When you get to the point in the discussion where projections are relevant, there is a drill-down method here used by virtually every investor. Some may be subtler than others, but I guarantee you that the thought process is exactly the same.
At the end of the discussion, the investor wants to know:
1. What must go right for the plan to succeed;
2. What can possibly go wrong;
3. What it costs if it does;
4. Whether it is fatal or not.
In general, the first part of the discussion runs to whether or not your numbers are tied to metrics with an underlying set of assumptions, or if they are simply a function of a mathematically applied growth rate. Do you have assumptions about how long it will take to achieve each order? What it will cost? This cost and timing can easily be laid out in a matrix that may yield to testing easily. In other words, if you are forecasting 100 orders in the next quarter, at $10,000 each, I’d ask how many potential orders there are in the market, whether there is any existing competitive experience, and how you derived your timing. Timing relates to cost and I’d like a sense of the total cost of each of those 100 orders. This includes selling costs, marketing costs, and so forth. I’d want to know that you had an “in the ballpark” sense of what this all might cost.
(Of course, it goes without saying that no one would bottom-up an expense budget then fill in revenue to make it “come out,” right?)
Then, on the expense side, I’d like to begin to understand how the growth in the business will drive costs as complexity increases. Growth involves, in many businesses, more customer service, product development, support, marketing and so forth – in addition to more R&D.
I’m going to ask about ratio analysis based on what you know about what others spend in similarly situated companies, and where your data come from.
So, if all of your costs rise smoothly in direct proportion to sales, I would suspect you built these costs for the first month and then just scaled them going forward. That’s longer a budget; it’s a math exercise.
Out of the many facets of this discussion, a savvy investor will get a feeling for your understanding of the market you are in – or entering – and your level of experience about the planning process.
All of that is antecedent to assessing your reaction to the process of discussing the assumptions. I’d like to quickly begin a conversation about how “we” will go about finding validation for those assumptions or gaining new information that will help us change them.
This takes a lot of risk out of the business process.
In our first startup, my partners and I built a customer acquisition model and tested it. We pinched and scrimped to do that on our own money (about $75,000 in 1989 terms, which lasted us six months). By the time we were done, we proved the model and gained enough new business that we didn’t need venture capital for almost a decade.