Those of you who have looked at some of the startup listings on Seedrs will have noticed that none includes financial projections. That was a conscious choice by us when we built the platform, and I thought I’d take a moment to explain why we made that choice.
Financial projections are always speculative. Even for the most well-established companies, saying what will happen in the future involves a substantial amount of guesswork. When the company has a meaningful operating history, however, projections can be very useful, as they show how anticipated changes in internal or external factors are likely to cause variations from past performance. They still need to be taken with a grain of salt—the whole concept (which is common in public markets) that a company is a failure if it predicts that it will make 39p per share but actually makes 38p is ridiculous—but at least there is sufficient value in these projections to be one component of making an investment decision.
For seed-stage businesses, with no operating history at all, the story is very different. Financial projections become not an indicator of variance from the past but instead a pie-in-the-sky dream of what might be. The only “hard” numbers available tend to be, at most, a year’s worth of cost estimates, with later costs and even early revenues being purely guesses. If you’ve ever sat with an entrepreneur who is trying to draft projections for a brand new business, you’ll recognise the experience: he will start with year 5, figure out how big he wants the company to be by then, and then work backwards to show numbers that build into that end-result (preferably in a hockey-stick pattern, so that growth becomes exponential in years 4 and 5). It may sound ridiculous—and many people would prefer not to admit that this is how it’s done—but it is the reality, and it’s the reality because there is simply no sounder way of creating projections for a business at this stage.
As a consequence, we think that financial projections for seed-stage businesses are not only irrelevant but positively distracting for anyone trying to make an investment decision. When numbers are presented, investors tend to focus on them as a source of comfort, often to the detriment of all the other available information. This, we believe, takes investors’ attention away from what does matter when evaluating a seed-stage business: a qualitative evaluation of the idea, the market and the team. More importantly, it leads investors to make decisions based on information that is inherently misleading, and that is a sure-fire way of causing them to suffer “investor’s regret” down the road.
So if you see one of our startups and think to yourself, “Why can’t I see their net profit projections for year 3?”, the answer is that they don’t exist in any meaningful form. The real choice is to see made-up numbers or not to see any numbers at all and instead focus on the genuine information that does exist about the business. We believe the latter is the better approach, and as importantly, we don’t want to be a part of presenting inherently misleading information. That is why we have excluded financial projections from Seedrs listings.
A good idea. Brave move – I hope investors see this as a reality and approve.
Thanks Roger!
I have to disagree. Financial projections are and can be very helpful. To say they are speculative and requires lots of guess work is only partially accurate. That would be like saying buying a business is speculative and requires guess work. There is difference between speculation and calculated risk. The bottom line of any business is the bottom line. No one gets into a business for the pure joy of it. It’s to make money and before entering into such an endeavor you want to know as much as possible especially the past operating history to get an idea of what it’ll do in the future. Financial projections even for start-ups gives one a range of what they can reasonably expect.
Again, I think you’re missing the point of seed stage capital.
Nobody can project figures for a business that has few or no direct comparisons.
I believe my project can reach a potential audience of 4.2 million in the UK – I believe I can get each of those 4.2 million to buy a digital download for £1.00 – (By the end of year 2) and on a start up budget of less than £70,000. I think we can turn over 5 million by year three with a net (pre tax) profit of 3.9 …
But I wouldn’t begin to suggest that to investors. They’d think I was insane. And despite all the solid research I’ve done and legitimate statistics I’ve pulled together to support the project all I get is ‘But…’
Most start up’s are run by people short on time.
I certainly don’t have time to placate the fears of someone who’s nervous about losing £500.
You want security and guarantees, put your money in a bank. Oh, wait …..
Hi Jeff
I see your point and there is sound logic there but, quite a lot of investors may not agree with you, and will still want to see figures: so I hope you won’t be banning companies on Seedrs from privately sharing projections with interested investor candidates.
I think the point I would make (having raised angel capital a number of times) is that, although you’re right that sales projections are very hard to make, there are a lot of other figures – costings, margins, market size estimates – which can be projected. In particular, for a manufacturing startup (yes there really are some), the costs of such things as early production tooling can be very accurately projected (from hard subcontractor quotes), as can the build costs of hardware and the costs of components and subcontract assembly and so on. So also can marketing costs – exhibition stand cost, travel costs for a trip abroad, etc. So there is still a place for financial projections, even if the top sales line is likely to be somewhat ‘finger in the air’. But then experienced investors are used to that, and are likely to rework the spreadsheet themselves !
