Getting Funded

This was originally posted on Dan Allred’s blog Volume Game. You can view the original post here.

I look at lots of financial plans, and I often help entrepreneurs think through their financial modeling. One of the questions I get a lot is whether a financial plan should be based on a tops down analysis or a bottoms up analysis.

In my experience, a bottoms up analysis is much more valuable when it comes to operating a business and checking the vital signs of a business such as progress versus plan, performance to expectations, hitting key performance indicators, etc.

That said, you need to do a tops down analysis as well, but that analysis should be a quick exercise to help determine which markets are attractive to your business.

Here’s how I think about building a financial plan:

Step 1: Conduct a tops down analysis of the market where you intend to do business. This analysis should tell you whether the market is attractive enough - i.e. big enough, dynamic enough, etc. - for you to pursue it.

Step 2: Assuming the market is attractive enough for you, build a bottoms up financial plan that illustrates what your penetration of this market will look like - from the perspective of both revenue and expenses.

A good bottoms up financial model is the reality check to the excitement that comes from a tops down analysis of a really attractive market. More than that, it is a management tool for your business because it forces you to think through the performance metrics that will be key value drivers for your business.

Let’s take a look at what it looks like to build and use financial models in the way I describe above.

Tops Down Analysis

A tops down analysis typically starts with an estimation of how much money is spent in a particular industry on an annual basis. This information can be gathered from analysts such as Gartner and IDG or from industry trade groups.

These figures often include practically everything spent within an industry, although they are more helpful approximations of the true attractiveness of a market when they can be narrowed to the market segment that is directly relevant to the product or service that you are developing. It makes sense to spend some time on this because 1) better analysis of the data is going to be helpful to you as you think about your financial and marketing plans, and 2) prospective partners, investors, etc. are going to challenge you on your assumptions about the market.

Many businesses are targeting multiple markets and therefore need to conduct this exercise several times over. The results will be helpful as you begin to build a bottoms up model as it will help you prioritize markets and decide how to deploy your finite resources to attack each market.

Bottoms Up Analysis

The key to the bottoms up analysis is the assumptions you make as you build the model. Think of a bottoms up model as building a house. You make some key assumptions about customers - how long will it take to close a customer, how much will each customer spend with you, how long will you keep them, etc. - and these assumptions lay the foundation of the house. These assumptions really drive the model as they drive the revenue build, which is probably the primary long-term value-driver in your business (along with profitability). You also make some assumptions about how you will attract and convert these customers. Think of these as the walls of your house, what people see when they look at your company. These sales & marketing assumptions will help build out the expense portion of your bottoms up model. Finally, you need keep your house safe and make it livable for your employees, shareholders and customers, so you need to invest in IT systems, financial oversight, legal counsel, human resources, insurance, etc. These general & administrative expenses are like the roof and plumbing of your house - not the parts you spend a lot of time thinking about but very important nonetheless.

Here is some advice on how to think through each assumption category:

Revenue assumptions
- Think about the types of customers you have and build an assumption case for each type of customer.
- Think about the products that you have and how they are priced. Which products are each class of customers most likely to buy, will you be able to upgrade them to higher priced products or sell them additional products? If so, when?
- How long will you realistically keep these customers? How much money will you make on them over that time period - subscription revenue, maintenance revenue, upgrades, upsells, cross-sells, etc.?
- How much does it cost you to deliver your products and/or services to your customers? Factor in any variable cost into this section of your bottoms up plan as cost of goods sold (COGS). These would be expenses such as material costs, implementation costs, customization of software, etc.
- Are there network effects or other inflection points in your business that allow you to either charge more or deliver your product at lower cost? If so, make sure you build those revenue enhancements and efficiencies into your plan as you achieve the relevant milestones (probably closely related to a certain number of customers).

