Early stage startups should have a financial model

I met recently with an early investor in Deliveroo, a current darling of the UK tech scene, who cited their financial model as one of the things that made her invest. The model she said was well thought through and covered all the important elements of the business without being too detailed. And it didn’t have any mistakes.

That struck a chord with me mostly because what we’ve seen over the last two years of working with idea stage companies is it works best when they have a financial model from a very early stage (we’re sufficiently convinced of this point that we are going to add it to The Path Forward). The other part of the story is that I’m a bit of a modelling geek myself. I love a bit of Excel 🙂

All of this is a bit counter the ‘modelling is something that bad investors make founders do’ meme which is prevalent in some parts of the startup community. I think the difference comes down to what’s in the model and why it’s built. What I’m talking about is model for the next twelve months which charts the path from today to where the company wants to be. Done well a monthly model like this does three important things:

  • Forces the company to define it’s goals in hard metrics
  • Shows how feasible the goals are by breaking the path there into monthly increments
  • Gives a plan which can be used to set targets and monitor progress

The other, bad, type of model that some investors ask for (and I think fewer and fewer these days) is a five year plan with lots of detail in the out years. Having a notion of where you expect to be in five years is a good thing, although it should be done fairly quickly, but trying to work out lots of detail is premature because everything will change.

It’s also true that a lot will change during the twelve months of a one year model, but in this context the model is helpful because you know earlier when you are off track and have more to time adjust. If the business gets off track to the point that it won’t get back on track then it makes sense to update the model. That should only happen every couple of months at most and shouldn’t be a big exercise because unless something has gone dramatically wrong most of the logic will still hold and the changes will mostly be changes to assumptions.

This post explains why it’s important to have a model. In the New Year I will follow up with a post explaining how to do it.