Incidentally, Michael Blakey commented very usefully on this last year at the London funding Conference:
Part 1: http://ow.ly/cFbum
Part 2: http://ow.ly/cFbJy
Best wishes with all that’s going on at Seedrs – a brilliant enterprise. More power to your elbow.
Thanks very much for your thoughts, Mike. To answer your question, we don’t prevent startups from sharing financials (or any other information) directly with interested investors, either through the Q&A or off-line, although we do remind them that they are responsible for the fairness and accuracy of that information, Our focus and limitations are solely around the approved listing that’s seen by everyone.
You’re right that some information, particularly on costs, can be projected with some accuracy, and we don’t actually object to a startup talking about specific cost items or margins as part of their listings if they feel its relevant and can support the statements. But I do think that the finger-in-the-air nature of so many of the numbers means that presenting a full set of financials (as one would for a later-stage company) isn’t sensible: even though some of the line items are reasonable, full financials are about painting a whole picture, and we don’t see how that picture can ever (or almost ever) be reasonable at seed-stage.
Thanks again for your thoughts, kind words and interest in Seedrs!
It’s more rational to believe in Santa than in long-term financial projections for highly dynamic markets.
Great move seedrs!
You’re supposed to start with year 5 numbers & work backward? Why didn’t somebody tell me; all this time I’d been properly modelling cash flows based on a mix of known costs and assumptions, revising every time I turned an assumption into a known. That’s what a management degree does to you…
Given the nature of crowdfunding, it makes sense to keep figures off. Potential investors only initially see headline figures, hence the desire on the part of the startup to have a big year 5 and work back; the more knowledgeable investors ask to see the model and will quickly take it apart if any assumptions are obviously flawed (or if it’s just straight bad maths). I supply mine complete with a set of variables that can be altered to see how that affects future predictions
Of course in the end there’s one variable no one can make into a known – just how strong is the future market for the company’s services. I’m pretty confident about mine!
My last startup had a battery of shareholders who formed our board and who insisted on measuring the unmeasurable with Excel. Whenever our development overrun further delayed our enforced and fabricated revenue projections, they became ever more frustrated. Agile we were, but the total lack of understanding shown by ‘supposed’ professionals on management’s aspiration of being best to market and not just first to market, just made the gap wider between management and the board. If you really mean to ignore financial projections in your selection criteria I’ll move my current startup from Denmark to the UK to partner with you. @Andre…I don’t believe in Santa either!
Love it! I’ve had experience firsthand with dubious financial projections so this strikes a personal chord.
I hope you don’t mind, I’ve reposted this on LinkedIn to loop in others to the discussion. I think smart constraints like this are going to be critical to the success of crowdfunding (and it will vary by profile of company, i.e. high growth startup vs mainstreet smb).
Great – the more people in the discussion, the better!
Hmm, interesting and I can’t defend made-up numbers. But all of the startups are offering a share of equity for an investment which explicitly puts a value on the company. As you will have seen from many of the Q&As, prospective investors often challenge, or at least want an explanation. Have a number-free pitch just invites this. Haven’t we just moved to making up the capitalisation and working backward from that – in some cases?
Valuations are a very different species from projections. Valuation is about what the market will bear: investors make a decision of what they think the company is worth based on the mix of information they have, and in our take-it-or-leave-it system, they invest only when they think it’s a good deal (an alternative, of course, would be an auction system where they bid the price they want). Financial projections, by contrast, are one component of the information that investors might consider in deciding on a valuation, but if (as we believe) they are misleading information, then they make it more difficult for the investor to arrive at a reasonable valuation than if the investor just focuses on the real information about the business.
You’re right, of course, that some investors still want to base their valuation decisions on numbers, and that’s why they’re free to do so in the Q&A. But our core goal as a business has always been to bringing efficiency and rationality to the market for seed capital, and while we can’t stop investors from asking what they please, we think that at least trying to steer them away from reliance on financial projections is a step in the right direction.
Interesting stuff and there’s definitely a lot to be said about the role of financials here. But doing away with them all together? The words “baby” and “bath-water” come to mind.
It seems that at the heart of Jeff’s position is an assumption that simply isn’t true. The purpose of ‘projections’ in this context (or almost any context for that matter) is not to attempt to predict the future. We all know we can’t.
In fact the purpose of financials is simply to ‘set out the stall’. Done well or badly it tells us a lot about a business, and makes a major contribution to that vital consideration that Jeff is so keen on – is this someone I want to invest in? That’s not to say it’s the major one; it’s just part of the picture.