Sales & marketing assumptions
- Lots to think about here. Most fundamentally, how do you sell your product: direct sales, inside sales, ecommerce, channel sales, OEM, etc.? The answer to this question has significant bearing on the assumptions you make here as it affects how you market your product, who you employ to sell the product and how much cost is associated with each of those employees.
- Think about your sales funnel and relate it to the assumptions you made above about the number of customers you plan to attain. For each of those customers, how many sales people need to be involved and over what period of time? And how many other potential customers do they need to talk to in order to land one - i.e. what is their realistic conversion rate?
- In a somewhat related assumption, how long does it take a new salesperson to come up to speed before the assumptions you made above about their effectiveness is relevant? Factor that in.
- Where do all of these prospective customers come from - i.e. what does the very top of your sales funnel look like? If you have a channel strategy, how do you develop this channel and what costs are associated with that? If you have an inside sales force, how do you generate leads for them to pursue - inbound marketing, SEO, SEM, etc. What costs are associated with this? If you have a direct sales force, then chances are you have a more complex sale with a longer sales cycle, not to mention more expensive sales people, so factor this in.
- Building out this portion of your bottoms up model should be a good exercise for you and your team. This is a reality check for both the revenue assumptions you’ve made as well as the tops down analysis you completed. This bottoms up plan should give you a blueprint for how you will attack the market and what kind of resources you will need to do so.

General & administrative assumptions
- This should be a small portion of the expenses for an early-stage company and will grow over time as the business becomes more complex, requires more oversight, third party opinions, etc.
- Think about the systems, services, policies, etc. that you need and ask around to get an idea of the cost assumptions you need to make around these items. Our market has many great resources for outsourced G&A services, such as finance, accounting, human resources, etc. Taking advantage of these resources will help you get experienced people on your side without committing to the expense of full-time employees. There are also many service providers , such as attorneys, bankers, real estate advisors, etc., who are accustomed to working with start-ups and willing to tailor their services, fees, etc. to the needs of a start-up with an understanding that they will grow into a more traditional relationship as your business scales. So ask around (and ask me)!

In my estimation, your bottoms up model will require at least 15-20 times the effort of your tops down analysis, but it will add real value to your business. If done properly, a bottoms up analysis will tell you: 1) how much capital your business requires in order to reach the revenue & profitability objectives in your plan, and 2) how to manage your business according to the key metrics that drive value in your business, as you would have thought about all of these metrics up front when you made your assumptions.

Dan Allred is a Senior Relationship Manager at Silicon Valley Bank. To hear more from SVB professionals check out our Expert Lunch hosted by Silicon Valley Bank on Debt Financing Options.

This was originally posted on April 19 by Micah Rosenbloom on his blog. View the original post here

Timing is everything – especially when it comes to raising a round of capital. My Founder Collective colleague Eric Paleyand I discuss (and debate) it often. Here are some observations having been an advisor to two recent TechStars companies and co-founder to three start-ups.

Be weary of the artificial timeline

Both Brontes and Novophage are classic university ventures. They started in labs, later received university and government funding (Deshpande Center, BU’s office of Tech Development).Both companies went on to win or place in the finals of highly regarded business plan competitions at Harvard, MIT, Duke, etc. It seemed opportune time to raise capital, but the businesses were still not ready. While business plan competitions are excellent catalysts for founding teams, and useful for gathering feedback, they do not ensure that a business is ready to launch (even so for winners/finalists).

Any process that sets an artificial timeline – expiration of government or university funding, graduating from school, a business plan competition or the conclusion of an incubator program does not inherently mean it is time to raise money. All businesses need to incubate at their own pace. Early market pivots, prototype development and building the founding team should generally happen on the founder’s nickel.

Fundraising = acceleration not inertia

All too often entrepreneurs approach fundraising as the start of the venture. This attitude often leads to disappointment. A business should be operating as a regular business – with the makings of a culture, meeting routine and infrastructure (Novophage had 6 gigs of in its Dropbox before fundraising)!

