really evaluate any new business, but they can assess the logic behind your numbers, and compare that logic to their experience and rational business norms. Most have developed their own financial “rules of thumb” that will help them decide if your startup is fundable, in conjunction with their assessments of your team and your basic business concept.  If you are lucky enough to not be looking for an outside investor, meaning you are bootstrapping the business, the secrets that smart investors use to evaluate startups can help you understand your own risks and help you set reasonable expectations for yourself. Here are some key rules of thumb from my own experience:

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New domain names: strategies for brand owners to protect their trademarks (part 2)

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New domain names: strategies for brand owners to protect their trademarks (part 2)

John H. Rees

By John H. Rees
September 15, 2015

This is part 2 of a three part series on how brand owners can protect their trademarks with the introduction of several hundred new generic top level domain names.

Concerns

Trademarks are source identifiers. In order to develop strong trademarks, brand owners often spend significant amounts of money, and expend significant efforts for consumers to associate specific products and services with their brands. These trademarks become very valuable, and bring significant goodwill to the brand owner. As extreme examples, the APPLE and GOOGLE brands are valued at approximately $100 billion each.

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Why Venture Debt is Better than Equity for Entrepreneurs – originally published in Beehive Startups

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Why Venture Debt is Better than Equity for Entrepreneurs

Equity investors are going to push you to take really big risks, often unrealistic ones, so they can make the most money in the shortest amount of time. It is easy for investors to tell you to take big risks because they will only lose some discretionary money while the entrepreneur can lose everything.

 This is a guest column written by Steve Grizzell. The views and opinions expressed are those of the author and do not imply endorsement by Beehive Startups.

I have provided venture debt to over fifty entrepreneurial companies and concluded that borrowing is often a better option than equity for a lot of entrepreneurs. I am not talking about seed companies — they don’t have any monthly cash flow to make loan payments — but for companies that have rapidly growing sales and are just becoming profitable. If you can increase your company’s sales with a loan then you are better off with debt.

I am not talking about traditional bank debt but alternative sources of debt, which are becoming more and more prevalent. Commercial bank debt is usually only available to businesses with collateral and a couple of years of profitable operations. Alternative lenders are able to loan to service and software companies that don’t have collateral. They will also consider loans to companies with only a few months of profitable operations.

Raising equity is too much about ego. “I raised a lot of money from investors, so I must be smart and my company is the next “FILL IN THE BLANK UNICORN COMPANY.” If you consider con artists like Bernie Madoff your role model then talking people out of money is great. But if you have integrity then talking people out of money is not much to be proud of when you don’t have much of value in your company, although you wouldn’t guess this by listening to a lot of entrepreneurs. Indeed some venture accelerators only teach entrepreneurs how to pitch and not how to figure out if you have a great company.

Another drawback is that when you sell stock in your company you give up some of the control of the future of your business. If you take a first round, you will almost certainly take another round. I often hear entrepreneurs saying, “I probably won’t need another round of financing.” That assumption is usually pretty naïve because most fast-growing businesses need a lot of cash, even SAAS businesses. Once you taken your first round of equity, your round has to be at a higher valuation or you lose control of your company or even go out of business.

Equity investors are going to push you to take really big risks, often unrealistic ones, so they can make the most money in the shortest amount of time. It is easy for investors to tell you to take big risks because they will only lose some discretionary money while the entrepreneur can lose everything.

If you give up equity too early you could be giving away millions of dollars. Dave Bateman founded Property Solutions, now named Entrata, and during an interview he said that in hindsight taking money from angel investors was his biggest mistake. It cost him millions of dollars and did not provide millions of dollars of value back to him. Full disclosure: I made a few million dollars for one of the funds that I manage from Dave by selling him back my stock.

If you take debt you are showing you really believe that you will succeed, especially if you put some of your own money and personally guarantee any debt. Personal guarantees are not required with venture debt, but if you are willing it will make a very positive impression to any venture lender. If you think it is too risky to guarantee a loan then you are right – a loan is not for you. Your business is too risky for a loan! Venture debt isn’t perfect but often it is a lot better than equity.

Steve Grizzell Twitter LinkedIn

Steve Grizzell is a 25-year veteran in entrepreneurship, finance, innovation and economic development. He is Managing Director of InnoVentures Capital Management, which manages two Small Business Investment Company and a non-profit lender that provides venture debt to early stage companies.

