Updated: Jan 5
Creating a professional financial model is a critical part of raising capital from investors. While a financial model can be as simple as jotting down some calculations on a piece of paper, you'll need something more professional when it comes to asking investors for their hard-earned millions.
With over a decade of experience in financial modeling, I've learned that there are five critical things investors look for in a professional financial model: Use of Funds, Profit, Scalable Unit Economics, a Compelling Growth Story, and Thoughtful Assumptions.
A Quick Note About Financial Models & Investors
A financial model is simply a projection that shows the financial and business results of your proposed business model over time. You'll be using it not only to raise capital but to see if it's a business worth pursuing and to think through what the business needs to actually grow and become sustainable.
Contrary to popular belief, sophisticated investors will not be excited by your financial projections by themselves. They've done this before and they know that the reality is almost always wildly different than the plan put on paper.
However, they will be interested in seeing that you have thought out your business well and that you touch on those 5 components that I listed earlier.
#1 - Use of Funds
You'll want to know how much capital is required to take your business to the next level before you approach investors. For example, we recently worked with a digital media business that had multiple recurring revenue streams and which required significant marketing and content spending to grow its customer base. One of the main questions investors and advisors consistently asked was: what exactly are you going to buy with your content budget?
Your use of funds should be both broad (e.g. 20% to marketing, 25% to salaries, 50% to inventory, 5% to legal) and specific (e.g. $5,000/month in social media marketing, $10,000/month for CEO's salary, $100,000 in Q1 for inventory purchases, etc.).
Your use of funds should also be comprehensive, taking into account all of the major potential expenses you could possibly incur. You can also add a buffer for small minor expenses, in the range of 10 - 30%.
Lastly, your use of funds should be used in a way that will get you to either A) the next stage of your business (which would require additional funding) or B) a profit.
#2 - Profit
The next thing investors are going to want to see is how and when you plan on making a profit.
There are a few key ways that businesses make money:
- through revenue (sales, subscriptions, fees, etc.),
- by reducing costs, and
- through investments or financing.
Some businesses are able to make a profit immediately, while others may take years. Regardless of your situation, you'll need to have a clear plan for how you're going to make money and when.
If your business is not yet profitable, then you'll also need to show how much capital you'll need to get to profitability. This is why it's important to have a clear understanding of your use of funds (as mentioned in the previous section).
#3 - Scalable Unit Economics
The second key element that investors look for is your ability to scale your business. In other words, can you grow your revenue and profits at a rate that is higher than your costs?
If you cannot show this, then investors will not be interested in giving you money. This is because they know that if your business doesn't grow, they will not make any money back, and they could even lose their investment.
One way to show this is by looking at your Unit Economics. This is a metric that shows how much it costs you to acquire a customer (CAC), and how much revenue you generate from that customer over their lifetime (LTV). If your LTV is greater than your CAC, then you have a scalable business.
For example, let's say that it costs you $100 to acquire a customer and that customer spends an average of $120 over the course of their lifetime with your company. In this case, your LTV:CAC ratio would be 120% and you have a scalable business.
Investors will want to see that you have a clear understanding of your Unit Economics and that you have a plan to grow your business in a way that is both profitable and sustainable.
#4 - A Compelling Growth Story
The third key element investors look for is a Compelling Growth Story that shows how your business is going to grow and become successful.
This could be a story about how you're going to expand into new markets, how you're going to increase market share, or how you're going to penetrate a new segment of the market.
It's important to have a story because investors want to see Growth Story. This is simply the story of how you plan to grow your business and become successful.
Your story should be clear, concise, and compelling. It should also be supported by data and market analysis.
If you can tell a convincing story about how your business is going to grow, then investors will be more interested in giving you money.
#5 - Thoughtful Assumptions
The fifth and final key element that investors look for is thoughtful assumptions.
This means that your financial model should not be based on unrealistic or overly optimistic assumptions. For example, if you're planning to grow your business by 100% per year for the next 5 years, that might be a bit too aggressive.
Investors want to see a financial model that is grounded in reality and that has realistic assumptions. This will give them a better idea of how your business is actually performing and whether or not it is likely to be successful.
So, those are the five key elements that investors look for in a financial model. If you can show that your business has these five elements, then you will be in a much better position to raise funding.
Remember, your financial model is one of the most important tools you have to convince investors to give you money. So, make sure that it is clear, concise, and based on realistic assumptions.
Do you have any questions about these five elements? Let us know in the comments below.