How to create believable venture capital proformas

By: Peter Adams Tuesday December 27, 2016 0 comments Tags: Peter Adams, Rockies Venture Club, proformas

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By Peter Adams

Rockies Venture Club

Investors see wild hockey stick projections made from “conservative estimates” every day and they can’t tell quite what to make of them. These crazy projections come from founders who don’t have the experience or who haven’t done the research to come up with something that resembles reality. 

Here are a few tips for creating a believable proforma. And by the way, these are the things that investors should be looking for in a proforma when doing due diligence!

  • Comps are critical. There’s no reason that a proforma has to be created totally from scratch. The best proformas I’ve seen are based on the actual performance of several companies in a similar industry who have been through it all before. By mapping out the pathways of four or five predecessors and placing your growth curve right in the middle, you’re showing that you expect to grow at the rapid pace that the successful companies did, but you’re not audacious enough to show that you’ll exceed them. By all means – do everything you can to beat the norms, but that’s not what proformas are for.
  • Start with BOTTOM UP analysis vs. Top Down. The obvious truth is that every Top Down proforma you will see is probably at least ten times higher than the performance of comparable companies. The reason for this is that a top down proforma begins with a ridiculously high Total Addressable Market and then projects a “conservative” 5-10% market share. 10% of a huge number is huge, but it’s not something I would base an investment decision on. 

Bottom up projections are even better than comps in some cases since they are based on what YOU are able to do when selling YOUR product. Ultimately, the investor is wondering whether customers will actually pay for your product and if you can show that they will and you can demonstrate the cost of acquiring a customer, then you have a pretty valid set of data to start scaling from.

I can’t believe how many founders have told me that they aren’t even selling their product because they don’t want their sales to look low. That’s the sure fire way to demonstrate that your risk is even higher than a company with low sales and will make investors unlikely to invest and if they do, it will be at a lower valuation. Better to establish a beach head and show how many customers you can get for a little money, and then show how many you’ll be able to bring in once you’re funded.

  • Show your work. If you’ve done a ton of research in creating your proforma, there’s no reason to hide it away somewhere. You can actually embed some of your research into the proforma itself so that investors can see your data and assumptions from the original sources. If you’ve picked only the two home-run companies in the past two decades and ignored 99 failures, then this dishonest projection work will be made transparent by showing your data. Better to find a more believable mean that takes the winners and losers into account and show where you got the data from.
  • Know your industry. One thing investors are looking for when evaluating a proforma is whether you know how your industry works. What are the norms for distributors and retailers margins in your industry? Have you taken those into account? Do you have an aggressive gross margin and can you keep expenses down?  If you’re growing at 100% per year do you have a marketing budget that supports 10 times the industry norm?

Follow these guidelines and investors will be much more interested in your business and your negotiation process will be much more productive. Ignore them and you are not likely to get to the negotiation phase at all.

Peter Adams

About the Author: Peter Adams

Peter Adams is co-author of Venture Capital for Dummies (John Wiley & Sons. 2013) and serves as the Executive Director of the Rockies Venture Club, America’s oldest angel investing group.  RVC is a non-profit organization furthering economic development in Colorado whose companies raised over $23 million in the past year.  RVC’s connects investors and entrepreneurs through conferences (Angel Capital Summit and Colorado Capital Conference), networking events, angel investing educational offerings and facilitation of Colorado’s largest angel investor groups.  Peter is the founder of the Biz Girls CEO Development Program for high school age girls and is an Adjunct Professor in the Colorado State University EMBA program. Peter holds a BA Degree from Colorado College, PhD/ABD from University of Colorado and an MBA from Regis University.