An Accelerator For Impact Fund Managers Targets The ‘Pioneer Gap’

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Entrepreneurs
2 FREE Issues of Forbes
Sep 9, 2015 @ 02:19 PM 298 views
An Accelerator For Impact Fund Managers Targets The ‘Pioneer Gap’

Anne Field

Contributor

I cover for-profit social enterprises and the people who fund them

Follow on Forbes (288)

Opinions expressed by Forbes Contributors are their own.

In developing countries, there’s something known as the “pioneer gap”. Usually it refers to a shortage of financing for early-stage startups, after friends, family and angels and before VCs get in on the act. But the term also can allude to a shortage of capital for impact funds seeking to invest in those companies.

That’s where Capria Accelerator comes in. The new Seattle-based global business accelerator for impact VCs will invest in, support and help capitalize new fund managers backing early-stage startups mostly in South Asia, Southeast Asia, Africa and Latin America. “We’re addressing the pioneer gap among fund managers, just as those funds are addressing a gap among entrepreneurs,” says co-founder Will Poole.

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Part Three: 7 Reasons Convertible Notes Are Your Worst Option

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Part Three: 7 Reasons Convertible Notes Are Your Worst Option
By: Preferred CFO
inShare
Wrong Choice!
This is the third of three articles on Convertible Notes for founding entrepreneurs. Convertible Notes Part One: The Basics defined what a Convertible Note is and compared it to Preferred Stock. Convertible Notes Part Two: The Crucial Details examined how negotiations arrive at Convertible Notes. This article identifies 7 reasons that Convertible Notes are the wrong way to go.

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Steve Blank, Founder of Lean Startup Movement, On Entrepreneurship in Healthcare and Life Sciences (INTERVIEW)

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Steve Blank, Founder of Lean Startup Movement, On Entrepreneurship in Healthcare and Life Sciences (INTERVIEW)

Steve-BlankSteve Blank needs no introduction as the man who started up the Lean Startup movement (in case you need one, find it here on his blog). But, you may not be aware that he has taken significant interest in entrepreneurship in life sciences, digital health, and healthcare. He teaches entrepreneurship in these realms at UCSF and the National Science Foundation (NSF). Very recently, in fact, the White House announced in August that it is “scaling up” the “rigorous entrepreneurship training program” that Steve has developed, called I-Corps.

Steve was generous enough to make some time to discuss healthcare innovation and entrepreneurship recently with me. We talked about a variety of things, including general entrepreneurial principles for building a successful company. In an effort to craft my transcript more toward health care professionals, I urge you to read his book, The Startup Owner’s Manual, for more on his fundamental entrepreneurial principles. I have distilled below some of the pearls Mr. Blank shared about healthcare entrepreneurship.

 

Jonathan O’Donnell, Medgadget: What are some of the qualities of a successful healthcare innovator based upon your experience with the participants in your UCSF course, Lean Launchpad for Life Sciences & Healthcare?

Steve Blank: The fundamental qualities of a successful innovator are common to every domain. Successful innovators are agile, relentless, curious, passionate, pragmatic, and focused, to name a few. But there are some unique qualities for health care innovators. As one example, the good thing about clinicians versus, say, material science engineers is that those who practice healthcare recognize that they don’t completely know something, and are more open to hypothesis-testing than those in other domains. This is the same for successful entrepreneurs, who are more amenable to testing many hypotheses.

Successful healthcare innovators are domain experts. The business of healthcare is not intuitively obvious to those outside of healthcare. There are many more moving parts, such as product-market fit, regulation, intellectual property, reimbursement, clinical trials – all those things that are on the “left side” of the Business Model Canvas – whereas, in other domains, once you find product market fit, you are off to the races. And all of this changes depending on if you are working on health software, diagnostics, devices, etc.

 

Medgadget: Your blog recently hosted a guest post about the 7 Deadly Healthcare Startup Sins. In what specific ways have you seen clinicians succeed or fail in healthcare entrepreneurship? What can aspiring clinician-entrepreneurs learn from these examples?

