Forecasting Best Practices From The Startup Factory’s Dave Neal

 

The local startup community came together to show support for this legislation, and now they’re coming together with state regulators to help create the rules to govern it.  

With this new funding tool coming quick, I want you to think about this question: Are you prepared to raise capital? As discussed in my first article, before you raise capital you need to develop a realistic financing plan by understanding your business, your business model and how it scales, your milestones, how much money you need and how long it will last. All that work will result in a detailed forecast, which will be helpful to your team, investors and other key partners helping you grow your business. 

 

I started this conversation back in May with Tim DeBone, director of finance at Windsor Circle. To discuss it further, I recently interviewed Dave Neal, one of the area’s entrepreneurial thought leaders who helped support the NC crowdfunding legislation. Dave is a co-founder of The Startup Factory, advisor, angel investor and CFO. He also has a BS and JD from UNC and an MBA from Stanford. 

 

He shared the following forecasting best practices: 

 

A bottoms-up model is the most realistic way to project what is likely to happen on the financial side of your business. It forces you to think carefully and exhaustively about the personnel, sales and marketing expenses, software licenses, revenue shares and other uses of cash. A bottoms-up model also can be the outline of an operational plan and goal set. 

 

If you don’t look at the financial aspects of the business early enough, you may spend a lot of time pursuing an idea that has little chance of working due to financial structure. If it costs $10 to acquire a customer and the lifetime value of the customer is $7.50, you can’t “make it up on volume.” Without this exercise you are also unlikely to understand how to use your cash most effectively. 

 

My opinion on this has changed since the advent of Lean Startup methodologies for the pursuit of startup success. The Lifetime Value of the Customer/Cost of Acquisition (“LTV/CAC”) has become a proxy for financial projections at the earliest stages of the company. Obtaining accurate, reportable data of this type enforces a positive discipline that values customer acquisition at a time in the corporate history when that must be paramount. Once the customer acquisition and retention engine has reached a mature state, the usefulness of traditional forecast models once again returns to the forefront again. 

 

How often should a forecast be updated, and what are the best practices when reporting your actual results during the year versus your forecasted plan? 

Actual results on a handful of key performance indicators should be compared to the forecast monthly. At the end of the day, there are only a few key indicators that will tell you the health of your business. More in-depth reviews can be done on a quarterly or semi-annual basis.  

What are your lessons-learned over the years to developing a realistic forecast? 

Work hard to assemble quality, unassailable data for your forecast. No matter what you put down, investors will challenge you. The ability to respond with crisp, factual backup for the way you’ve built a forecast goes a long way toward building and enhancing your credibility. Also, making things too complicated or trying to measure too much, places strains on the organization that are not helpful. For example, it’s fairly easy to collect financial information at the two standard deviations or 95% level. Increasing your collection accuracy to three standard deviations level doesn’t help that much with accuracy and it’s much harder to accomplish. 

 

The love of complexity is one thing I had to free myself from. Just because you can model something very accurately with Excel doesn’t mean that it’s worthwhile to do so. Also, the model should be flexible with a generous number of assumptions that can be easily modified to reflect changing conditions. What industry-specific forecast issues are there? In my mind, the real issue here is determining the purpose of the financial work you are doing. Financial work is intended for certain audiences or specific purposes. Accordingly, how you prepare the financial data is governed by those audiences and purposes.  

Focus first on learning the cost of acquiring your customers. This will help you remain targeted on the one thing that your business must have in the earliest stages. After some time has elapsed, you’ll be able to estimate your lifetime value of the customer more effectively, but you can get a rock-solid cost of acquisition numbers early. This will serve you well. 

 

Dave Neal’s practical advice demonstrates the importance in fully understanding your business and the due diligence it takes to develop a realistic forecast. With this forecast and deeper understanding of your business, you are now better equipped to take the next step in your fundraising journey knowing how much money you need and how long it will last. 

 

Next, we will find out what Brett Farabaugh thinks about this subject. As CFO of Tryton Medical, Inc. in Durham, Brett has helped raise significant rounds of capital from VCs and will provide insights in forecasting from a medical device industry perspective.