5 Financial Reports to Prepare Before Meeting with Venture Capital Firms
by Michael Burdick, on Jul 10, 2018
When seeking funding, venture capital firms are common choices. In 2017, the median VC investment is $5 million for early-stage and $10.8 million for large-stage VC rounds. They not only provide capital, but also strategic assistance and whatever resources are necessary to grow your business to the next level. In fact, research shows public companies that previously received VC backing account for one-fifth of market capitalization.
But getting VC/PE funding is more difficult than it looks on TV shows like Shark Tank or The Profit.
Numbers don't lie, and everybody wants to see them
Anything you tell a VC investor needs to be backed up with data. During due diligence, these firms are going to have accountants review your financial reports with a fine-toothed comb. Investors look at income statements and balance sheets for key assumptions like customer acquisition cost, average purchase amount, and retention rates, along with key financials like gross profits and expenses. Every penny and product needs to be accounted for with reports and receipts to back it up.
Even if you’re accurate about a statement, it’ll be hard to prove if it’s not reflected in documentation during this phase. A simple accounting error can make the difference between getting funding or not, and VCs do this for a living, so they don’t miss a beat.
Receiving funding is long process - it’s a transition for any company, and conforming can be quite difficult. Well-prepared financial reports will get things started on the right foot, and there are CFOs who specialize in this specific process. Here are five things you need to be able to show in your financial reports.
1. Your Company's Equity, Debt, and Capitalization Structure
A company’s capitalization ratio is the barometer for how it’s financing operations now and in the future. Equity and debt are the two main financing options, with equity giving away stake in the company, and debt – taking on a loan.
A study of 885 institutional VCs at 681 firms by the National Bureau of Economic Research found 95 percent of VC firms say the management/founding team is an important factor for determining an investment. Nearly half say it’s the most important factor, so it’s important to understand who owns what stake in the company and who’s in place to keep it running.
Investors want to rest assured that the company they invested in is being run by a level-headed leader. If you sold over 50 percent of your company’s equity, you’re no longer the majority shareholder. If you have $1 million in debt, your annual revenues need to be adjusted to account for this. These numbers can be deal breakers, making it vital that they’re prepared before you even walk into the room to negotiate.
According to Kevin Rakin, former CFO/CEO and private investor, “You want a CFO and a CEO who’ll be able to call each other on a Sunday night, talk honestly and hash something through. Investors pick up on that. When you go out on a roadshow they can see whether these guys are a team or are going to have ego fights over whatever’s going on.”
2. Sales, Marketing, and the Business Model
Ultimately, sales are the lifeblood of any company – and marketing drives sales. Both are cornerstones of your top-level business model. This business model is what drives your elevator pitch to gain investment in the first place. If you can’t explain your business and how you plan to make sales, you’re not going to get VC/PE funding.
The business model is the second most important factor with 83 percent of VC firms reporting it as part of their decision-making process. And, as VC David Frankel points out, “Rule of thumb: The larger the check you’re requesting, the more time a VC will spend checking into your claims. At over $50 million, expect multiple parties (including paid external consultants) carefully checking you out.”
It shouldn’t be complicated – both Facebook and Twitter are huge social media companies. Each has a different business model, but the basics involve gathering users and selling advertising to those users. If you can explain their business models in one sentence, you can explain yours in one minute or less to potential investors.
3. Historical Revenues and Future Projections
Beyond the business model and leadership, the third most important factor (especially in later-stage deals) VCs evaluate is company valuation. One way to show this is with realistic revenue projections based on several factors.
Historic revenues are the foundation of future projections, but success (or failure) in the past doesn’t guarantee the same performance in the future. No VC will leave this up to chance, and that’s why they’ll heavily scrutinize your revenues and projections to understand exactly where it’s derived from.
Morten Sorensen, a Professor of Finance at Copenhagen Business School, found deal sourcing and selection are the two most important factors for generating a return. The third important factor is post-investment value add, meaning the firm’s active involvement in your company.
You need more than just an accountant to crunch the numbers and provide financial services. You need to understand every number front-to-back to even begin living up to an investor’s expectations. One-on-one financial training should be a priority of your virtual CFO to ensure everyone in the C-suite understands the company’s projections.
4. Budgets, Expenses, and Operational Costs
Once you have the high-level reporting done, it’s time to collect individual reports for budgets, expenses, operations, and other overhead costs. Each report provides detailed insight into where every penny is going in the business, along with how it’s allocated.
These reports should exactly match the company performance so that everything can be traced in the event of any issues. The more transparent and organized your financials are, the more impressed investors will be. It also provides insight into where their investment will be spent.
The typical VC investment is a 10-year commitment, says Founders Collective venture partner Micah Rosenbloom, "As a venture capital firm, we are not in the business of funding inventors or inventions, we are in the business of funding fast-growing companies.”
With operating costs calculated, it’s easy to calculate when the company will become profitable. This metric is used by investors to calculate when they’ll receive returns on their investments, and seven years (10 years minus three years of investments) is a short time to achieve it.
5. The Cost (and Value) of Customer Acquisition
The most important metrics to know about your business are the cost to acquire a customer, and a customer’s lifetime value. If it costs you $100 to acquire a customer who only ever spends $50, your business is going to quickly run out of money.
CAC directly impacts a company’s cash flow, and any financial services firm (banks, lenders, investors, etc.) is going to want to know this number. If you have it, you’ll find raising money to be much easier because everyone will be assured the business can sustain profitability.
Work hand-in-hand with your virtual CFO to calculate these costs on an annual basis, and review the information monthly and quarterly to compare budgets and forecasts to actual performance.
VC/PE funding is a great boon to any company. Every brand you’ve ever heard of eventually sought and received funding from investors, but it’s a complicated process. Late-stage funding gets even harder, as your company expands and gains history.
If you want to follow the lead of companies like Facebook, Google, and Uber, prepare your pitch and start contacting VC firms. Be sure to research ones who are interested in your industry, because you can’t fire your VC.
And understand the work doesn’t stop after the deal is made. If you spend your first three years struggling to keep up with VC reporting expectations, you’ll have less time than you think to get on track and exceed revenue goals.