Steve Blank: I have seen success and failure begin with 1) clear definitions of the startup end-game and 2) expectations for how to get there. If you are a clinician or researcher, delivering care is different from building a company. On Day 1, you have to candidly ask yourself, “what is my goal?” Is it to build a successful company that lasts for 15 years? Or to build a company and sell it? Or to “change” medicine and you don’t care how it gets done but you wish to dedicate your life to it and you don’t care if it is profitable? Really, what IS your objective? Ask yourself how does your objective get done in your particular field. For example, there is no way you will build a standalone company in implantables, but you may be bought. Understanding that on Day 1 that is the end point is crucial to objective and subjective success. Most clinicians don’t think about this coming out of the hospital. I often give the example of the chief of surgery at UCSF. He had been in the lab working on a device for couple of years, but had no idea how revolutionary it was. However, he had no idea about the FDA’s pre-market approval, clinical trials to run, the amount of capital he needs, etc. He abandoned his idea, stating, “I have other stuff to do and if this is what it takes to bring it to market….” That’s one end of the spectrum.

Moreover, in healthcare, it is often not even clear who the customer is. For instance, I often run a classroom exercise with students – “say you consider a hip replacement because grandma needs help. Can she acquire the hip herself, or perform the hip replacement surgery? No, a doctor does. But how does the doctor get the hip? Does grandma or the doctor pay for the hip? Well, insurance pays for it, reimbursing the doctor. And a device company may supply the hip.” So, within this 90-second Socratic dialogue, students understand that it is tricky in healthcare to figure out who the customer is – grandma is the least important part of the process. In this hypothetical example, an entrepreneur is building new replacement hips is not building a better hip for grandma, but building a better hip for payers. You have to know who your customer is, which can be different from the end-user, supplier, etc. It can be very confusing in healthcare.

 

Medgadget: How should one approach designing an MVP (minimum viable product) in an industry that requires perfection, that often can literally be a matter of life or death?

Steve Blank: Let’s consider an implantable device. True, you can’t make a half-assed heart valve, but you can spend a lot of time with clay models or different materials for your prototype. Then you go talk to the surgeons and listen to their description for how they practically perform the surgery with those pieces and listen to feedback like, “gee, this material is not biocompatible with x or y.” For you to think that your MVP is a fully functional device misses the point. The goal of the MVP is to maximize learning at that specific point in time and development.

What about therapeutics – how do you make half of a cancer drug? Well, have you talked to Merck and discussed their pipeline? They may say they have four similar drugs to the one you propose, but they have nothing addressing a particular area, and you could collaborate. In therapeutics, what we find is if you are on the right target, you can a partner with Pharma to produce a product in 18 months rather than 10 years on your own.

And in healthcare software, there is no excuse for not building MVPs.

Again, thinking about your MVP as a finished version or working prototype is misunderstanding its point for learning. You should think of the lean process as an iterative “clinical trial” of your business model, learning all along the way.

 

Medgadget: What curricular elements do you feel are missing from health professions education that should be instilled in order to drive successful and effective healthcare innovation and entrepreneurship?

Steve Blank: Humility! (chuckling) – I have a great video of when we challenged this passionate clinician:

“thank you for your opinion – we don’t matter how smart you are – you haven’t talked to anyone else – well I’m an MD/PhD – well, welcome to the room, so is everyone else, welcome to the real deal!”

As a given, as a clinician, you are the smartest person in the hospital or building. That’s fine. But it doesn’t matter! There’s no way you are smarter than the collective intelligence of your potential customers. That’s the whole core of entrepreneurship! Unless you are the core person yourself who buys and will use it, your belief is just an opinion. You, in fact, have a faith-based enterprise rather than a company.

The best class for a physician who wants to start a company is a lean startup class (you could start with my massive open online course hosted by Udacity). In such a class, you will learn to start talking to customers, users, partners, payers, and get out of your clinical environment – and you may be stunned that your understanding of your defined Need may not be shared by others. The lean startup methodology doesn’t guarantee success, but it moves

7 Reasons Convertible Notes Are Your Worst Option

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PreferredCFO

Wrong Choice!

 

This is the third of three articles on Convertible Notes for founding entrepreneurs. Convertible Notes Part One: The Basics defined what a Convertible Note is and compared it to Preferred Stock. Convertible Notes Part Two: The Crucial Details examined how negotiations arrive at Convertible Notes. This article identifies 7 reasons that Convertible Notes are the wrong way to go.