I’d go a little further and say that if I were an investor on Jeff’s platform I’d find it a little patronising to be told that I’d find financials a ‘distraction’ that I wasn’t capable of managing. Thanks, but I’d glean from them what I wanted and ignore the rest. (Just please God, give me numbers that are complete, transparent and easy to read – whatever fantasy they contain.)
Even in an early-stage, pre-revenue business a transparent set of numbers reveals much about the entrepreneur’s sense of reality, about his commercial-awareness and about his aspirations. None of them deal-breakers, but again, all part of the package. It tells us about the short-term operating budgets he has in mind – at least what he currently thinks he’s going to spend the investor’s money on. Done well, it’s an efficient way to tell us about the business model. And often even early-stage businesses have already spent money that they sometimes have, how shall I put it… ‘creative’ ways of thinking about, and which an insistence on a transparent set of financials should lay bare.
I’m all for increasing awareness amongst naïve investors about the plausibility of ‘projections’ (and amongst entrepreneurs themselves come to that – they’re the worst at believing them), and recognising that they’re a long way off the most the important thing in the pack, but to throw out any sense of a financial plan as a basic requirement of a business seeking investors’ money? To my mind eschewing financials in this way is like saying don’t look at a tube map because some the stations may be closed.
But my biggest worry overall is the sense I get that the rules are somehow different when It comes to the little guy investing little sums through the crowd. If Jeff were putting his hand in his pocket for the whole of a £50k round in a start-up business would he – or should he – take this attitude? I doubt it. So the message: don’t think about it, just take a punt if you like the look of it, doesn’t sit well. Let’s not throw the baby out with the bath-water. Be inspired by an idea; be inspired by a person. But give some thought to whether it adds up. (And maybe if you’re investing through a platform like Seedrs or Crowdcube, you might just expect them to have taken at least a bit of this approach on your behalf.)
Businesses start with ideas and people. But in the end they all come down to one thing. Money.
I don’t think it’s a matter of not looking at a London tube map because some stations may be closed. It’s a matter of not looking at a London tube map when you’re actually riding the New York subway. And I don’t see it as the least bit patronising that the New York subway system declines to post London tube maps in its stations.
And to answer your question, yes, if I were putting £50K in, I’d feel the exact same way. There is nothing different about small investments — I don’t believe financial projections are useful for companies at this stage no matter how much one is investing. (Note that the leading accelerator programmes, such as YCombinator, don’t look at financials, and they are putting in larger chunks of change).
I do appreciate, Simon, that you’re in the business of financial forecasting and therefore have to make these arguments — and everything you say makes sense once there becomes a meaningful basis for the numbers. But at true seed-stage, it’s a very different story, and the more that everyone in the early-stage investing ecosystem acknowledges that, the better the investment decisions that will be made.
I am struggling to overcome my general empathy with what Seedrs is trying to do with my rational responses which are well stated by Simon Thompson’s post. I do appreciate that valuations are based on more than projections, earnings and so on. But the ONLY number that Seedr startups publish is their (derived) valuation. It is the loneliness of this number that seems not quite right.
And your suggestion that investors can ask and be answered in the Q&A overlooks the fact that Seedrs explicitly excludes any answers from being reliable for investment decision. I appreciate this is partially a tick-box, proforma statement, but I would be more comfortable with whatever projections are made, if they were made in the official listing.
I also appreciate that some startups consider financial information to be somewhat confidential, and want to protect themselves against competitors. But they have come to this marketplace, they have to provide information.
Jeff, I don’t (have to) make these arguments because I’m in the business of building forecasts. I think I’m in the business of building forecasts because well-constructed numbers, even in an early stage business illuminate and inform the process for both the investor and the entrepreneur. In all sorts of ways. They’re not the be-all and end-all (happy to agree that the people, the idea and the market are way more important) and the one thing they don’t ever do is predict the future, but they can and do tell us a lot else besides.
I recognise the short-comings in projections. I just don’t get the corollary that says because part of what they tend to do can’t be relied on, let’s chuck out the rest. Done properly, they contribute; they don’t detract. If there’s nothing germaine in them, fine: now I know, and it takes me 30 seconds to move on, but at least I’m not left wondering what I haven’t been told.
You say that “everything you say makes sense once there becomes a meaningful basis for the numbers”, and that’s the point. There can (and should) be a ‘meaningful basis’ for much of what goes into early-stage projections. Not revenue perhaps, and let’s take everything beyond month 12 with a pinch of salt, but there’s every reason to have a go at them and no reason not to bother. All you’re doing is setting out what little you know and what you think, but in financial terms. It isn’t difficult. Nothing is improved by not bothering. You put in what you know, you estimate what you don’t and you make it clear which is which. And nothing about that process detracts from one’s ability to present or consider the team, the idea, the market, in the way you describe.
