Wednesday July 9, 2014 0 comments
By Peter Adams
Investors hate to see overly optimistic proformas, just as much as they hate to see projections that don't show sufficient returns to make the investment worthwhile. A good proforma does look like a hockey stick, but it's not that simple.
What is a Hockey Stick Proforma?
First, let's start by understanding the concept of the hockey stick proforma. This is a graph that essentially shows a period of low or no growth (the shaft of the hockey stick) followed by a period of rapid growth (the blade). Venture Capital companies have hockey stick proformas because that is the kind of growth that a VC requires in order to make an investment. If the company is not roughly doubling (or more) every year, then it is not likely to fit the risk/reward profile that VCs need to work in their high-risk environment.
Graphs that take off with 100 percent growth from the first month are subject to some skepticism, since results rarely happen overnight. Proformas put together by teams that have not had to go through the process of building a market often start up with first-year sales of $10 or $20 million and go on to double and triple every year after that.
More realistic teams know that the first year or two will be spent hiring and training sales teams, building distribution networks and strategic partnerships. Customers will be testing products in their environments and watching their peers to see what they think rather than being the first on their block to implement a new product category.
The point here is that there is a reason for the long shaft of the hockey stick - it takes time to get your networks set up and working for you. If things really take off after that, then that's great, but it doesn't just happen by itself.
A Proforma should embody your go-to-market strategy in numbers
Experienced teams start their proformas with a strategic plan that outlines their channel strategies, product mix, distribution discounts and balancing-of-product marketing methods. Their proformas will reflect these strategies with separate tabs for each. Some will grow more quickly but perhaps with lower margins, and others may take a while to develop but may have higher margins.
In any case, the experienced team rarely starts their proforma with a top-down strategy of "x percent of the market" type thinking, but rather they start with demonstrated strategies with proven cost of customer acquisition and a growth curve based on those figures.
Business plans take longer to execute than most entrepreneurs think
Investors see many deals over the years, and the one similarity among almost all of them is that the plan is going to take a lot longer to execute than the entrepreneur thinks. Occasionally, a startup team will exceed expectations, but in most cases it will take much longer to reach profitability than anticipated.
Teams with a hockey stick graph show that they know that it will take a while to get to high-growth mode, but that when they get there, they will be roughly doubling or even tripling in growth every year after that. Venture capital investors need that high growth to interest potential acquisition partners and to drive high-exit valuations, which should be the ultimate financial goal for most companies.
By creating a thoughtful and well-researched proforma, most companies will end up creating a hockey stick graph of their growth. This process shows investors that the entrepreneurs are both realistic in understanding the time it takes to build a market, and also aggressive and understand the need for a rapid-growth model to justify the risk that a venture capital investor makes.