You’re Strong Enough to Get a Loan

If your company is destined to be the next Facebook sensation, you’ll make the most money by delaying sale of your company. To do that, you’ll have to convince someone that you can safely pay off a loan, with interest. If you’re strong enough to do that—and you think your company will appreciate—don’t sell off future rights to your company. Get a Loan.

You Can’t Afford to Pay Interest

Convertible Notes can let you delay the date when you sell your company, but they come with the cost of paying/accruing interest until that time. Every business is different, and yours could have a bright future while still being unable to make interest payments. If you can’t afford interest now, then you need to consider equity instruments like Preferred and Common Stock. Keep in mind that there needs to be a good reason that the future will be brighter than the present for investors to take you seriously.

You Aren’t Good at Terms

Convertible Notes offer more flexibility. While that can work to your favor, it can also work against you. Setting a fair cap, discount and interest rate are the important terms for when your valuation goes up…but what if your valuation goes down? Unless you can see the future, you need to consider all possibilities. Conversion rights in case of lower valuation are important and can lead to anathemas like Full Ratchet. If your Convertible Note includes the wrong Liquidation Preferences, any unfortunate need for liquidation could leave you with a lower effective ownership percentage than you’re comfortable with. But in the end, if you can’t negotiate the flexible terms of a convertible note, you’re going to have a really hard time with the rigid terms of an actual term sheet.

You Can’t Agree on Terms

Being good at terms doesn’t mean you’ll be able to get the terms that you want. Convertible Notes have more flexibility, but savvy investors will want to use that flexibility to their advantage just like you’re hoping to use it to yours. Sometimes more established, less flexible forms of funding will result in less arm wrestling. If the terms you can get from another funding instrument are better, the flexibility of Convertible Notes may not mean much. If that’s the case, get Series funding.

You Don’t Have a Long-Term Plan

Convertible Notes can let you price investors differently—giving you more negotiating power—but pricing investors differently comes with a cost of higher complexity down the road. The higher complexity can cost you more in legal fees and limit your options when you’re ready for your next round. That may be an acceptable cost, but it shouldn’t ever be a surprising cost. Don’t let short-term pressures keep you from considering the long term.

 You Don’t Understand the Gamble

All investments are a gamble, but Convertible Notes act as both debt and equity, meaning you don’t get to dodge the risk of either. That higher complexity isn’t necessarily a bad thing, but it shouldn’t be mistaken for a good thing either. A good gambler is one who considers all possibilities, correctly estimates the probability of each (beta), and makes sure the terms of the agreement are better than the risk (alpha). The terms of your Convertible Note will determine what kind of a gamble you’re taking. If you don’t understand the gamble enough to decide whether you like it or not, you shouldn’t be taking it. Get help or stick to less complex financial instruments.

You Don’t Need To Retain Control

With all these pitfalls, you might be wondering why it is you should like Convertible Notes in the first place. The reason is simple: flexibility and control. Flexibility can (sometimes) let you raise money quicker, with fewer legal fees, and negotiate stronger. Frequently founders use their flexibility to maintain higher levels of control, keeping their investors off of the board, and keeping their investors from having veto rights on future rounds of funding. If you need neither flexibility for unusual terms nor more control than typical Series funding will provide, Convertible Notes hold little value for you.

Next Steps

Each of these pitfalls requires expert analysis to be correctly evaluated. That means you need an experienced CFO. While a full time CFO can be too costly, lacking at least a part time CFO can be more costly. While hiring a temporary CFO is an option, businesses inviting investor funding benefit from a lasting solution. An outsourced CFO is the most cost-effective way to buy long-term expert advice while avoiding the heavy cost of an expensive internal officer.

Please speak with Preferred CFO for a personalized analysis.

###

 

Social is dead: What 146 startup pitches showed me about the next wave of tech companies

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Flock

Social is dead: What 146 startup pitches showed me about the next wave of tech companies

• Biz Carson
• Aug. 26, 2015, 8:41 PM
• 34,074

Investing in startups is like bird-watching, or at least that’s the quote from legendary venture capitalist Mike Moritz.  Over the past two weeks, I have listened to 146 startups pitch in rapid-fire succession at demo days for Y Combinator and 500 Startups.  Of those startups, probably five or six will emerge as the next Airbnb, Dropbox, or Reddit. The founders of the next billion-dollar startup have probably run through their pitch deck in front of me.  The rest of the flock will disappear from the sky, selling to a bigger company, going adrift, or maybe shutting down entirely.
For venture capitalists, Moritz advises not to look at the flock, but at each individual startup. “Each one is different, and I try to find an interestingly complected bird in a flock rather than try to make an observation about an entire flock,” Moritz has said.