How can financials be this terrible thing you’d have us believe? Decent financials make a small but healthy contribution to the process. (Perhaps they make the business of getting someone pitch-ready for a crowd-funding platform just a bit more difficult?)
Perhaps we’d all be better off not with this either/or mentality, which really does risk throwing the baby out with the bath-water, but thinking about how the worst excesses of ‘projections’ can be avoided and the useful, meaningful information in good financials retained, and presented with the maximum accessibility. For the good of entrepreneurs and investors alike.
Jeff,
This is one of the most interesting topics regarding equity crowdfunding. I’ll elaborate much more in the next few months on my blog on this subject, but for now I want to say there’s a big difference between doing an investment of 50 EUR or 5K EUR. If I invest 50 EUR I won’t spend much time doing DD, but when I invest 5K or more in one company I want to know a few things about the entrepreneur. And yes, that includes financial projections. See this blog piece from Mark Suster which explains why: http://www.bothsidesofthetable.com/2009/11/03/are-business-plans-still-necessary/
I understand most projections are not correct at seed stage, but that doesn’t imply entrepreneurs nor serious investors (who want a healthy ROI) shouldn’t pay attention to financial projections. In my opinion “a qualitative evaluation of the idea, the market and the team” and discussing financial projections are not mutually exclusive.
Looking forward to your response,
Kristian
Hi Kristian,
My view is that when projections are likely to be so far from reality, that actually does mean you shouldn’t pay attention to them. I appreciate that many investors *want* financial projections, but I don’t think they want a bunch of made-up numbers — what they want is projections that have some basis in reality, and for a true seed-stage business, I don’t think those exist. I *want* a time-travel machine, but if you give me a plywood box with the words “Time-Travel Machine” painted on it, that doesn’t actually satisfy me, whereas it may cause problems when I make detailed plans for my trip into the future based on the assumption that it actually works…
Of course, as discussed above, there are certain numbers — particularly year 1 costs — that can sometimes be predicted in a meaningful way. In those cases, I’m all for sharing them, but only as a standalone disclosure and not as one line of a set of financials that are otherwise useless.
As for Mark Suster’s piece, I disagree with the notion that showing that you’ve “thought through” your financials has value. It’s just too easy to come up with a set of predictions, based on seemingly complex and detailed assumptions, that are complete rubbish. The further along the company is, the harder that is to do, as the assumption have objective bases. At seed-stage, showing that you can put together financials is about as relevant to your ability as an entrepreneur (or the prospective success of your business) as showing that you can drive a car. It’s a nice skill to have, but it just doesn’t mean much.
Thanks for engaging on this, and I’d be interested in any further view you have!
Cheers,
Jeff
You know, I think this is down to the type of investor! I’ve noticed over a number of years of investment readiness coaching that investors either want to meet the entrepreneur or team first or sit down and look at the numbers.
Relationships are really impotant in early stage businesses and having confidence in and liking the entrepreneur is generally the key component for individual investors. Investor syndicates and networks tend to start with the numbers though.
Hi Jeff
I’m a little late to the table on this debate but thought it would be worth contributing. I fully agree with Simon (who I do not know). By way of full disclosure for other readers, my business is business planning software so I have some knowledge of the area (and I guess a vested interest in financial forecasting being necessary).
It seems that you are discounting financials primarily on the grounds that they are likely to be misleading. What about all the future oriented statements in the narrative? Will they be more accurate? “We will do X, Y and Z”… My sense is there will also be a lot of errors in how people describe their plans and how the business will play out, but it seems ok to rely on these? Are many of these statements not wild guesses also?
Forecasting is not about being right though – business planning is not accounting. It is about coming up with a plausible narrative, backed up with financials which together help prospective investors assess the investment opportunity. As a prospective investor I can get a sense of the size of the opportunity by looking at the financials.
In terms of the methodology – there are numerous ways to approach it including a simple 1 year proforma P&L, which is pretty common also (I am not sure the 5 years and work back method is as common as you suggest). Entrepreneurs can use proxies and analogues to come up with a reasonable range. The values they put in their plan will then enable the reader to assess how realistic they are, and what assumptions underpin these figures. I also agree with Mark Suster that you can learn a lot about the entrepreneur from the financials.
The aim of sales forecasting is to come up with some revenue figures that can be considered to be credible in the wider context. