Weekly Accelerator Updates

Week 7: Finance, Strategy and Operations

Week 7 Recap

This week, teams are doing a deep dive into social media marketing & entreprenurial law for their businesses. Topics covered include:

  • Platform specific marketing
  • Social media messaging
  • Legal considerations

Below are resources designed around financial planning, strategy and operations.

Pro-Forma Income Statement

If you are new to the world of finance, start by watching the following short videos from the Kaufman Foundation.

The income statement

We will start with the income statement as that is the most helpful financial dashboard to help early stage ventures see into the future, even before they start operating as a standalone business. The income statement, or profit and loss statement (P&L), requires entrepreneurs to be clear about their assumptions in order to answer the following questions.

  • How much revenue are they taking in?
  • What are the expenses?
  • What is the profit or loss?

The 5-year Pro-forma income statement

Entrepreneurs building new ventures frequently find themselves creating a 5-year projection of your income statement. This is called a “pro-forma“. In real life the pro-forma income statement can be arbitrarily complex – to help operate your business, you might project your profit and loss on a monthly or quarterly basis, especially in the current year. For early stage entrepreneurs who want to use this tool to help guide strategy, a 5-year annual projection guided by a bottom-up analysis is much more helpful. It forces entrepreneurs to stay at the big picture level without falling into the trap of false precision which can happen when you run this analysis on a monthly basis.

While a 5-year pro-forma P&L for a new business is guarantied to be a work of fiction, putting your core assumptions on paper forces you to do a bottom-up thought experiment to think through how you manage your business activities to achieve your revenue projections – and what it takes from a people and budget standpoint to get it done. The accuracy is not the point. The structural thinking is the actual value.

Getting a sneak preview of your business

Creating a pro-forma also helps the entrepreneur get a sneak preview on what kind of business they are building. Here are two common patterns that reveal themselves once you have some fun with spreadsheets.

  • B2C – low value, high volume, short lead time: A B2C business charging a low price per consumer (e.g. <$100 per year) will find it easy to start and can start generating revenue very early, but getting to a $100,000 per year revenue will require large numbers of consumers in their install base that can be expensive to acquire.
  • B2B – High value, low volume, long lead time: A B2B business charging a large amount to enterprise customers (e.g. >$50,000 per year) will have long sales cycles, so the first couple of years might be characterized by much smaller pilot deployments – and they need to hire sales folks a year or more before the new sales force can close deals and generate revenue.

The Investability Test

One last benefit is that you will see the scale, scope and rate of growth of your business at a glance from the rate of revenue growth. This is tremendously helpful for many for-profit businesses, because investors want numbers.

  • 8 years ago, Techcrunch posted an article in which they examined 5 public SaaS companies’ “path to $100M” in their early lives (all of them achieved it in about 5 years).
  • 3 years ago, Shasta Ventures posted an article where they shared what it takes to raise an A round in Annual Recurring Revenue (ARR) and growth rate.

Being able to forecast the scale, scope and projected growth rate of your business will tell you whether your business checks all the boxes to appear “investable”.

  • If so, it will give you what you need to raise money.
  • If not, it can be used as a tool to iterate your business to get to cash-flow-even.

Modeling revenue and expenses

For those of you who have not taken a finance course, the pro-forma can be scary. Let’s do a simulation so we can work through the key concepts, terms, and equations you need to understand in order to create a pro-forma P&L, starting with revenue projections.

Imagine we are a marketing insights company (like CBInsights), and we do specific industry research in, say, the business trends for robotics and AI. We offer a subscription service to companies requiring this type of research, at a company-wide license starting at $5,000 per month, or $60,000 annual recurring revenue (ARR)per year.

Modeling Revenue

For this business, we can model our revenue for our second year in business as follows: (you will see in a minute why we chose the second year and not the first year.)