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Convertible Notes: The Debate Continues – Forbes

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Aug 12, 2015 @ 12:37 PM 389 views
Convertible Notes: The Debate Continues

Marianne Hudson ,

Follow on Forbes (49)

Opinions expressed by Forbes Contributors are their own.

Convertible notes can add flexibility for many angels, as I wrote last week. I really like how Angela Jackson thinks about these deal terms for first investments in startups, but it also got me wondering: are angels still debating notes and priced rounds? I did a quick poll of angels, and boy did I get an earful. It’s safe to say the debate is on! Last week more than 100 members of the Angel Capital Association (ACA) responded to the survey. While not a scientific sample, it provides solid market representation since respondents were angels from across the US and Canada and invest in similar sectors and stages as the full ACA membership. Here’s what I found out:

82% prefer to do priced rounds for their initial investments BUT
78% had done at least one convertible note in the last 18 months AND
25% used convertible notes for more than half of their first investment deals

Getting angels on your team is important for getting your startup off the ground and keeping it afloat. (Photo by Dan Kitwood/Getty Images)

Interestingly the preference for convertible notes has actually doubled since 2011, the last time I surveyed about deal term preferences. Clearly angels are drawn to certain convertible debt deals or companies, even if they don’t love the deal terms. This feels like evolutionary change to me. Another thing that surprised me: while I thought geographical location would correspond with preferences – e.g. Californians would most like convertible notes – this wasn’t supported by the survey results. Midwesterners were just as likely to prefer convertible debt, for instance. A few respondents didn’t see convertible notes versus priced rounds as an either/ or decision. These angels viewed deal terms as a matter of what the deal looked like or how many investors were involved, and considered notes as “another tool” for investors. However, the larger majority strongly felt that it is an either/or choice. So why is that? Here are the main reasons:

Missing investor-entrepreneur alignment – Many angels use the term sheet negotiation process to make sure they’re on the same page and to ensure that the final deal sets terms align entrepreneur-investor incentives. Said one respondent, “Unless the convertible has a low valuation cap, we are loaning CEOs money to achieve a valuation that we never would have agreed to in the first place. We are playing on opposite teams, where the CEO is using our money to achieve proof points to give us a crushing valuation (in the next round).”Another said that notes reduce the need for financial modeling and discipline, not only creating strange incentives, but setting the tone for disagreements to fester. Still others mentioned that they don’t get to be on the Board of Directors with notes, further disconnecting the early investors and company.
Recommended by Forbes

Not wanting others to set the valuation – There are up-round risks for all angel investments and perhaps even more with convertible notes. As one respondent said, “The valuation of my investment is now determined by others, whom I may not know and who may have bad judgment, later.”

Next round investors didn’t honor note terms – Beyond others setting valuation there is another risk with next stage investors: at least two of the angels in the survey had the unpleasant experience of investors behind them not honoring the terms of the note. Each commented that they would have ended up with better terms in the A round had they started out with a priced round. Part of the issue is that their notes did not include investor protections that are normally included in an equity term sheet.

Missing out on tax benefits – The US tax code includes a couple of important tax benefits for early stage investors, including one that allows you to monetize your losses and another the minimizes taxes on gains in qualified small businesses. The catch is that the “clock” for starting these benefits is when the investment is equity. When you invest in a convertible note the likelihood of missing out on monetizing big losses increases. Additionally, you have to wait until the next priced round –plus five years – to qualify for a 50 percent exclusion on taxes from a successful gain. There are also some tax liabilities on interest from loans to be aware of when notes convert to equity.

Bridge to nowhere – Many convertible notes never convert to equity, if the entrepreneur isn’t successful in securing a next round. This makes some angels say notes are “bridges to nowhere.” Of course, investors can invest in companies using priced rounds that also aren’t successful in securing a needed next round either. Some angels feel strongly that they will only invest in a convertible debt when it is a true “bridge loan” in which the next investors are known and their investment is in sight.

