Forecast Modeling for Early Tech Co’s

As technology venture investors, we are presented with a wide variety of forecast models.  Given that we typically lead or participate in Series A / Series B rounds, we are often evaluating companies that are still relatively young (read: lean).  Understandably, many of these companies have yet to establish a dedicated finance function, so the task of developing a forecast model can fall – at least in part – on the CEO or some other, more operationally focused team member.  If this is the case at your company, and you haven’t built a lot of financial models before, we recommend seeking out input from someone with modeling experience before starting to shop for growth capital.

Your model is an extension of your pitch deck: it’s an opportunity to demonstrate you have a strong understanding of your business and its key drivers.  This wasn’t necessarily as important at the seed stage, as investors understood you were still working on product/market fit and a repeatable, scalable sales process. However, as your business enters the growth stage, you should have a lot more visibility into key metrics, the sales process and its drivers.  You can build confidence with prospective investors by demonstrating this in your model.

To help those without modeling expertise, I’ve attempted to put together a list of basics – call them best practices.  While these principles should apply to virtually any SaaS company, I wrote this with an orientation toward early / growth stage B2B SaaS companies seeking their first round of institutional capital.  This is by no means comprehensive, but it should include most of the key pieces.

Bookings and Revenue

Expected bookings (specifically the recurring portion) is the single most critical component and will likely attract the most scrutiny.  This piece needs to be well-thought-out and you should be prepared to defend your assumptions.

  • If you simply hard code projected dollars booked or # of new customers, it suggests you don’t really understand what drives your bookings and how capital can be applied to propel new sales. New bookings or customers acquired should be driven by the components that have driven your current sales production to date (e.g. # of salespeople, marketing spend).
  • Break out one-time and recurring revenue bookings and revenue line items
  • Don’t blend new and renewal bookings into one bucket. We recommend modeling new bookings only (i.e. recurring revenue from new customers plus net new recurring revenue, or upselling, from existing customers).  You can keep things simple in your model by assuming all recurring revenue continues in perpetuity with a reasonable level of churn applied.  Again, be prepared to defend your churn assumption with historical data.  If you’ve had no churn to date, you may still want to assume a reasonable level.  Almost all SaaS businesses experience churn at some point.  Churn can vary widely depending on business type, so seek out some comps in your sector if you have little historical data to work with.  Most SaaS businesses end up with a minimum of 5-10% churn, but 15-25% can still be viable if you have a cost-effective customer acquisition process.
  • To the extent that your company has multiple product lines with different selling dynamics, consider breaking them out into separate tabs with their own inputs / drivers

Hiring Plan

Your model should include a detailed hiring schedule so that a potential investor can gain an understanding of what types of positions will be necessary, at what points and at what costs.

  • Each FTE (current and future) should have a corresponding title, function, salary and start date (extra points for making this dynamic vs. static); expected commissions and/or bonuses should also be incorporated
  • Include a summary tab in the model (see below) with headcount by function over time so headcount growth can be seen at a glance

Cash Burn

Investors that review your model will try to assess how much cash it will take to support the company over a given time period and allow it to achieve the next “crank” of growth (whatever that mark may be).  This analysis will help formulate the size of the round.

  • Make sure your bookings and spending are in sync.  E.g. doubling bookings is great, but not if you plan to quadruple spending to do so; you should be getting more yield from that type of expense escalation.  Either pare back spending or increase bookings expectation. (It should be noted that certain businesses may incur more upfront costs in order to gain scale. In these cases the bookings may lag spending by a longer period of time.)
  • Show any material capex
  • A separate cash flow statement is recommended as it can provide useful insight into the timing of your collections vs. payments as well as your expected capital expenditures. Key components of a cash flow statement include operating income, depreciation & amortization, net working capital, capital expenditures and new financing.  If you are unfamiliar with the basics of building a cash flow projection, seek assistance from someone in your network who has experience in the area.  Quick note: in a perfect world, the projection model would include a P&L, a balance sheet and a cash flow statement by month that each change dynamically in response to the model’s drivers, but this is not always necessary at the early stages of diligence.

Key SaaS Metrics

Tracking a few key SaaS metrics in your model will not only serve as a good sanity check as you build your forecast, but it will also demonstrate a certain degree of sophistication and credibility to anyone reviewing the model. Key metrics include:

  • Cost of Acquiring a Customer (CAC) – this should technically include all sales & marketing expenses, including the portion of time the CEO / other non-sales & marketing personnel devote to helping sell.

CAC formula

  • Lifetime Value of a Customer (LTV) – visibility into this may be limited at this point due to the short history of the business, but it’s still good to show your assumptions. A high LTV means you are selling at a high price point and / or your customer churn is minimal

LTV formula 1

Which can also be expressed as:

LTV formula 2

  • LTV / CAC – If LTV is considerably greater than CAC, your business model can drive significant operating leverage; VC’s typically look for >3x
  • Payback Period – Another useful way to look at the capital efficiency of your business model; measures how many months it takes to recover your CAC; VC’s typically look for <12 months

Payback Period Formula

Timeframe

  • Show monthly P&L for next 24 months; also roll this up to a quarterly statement in the summary tab (see below)
  • Anything beyond 24 months will be severely discounted if not totally ignored
  • Include monthly historical financials going back 6 months+ to the extent they are relevant; make sure to clearly distinguish between historical (actual) and forecasted

Summary Tab

The summary tab should provide a quick snapshot of the model’s key outputs. Important components of a summary tab include:

  • Bookings: Provide new bookings only (broken out into one-time and recurring)
  • Quarterly P&L: Keep this high level by collapsing certain line items. The default level of detail should include Revenue (broken out into one-time and recurring), Cost of Sales, Gross Profit, SG&A expenses (broken out into Sales & Marketing, R&D and General & Administrative) and EBITDA. A more detailed breakout of each of these line items should be available on separate tab(s).
  • Financial metrics: Somewhere close to the P&L (we recommend directly below), provide recurring revenue growth (%), Gross Margin (%), EBITDA Margin (if applicable), Run-rate ARR, Cumulative Cash Burn, and any other relevant financial metrics
  • SaaS operating metrics: Provide customer count, CAC, LTV, LTV / CAC, payback period and any other relevant metrics (see SaaS metrics section above)
  • Employee count: Provide employee count by function, including Sales, Marketing, R&D and G&A

Answer the Important Questions

Ultimately, a model should help a potential investor answer a few basic questions:

  • What will the run-rate ARR be in 12 / 18 / 24 months?
  • How many customers will the business have at those points?
  • Who do we need to hire to get us there?
  • How much cash will it take to get there?
  • Do the unit economics make sense?
  • What are the key drivers of the business?

 

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