Building trust with investors
Establishing credibility and trust with potential investors is at the heart of any fundraising effort. A detailed and informed set of projections not only helps a business owner demonstrate a solid understanding of their business’s financial health, but also signals to investors that they are dealing with a company that has clear, data-driven expectations for future growth.
Investors, particularly those in private equity, are placing their trust - and often a significant amount of money - into your business. They need to be confident that the business has a clear path to profitability and that the financial returns they expect are achievable. Financial projections provide them with the roadmap for how that will happen. They also show that the business owner has taken the time to assess market conditions, operating costs, cash flow, and growth opportunities, all of which contribute to the company's long-term success.
A lack of well-supported or overly optimistic forecasts can send the wrong message. Investors may perceive this as a sign of uncertainty or a lack of preparedness, making them hesitant to invest.
Aligning the financial model with the business plan
Often a potential investor may require that a robust business plan is presented alongside the financial projections. This will help depict the story of current market conditions and where any potential gap may be, the current competitive landscape and also present a clear understanding of the company’s revenue streams, costs and funding requirements.
The story told by the financial model must agree with the story within the business plan, both of which serve very distinct, yet complementary, roles in the fundraising process. The business plan illustrates why the business will succeed, whereas the financial model shows how it will make money and achieve its goals. Investors typically scrutinise both the narrative and the numbers.
Creating robust, useful financial models
Key components and assumptions
Cash flow projections provide insight into the timing of cash inflows and outflows, helping both the business owner and potential investors understand the working capital requirements and where a funding requirement may fall. The more granular the level of detail in the model, the more useful it becomes. Considering factors such as payment terms, VAT rates, revenue seasonality and timing of capital expenditure will all be important.
The most effective financial models will be prepared with significant emphasis placed on the assumptions used at the input phase. Critically, the management team must invest time to ensure that the assumptions used are realistic and robust. In turn, this will allow for the incorporation of a sensitivity analysis to be built into the model.
The role of sensitivity analysis
Sensitivity analysis helps business owners understand the range of possible outcomes and prepares them for unforeseen challenges, while also demonstrating to investors that the business has considered risks and uncertainties. Before the release of the financial model, the company should have already anticipated key sensitivities and ensured the model is robust enough to sustain this sensitivity.
Clear presentation and scenario planning
Presentation is key. A set of financial projections should be presented clearly and persuasively to allow an investor to digest without confusion. Assumptions and inputs must flow through the workings of the model and directly link to clear outputs. It is often the case where a model is built using both a ‘base-case’ scenario to show how the future trading might look if the business carried on without any external funding, along with a ‘funded’ scenario.
The base case can often act as a benchmark for future performance where deviations (either better or worse) can be measured. The ‘funded’ scenario illustrates an optimistic but plausible scenario where the company achieves higher growth as a direct result of funding. This makes it clear to a potential investor the direct benefit their funds could have going forward.
Leveraging external support
Quite often, a business will hire an external advisor to build a financial model on behalf of the management team. This will allow the management team to focus on running the business and avoid hindering the company’s performance in the interim.
However, it is key in this scenario that the inputs and assumptions are management-driven, with the external advisor simply facilitating the building of the model. An external advisor may also be able to provide an indication as to the key areas certain funders could focus on.
Financial projections as a strategic tool
Ultimately, financial projections are more than just numbers. They are a strategic tool that communicates the health, growth potential, and funding requirements of the business. By developing a comprehensive and realistic forecast, business owners can significantly increase their chances of attracting the capital they need to grow and succeed.