So where does this leave us? Clearly, the debate on early-stage investment terms continues. For some, priced rounds may be the right choice because of certainty in pricing, more investor protections, alignment, and tax treatments. Still others will prefer that convertible notes provide great flexibility, reduced legal costs, and simple terms for all. The right choice is yours to make and in my opinion, there is no one right answer. Pick what is right for you.

Aug 12, 2015 @ 12:37 PM 389 views
Convertible Notes: The Debate Continues

Marianne Hudson ,

Contributor

I cover angel investing – trends, ideas and how to succeed.

Follow on Forbes (49)

Opinions expressed by Forbes Contributors are their own.

Convertible notes can add flexibility for many angels, as I wrote last week. I really like how Angela Jackson thinks about these deal terms for first investments in startups, but it also got me wondering: are angels still debating notes and priced rounds? I did a quick poll of angels, and boy did I get an earful. It’s safe to say the debate is on! Last week more than 100 members of the Angel Capital Association (ACA) responded to the survey. While not a scientific sample, it provides solid market representation since respondents were angels from across the US and Canada and invest in similar sectors and stages as the full ACA membership. Here’s what I found out:

82% prefer to do priced rounds for their initial investments BUT
78% had done at least one convertible note in the last 18 months AND
25% used convertible notes for more than half of their first investment deals

Getting angels on your team is important for getting your startup off the ground and keeping it afloat. (Photo by Dan Kitwood/Getty Images)

Interestingly the preference for convertible notes has actually doubled since 2011, the last time I surveyed about deal term preferences. Clearly angels are drawn to certain convertible debt deals or companies, even if they don’t love the deal terms. This feels like evolutionary change to me. Another thing that surprised me: while I thought geographical location would correspond with preferences – e.g. Californians would most like convertible notes – this wasn’t supported by the survey results. Midwesterners were just as likely to prefer convertible debt, for instance. A few respondents didn’t see convertible notes versus priced rounds as an either/ or decision. These angels viewed deal terms as a matter of what the deal looked like or how many investors were involved, and considered notes as “another tool” for investors. However, the larger majority strongly felt that it is an either/or choice. So why is that? Here are the main reasons:

Missing investor-entrepreneur alignment – Many angels use the term sheet negotiation process to make sure they’re on the same page and to ensure that the final deal sets terms align entrepreneur-investor incentives. Said one respondent, “Unless the convertible has a low valuation cap, we are loaning CEOs money to achieve a valuation that we never would have agreed to in the first place. We are playing on opposite teams, where the CEO is using our money to achieve proof points to give us a crushing valuation (in the next round).”Another said that notes reduce the need for financial modeling and discipline, not only creating strange incentives, but setting the tone for disagreements to fester. Still others mentioned that they don’t get to be on the Board of Directors with notes, further disconnecting the early investors and company.
Recommended by Forbes

Not wanting others to set the valuation – There are up-round risks for all angel investments and perhaps even more with convertible notes. As one respondent said, “The valuation of my investment is now determined by others, whom I may not know and who may have bad judgment, later.”

Next round investors didn’t honor note terms – Beyond others setting valuation there is another risk with next stage investors: at least two of the angels in the survey had the unpleasant experience of investors behind them not honoring the terms of the note. Each commented that they would have ended up with better terms in the A round had they started out with a priced round. Part of the issue is that their notes did not include investor protections that are normally included in an equity term sheet.

Missing out on tax benefits – The US tax code includes a couple of important tax benefits for early stage investors, including one that allows you to monetize your losses and another the minimizes taxes on gains in qualified small businesses. The catch is that the “clock” for starting these benefits is when the investment is equity. When you invest in a convertible note the likelihood of missing out on monetizing big losses increases. Additionally, you have to wait until the next priced round –plus five years – to qualify for a 50 percent exclusion on taxes from a successful gain. There are also some tax liabilities on interest from loans to be aware of when notes convert to equity.

Bridge to nowhere – Many convertible notes never convert to equity, if the entrepreneur isn’t successful in securing a next round. This makes some angels say notes are “bridges to nowhere.” Of course, investors can invest in companies using priced rounds that also aren’t successful in securing a needed next round either. Some angels feel strongly that they will only invest in a convertible debt when it is a true “bridge loan” in which the next investors are known and their investment is in sight.

