If you’re a startup, it’s crucial to have your financial information in order before approaching potential investors. The last thing you want is to have a lack of financial information causing delays in your fundraising when you have an interested investor at the table. I’ve seen many instances where producing financial information is a blocker in keeping momentum going with potential investors or in obtaining a term sheet. You want to have this critical financial information ready when approaching potential investors.
Accrual Based Financial Statements
First and foremost, it’s important for startups to have accrual based financial statements (balance sheet, income statement, and statement of cash flows) readily available. Having accrual-based financial statements means that the income and expenses are recorded in the period they were earned or incurred, rather than when cash is received or paid out. Accrual based statements give a clearer picture of the company’s overall financial health, rather than just focusing on cash flow.
Ideally. you are already working with a bookkeeper or accountant to maintain your financials on an accrual basis. An investor will normally ask for quarterly (or monthly) historical financial statements for the past two years to see the overall trend of the company’s financials over time. Are revenues increasing? Are expenses decreasing? What is historical cash burn? You should be prepared to provide commentary on any significant trends and anomalies in the financial information presented. The financials should support the story that the founders are telling about the business. If your pitch to investors is that you have had 3x growth the past year, your historical financial statements should validate that. Providing accurate and transparent statements will not only help build trust with potential investors, they will also assist with the due diligence process.
Financial Forecasts and KPIs
Most investors normally ask for a 3-year financial model as part of their preliminary diligence as they want to understand how the company plans to grow. The model should provide a clear picture of how the company plans to acquire and retain customers, what is the projected revenue growth (including recurring revenue/ARR for SaaS companies), the company’s expected gross margins, opex spend, and monthly cash run rate. The forecast should also tell an investor how long the current round of funding will last the company to ensure that the appropriate amount of capital is being raised in the current round.
A good financial model will support the growth plans that founders are presenting in their pitch decks. For example, if a founder is telling investors that they have a land and expand strategy when selling to large enterprises, their model should show that growth within customer accounts and highlight the resources required to drive that growth.
As part of their financial due diligence, an investor will also want to see the key performance indicators (KPIs) that a company tracks or will be tracking. This could include churn rates, customer acquisition costs (CAC), monthly recurring revenue (MRR), expansion revenue, the SaaS Magic Number, etc. These KPIs provide insight into the health of the business and how well it is performing. In many cases, earlier stage startups, especially seed round startups, may not have well established KPIs yet. In this case, it’s important for the founders to have a clear understanding of what they need to track in order to efficiently scale and grow the business and reflect their expectation of the what the KPIs will look like in their 3-yearfinancial plan.
Cap Table
Although it is not necessarily considered financial information, we also wanted to cover the need to have an up-to-date capitalization table as many founders do not have one readily available, especially earlier stage companies. A cap table is important as it is critical for investors to understand the company’s current ownership structure, dilution from previous rounds, option pools, and any outstanding convertible notes. Investors want to understand who the current investors in the company are, make sure that there is enough room for future dilution for their investment and potential follow-on rounds while also ensuring that the founding team has an appropriate amount of equity to act as a retention mechanism. The cap table should be kept up to date at all times as it is used for a variety of reasons throughout the funding process. Many companies will ask their lawyers or accountants to maintain their cap tables or use equity management software.
Summary
To sum it up, investors need to have a good grasp of the company’s financial history and future prospects in order to make an informed investment decision. By having accurate historical financial statements, a financial model, KPIs that are easy to understand, and a transparent capitalization table prior to kicking off your fundraising efforts, you will set yourself up for success and make the due diligence process smoother for potential investors.
If your startup is planning to approach potential investors and you’re unsure whether you have the appropriate financial information to provide them, contact us and we’ll be happy to provide an assessment.