This morning I was reading from the OSF Playbook about how they have built an ‘open source decision making model’ for investing in deep science startups. That’s a worthy endeavour, but what stood out for me is this quote:
we gained the most insight from the process of building the model, not from an absolute output number
There are two interesting things about this.
Firstly, building a model is the much more valuable than using somebody else’s. If the folks at OSF got value from the process not the answer then anyone who plugs in their own assumptions to the model and gets their own answer will be missing out on the most important insights.
Secondly, it’s also true that when startups build financial models they learn more from the process than from the numbers that come out at the end. A model can be tuned to give any answer its author wants and founders often question why investors want to see them. Here we have the answer – investors value the process of creating the model rather than the output number (although seeing the level of ambition in a startup is important).
In more detail, the value in building financial models mostly comes from being explicit about key assumptions. What are gross margins today and how will they evolve? Same for customer acquisition costs, salesforce effectiveness, account management costs and customer service costs. Eyeballing these assumptions gives a detailed understanding of how the business is expected to evolve and where the risk points are.