So where does this leave us? Clearly, the debate on early-stage investment terms continues. For some, priced rounds may be the right choice because of certainty in pricing, more investor protections, alignment, and tax treatments. Still others will prefer that convertible notes provide great flexibility, reduced legal costs, and simple terms for all. The right choice is yours to make and in my opinion, there is no one right answer. Pick what is right for you.

18 Ways to Make Your Financial Model Stand Out to Investors

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18 Ways to Make Your Financial Model Stand Out to Investors

Spreadsheet Modeling Standards

The median investor looking at your proposal is in her 40s.  Her eyes are going, not to mention her brain.  I look at a lot of spreadsheets and analytic reports, and way too many are difficult to read and therefore hard to understand.

In an effort to make my life easier, I’ve summarized here the steps that will make it much easier for people to read, understand, and hopefully invest in your business.  To help me, I interviewed the two most knowledgeable people I know about financial modeling.  My colleague Paul Bianco serves as interim CFO for a number of ff Venture Capital’s portfolio companies, and has built and reviewed hundreds of financial models.  I also spoke with Michael Hutchens, CEO & Cofounder of BPM Global, which helps organizations more efficiently build and maintain financial models.

Michael first recommends that anyone serious about financial modeling study the Spreadsheet Standards Review Board’s Best Practice Spreadsheet Modeling Standards.  My recommendations in this article are focused on making sure that investors understand what you have created.  The official Standards are more granular, and are the equivalent of programming style: a set of standard methods which help you create an easy-to-use and self-documenting model.

Michael also observes, “One other comment I think would be worth mentioning, even though it seems ridiculously obvious, is the importance of speaking with model users about what is and isn’t important to them when analyzing a model….So often I speak with companies that have charged ahead building an ultra-complex daily or weekly model with thousands of assumptions and complex dashboard outputs, when their potential investors simply want a high-level 24 month forecast with 12 months of reconciling historical data.”

HOW TO MAKE YOUR CELLS READABLE

1)  Include a key to abbreviations and terms. While many investors are familiar with terms like DAUs and QoQs, why not make it unambiguous for everyone?  In addition, make sure to formally define all terms.  E.g., when calculating “Daily Active Users”, does “active” mean “visited the website once”; “performed an engagement action”; or “bought something”?

2)  Format your numbers properly.  Use commas for all numbers over 1,000; long series of digits are difficult to parse.  Use an appropriate number of significant digits.  It’s misleadingly precise to have two digits to the right of the decimal in a CAC/LTV multiple for year 3 of your forecast (“Customer Acquisition Cost”/”LifeTime Value of Customer”).  It’s too imprecise to show only 1 significant digit right of the decimal when showing a $2m topline income statement formatted in millions.  All figures should have a denomination, either in its formatting or at least in the column header.

3) Use logical color coding.  As a general rule, font coloring is a great way to distinguish constants from formulas, e.g., put your assumptions in blue.  You can use fill coloring to distinguish assumptions cells, so that model users don’t inadvertently make changes to formulas and non-assumptions. However, when choosing font and fill colors to do this, bear in mind that about 8% of all men are colorblind, and many spreadsheets are printed in black and white. Also, you can’t sort data sets by color coding. Hence, different color shades should ideally be readable even to a color-blind person. To ensure this, the official Standards recommend that assumptions sheets use a light grey fill color, and white/no fill for output sheets.

4) Use a minimum font size of 10 points.  Font size is the #1 driver of readability.  If you have to fit a report on one page, shrink your column sizes and use less white space.

5) Do not use hard black lines to divide rows and columns; they make the page very busy and therefore hard to scan.  Instead, use alternating shaded lines or use soft dotted gray lines (suggestion courtesy Edward Tufte).

HOW TO MAKE THE ENTIRE DOCUMENT READABLE

6) Title your file in a format like [Company Name] [Forecast] [yyyymmdd], e.g., “[Company Name] Forecast 20150524″.  This allows readers to differentiate your file from all of the other files they receive, and also easily track the evolution of your document as it changes.  Naming your file “Forecast.xls” does not make you look considerate or organized.

7) Organize your tabs.  When multiple worksheets are used in a workbook, every tab should have a meaningful name, and should read in a logical order left-to-right.  One of the marks of an amateur model-builder is using three tabs (the default in a new Excel file), only one of which actually has data.