  • Unit: In this case the unit is a company that acquires a license with our Marketing Insights company
  • ARPU (Average Price Per Unit): In this case, it is $60k per year.
  • # New customers acquired this year: Let’s say for our second year, we will sell this to 10 new customers through direct sales.
  • # Customers last year: Let’s say last year we sold to 5 customers.
  • Churn: Churn refers to the percentage of customers who do not renew. We are so new that nobody has had time to cancel, so we have 0 Churn this year.
  • Install base: Based on the above, the “install base” is the # of customers last year plus the # of customers this year, minus churn. In order words, our install base is (5 + 10 – 0) = 25.
  • Cost of Goods Sold / Cost of Sales: This is the cost of providing the service to the customer and includes server costs, cost of the devOps department (i.e. engineers who keep the server running so people can download reports), customer support and the like. It does not include the actual analysts’ salaries or general web development costs or marketing costs – that goes into the operation expenses section (see below). Let’s say this is $250,000.

The gross revenue in Y2 is the install base multiplied by the ARR: (25 * $60k) = $900k.

The COGS in Y2 is $250k.

The gross profit is the gross revenue minus COGS: ($900k – $250k) = $650k.

This is the basic recipe for projecting revenue out to year 5. In year 1, churn is typically 0 and the install base is simply the “net new customers” in Y1. Moving into the out-years, churn will increase – but so will your install base because you are hopefully keeping 95% of your customers year over year (YOY). With this, you can project revenue by changing the number of new customer acquisitions, changing ARPU, or changing projected churn. You can now easily model different scenarios to help you make business decisions every step of the way.

Modeling Operating Expenses

For this type of business, most of your operating expenses fall into the following departments:

  • Product development – this includes the analysts who conduct the research, data scientists helping them manage and visualize the data and writers who turn data insights into reports)
  • Marketing and sales – these departments are often combined in the beginning but will usually separate into two departments over time 
  • General and Administrative – this includes finance, human resources (HR), legal and the like.

For each department, there will be a few types of expenses that dominate the spending.

  • Product Development will spend the lion’s share of their annual operating budget on headcount.
  • Marketing and Sales would have significant budget for doing direct sales, going to tradeshows and the like, in addition to their headcount expenditure.
  • G&A will likely have significant expenses in professional services like legal expenses.

Putting it together: Revenue – Expenses = Bottom line

Once you have modeled your revenue and expenses, you are ready to put it together into the same spreadsheet which has the three sections mentioned above:

  • Money you make (revenue)
  • Minus Cost of goods sold (COGS)
  • Minus money you spend (expenses)
  • Minus things like taxes, depreciation of capital equipment, etc.
  • Equals money you keep or lose (bottom line)

Legal Considerations

Legal considerations include but are not limited to the following:

  • Company formation: C-corp, S-corp, B-corp, LLC, or 501(c)(3)
  • Intellectual property (IP) protection: Patents, trademarks, copyright, trade secret?
  • “Capitalization Tables”: Who owns how much of the company
  • … etc

Watch Professor Joe Volman’s workshop on Entrepreneurial Business Law to learn more.

For non-US founders, immigration law for entrepreneurs and innovators add an additional level of complexity. Laws and policies are constantly changing. To stay abreast of the latest options, bookmark the US Citizenship and Immigration Services website – and be sure to engage legal counsel who is well versed not only in immigration law for employees, but in exploring alternative immigration pathways for cofounders.

Entrepreneurial Operations

Systems and Processes refer to the infrastructure that allows your company to operate effectively. When you are just starting out, the processes that tend to help include:

  • RACI models – clarity around roles and responsibilities
  • Accountability rituals – things like daily scrums, sprint planning and retrospectives help keep the team on task
  • Communications platforms – agree on when and how you communicate on which platforms, synchronously and asynchronously
  • Task management platforms – use something like Trello, Asana or make your own Kanban board to manage work and share status
  • Accounting platform – this is the financial backbone of your company. A lot of people start with Quickbooks Online then move on to a full-fledged Enterprise Resource Planning (ERP) platform when they are mature.
  • Customer Resource Management (CRM) platform – this allows you to manage contacts, record and write notes about sales calls and the like.
  • Marketing Technology (Martech) platforms – platforms like ThriveHive or Hubspot help you keep all your online marketing activities in one place and to manage the massive amounts of data that helps you build brand and acquire customers.