Capital is invested to accelerate a business that has initial momentum but has reached a point where only money can get the company to the next accretive, and risk-reducing, milestone. VCs use the terms “traction” flippantly but in essence what investors want to see is momentum before the fundraising. At Brontes, we needed a clear market focus (dentistry) and industry advocates before we were really ready for a Series A raise.

But strike while the iron is hot …

Having said all this, timing truly is everything. The investment community is momentum driven, just like the stock market. You’ve got to have a nose for when the timing’s right. A strong signal from a VC often suggests its time to talk to many and leverage the interest to terms sheets. If your segment is “hot,” find those pre-disposed investing actively in the segment you’re in.

In the end, the sequencing of fundraising often has a significant bearing on the outcome of the process.

Micah Rosenbloom is the Chairman and CEO of Novophage. If you want to hear more from Micah he will be a panelist during the Life Science Venture Fast Track on November 8, 2011. Early bird ends October 26 so so get your tickets now.

Posted by Dave McLaughlin

The hardest investor money to get is the first check. That starts the wheels turning. With Vsnap, the video messaging startup where I’m CEO and Co-Founder, I built a little wrinkle into the financing that put real money in the bank within two weeks of my going out to investors.

Speed matters a ton, especially for consumer internet startups. And with a small team, there’s a high opportunity cost to seeking investor money. Please don’t misunderstand me – finding aligned investors takes time, and this is the last thing in the world that you want to rush. But there is a point of diminishing returns and the more you get beyond that point, the greater the price you will pay.

Personally, I’m not confident that I have enough investors in my network who are comfortable with convertible notes, so I chose to price Vsnap’s seed round. I see this as me optimizing the process for speed and quality of partner, rather than for some illusory perfect price.

How did we set a price? We looked around at what other teams were getting and picked something in the middle. We gut-checked that with a few investors and a few entrepreneurs. We figured in the option pool from the founders’ share. We worked through the current dilution and sketched a range of scenarios for future dilution. We measured the total raise against our P&L then grilled ourselves on whether it would give us enough runway to generate the proof points to raise an A round. We tweaked the numbers a bit. And that was our price.

What matters most to me is that we get great investors with a minimum of bullshitting each other, and that the founders and the team retain enough equity to land key players in the future and to be deeply, viscerally engaged and incentivized through the dilution of future financings. Whether that’s precisely a pre of x.x or x.y…I don’t sweat that so much.

Now here’s the little trick, which I used to buy me the time to focus intensely on product and team – rather than on financing – through our alpha pilots and now approaching our beta launch.

We simply discounted the first half of the round.

I don’t often hear of people doing this, but it is not at all complex legally. It wasn’t a huge discount where the second half investors feel they’re getting screwed. Just enough to create a carrot and introduce a bit of urgency.

The result: three investors wrote meaningful checks within two weeks.

And we just kept right on running hard. We launched our alpha and ran pilots in the US and Europe. We’re about to launch vthankyou.com with some awesome celebrity partners, providing our alpha product to help people say thank you to America’s veterans. And our beta will launch in November, web and iPhone – with an amazing integration that is going to create tons of value for our users.

And now I need to get back to raising the rest of the seed round!

Dave McLaughlin is CEO and Co-Founder of Vsnap, a simple video messaging tool that helps consumers and businesses drive action from the people they communicate with. Formerly, he was Co-Founder of Fig Card (acquired by PayPal) and Boston World Partnerships.

This is a presentation created by Joe Medved a digital media VC with SoftBank Capital. You can read more from him on his blog: JoeVC

I have helped a number of our portfolio companies at SoftBank Capital build financial models over the years. This presentation walks through the construction of a general business model for early stage companies, with a focus on core revenue and expense drivers.

Want to learn more about turning your business idea into a fundable business model? Join us for our breakfast roundtable on October 19: The Capital Network Breakfast Roundtable: Building a High Growth Business for Angel and Venture Capital at the Foley Hoag Emerging Enterprise Center