8) Consistency builds confidence. Given the same calculation logic, the difference between a model that breeds confidence and one that creates anxiety is rigorous consistency. And consistency doesn’t apply only to formats and styles, it applies to every part of a spreadsheet including sheet zoom levels, heading indentation, decimal places, alignment, frozen panes placement, time series columns, etc.

9) Use styles instead of just formats. Spreadsheet applications, like word processing applications, allow styles to be set up once for a spreadsheet and then used throughout.  This ensures the consistency of similar content (e.g. headings, assumptions, etc.) without needing to manually format each cell.  I think far too few people take advantage of styles in both text documents and spreadsheets.

10) Create an area for assumptions and main drivers at the beginning (top or left) of the model.   Jake Perlman-Garr of Datavore points out that this helps facilitate both the auditing and tweaking of forecasts, and also helps a potential investor understand better what the entrepreneur thinks are the important drivers of their business.  One common option is a dedicated assumptions tab that flows into the rest of the model, and then outputs key pieces of data right at the bottom of the assumptions tab, so that the key inputs and outputs are in one place.

11) Separate out your model output. Some model users will want to stress-test assumptions and explore the detailed calculations throughout a model, but many important decision makers will only want to look at selected outputs (e.g. financial statement summaries, valuation analysis, ratio analysis, etc.) once a model has been finalized. Make this easy for them by creating a dedicated presentation outputs section and positioning it at the front of the spreadsheet.

12) Design for printing. Important decision makers often don’t attend meetings with a laptop, so they’re likely to print key model assumptions and outputs as meeting discussion points. Setting print areas, page breaks and scaling to ensure quick and easy high-quality printing will put you in favour with model users and allow them to impress colleagues with the printed outputs.  I recommend insert report title, date printed, and page number on every footer, for easy auditing.

13) Design for auditability.  Ideally, create a visual map of the structure of your analysis, so readers can understand the logic of your model.  Datavore is a New York startup which is working to improve on the functionality of existing tools like Microsoft Excel by creating a visual display of the calculations comprising complex analyses such as a financial model.  this allows for easier auditing and if/then testing that flows through each step.  Here’s a Datavore sample of a visual summary of a model:
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MODEL LOGIC SHOULD BE LOGICAL

14) Explain assumptions and make sure they tie to reality. A model that shows X% growth over time with no embedded correlation to sales/marketing is a huge red flag.  More reasonable: a company with a direct sales model may drive revenue growth based on the number of productive sales reps and a quota, with a target that is higher over time. If assumptions get better over time (lower customer acquisition, higher gross profit, better retention), note how you plan to achieve those milestones in the model. A more mature organization may project future revenues based on their actual sales pipeline, with a probability adjusted percentage based on stage.

15) Bridge historical and projected data. One of our biggest pet peeves is reviewing an operational model that starts in “Month 1″, and excludes anything that has happened in the past. A model that starts with historical data that flows seamlessly into projected data allows a user to understand how assumptions relate to reality.

16) Cash is king.  A model that shows Beginning Cash + Revenue – Expenses = Ending Cash doesn’t tell the whole story. A good model needs to factor in cash collections, disbursements, and other working capital considerations with a Balance Sheet and Statement of Cash Flows. While some of your customers may pay via credit card, perhaps some of your largest customers pay on Net 60 or even 90 terms. This is especially important for companies that carry inventory on their balance sheet.

17) Include a sensitivity analysis.  While not every model needs to have multiple pre-set scenarios built in, it is useful to see, at a minimum, how changing key assumptions impacts the model outputs in real time. It is particularly useful to see this output directly on the assumptions tab so there’s no need to flip between tabs after making an assumption tweak. Below is an example of a useful financial output summary located within an assumptions tab:

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18) Output key metrics, not just financial statements.  In addition to summary financial statements, include an output of key metrics like acquisition costs, lifetime value, cohort retention, etc.

I suggest also read everything that Edward Tufte has written, and see Hans Rosling’s work for another expert in visual display of quantitative information.  I’ve also written more previously on preparing spreadsheets and financial models.

 

This is part 5 of my series on communications:

Thanks also to Dr. An Nguyen and Alberto Pepe, CEO, Authorea, for helpful input.  I published a summary version of this article at Entrepreneur.com.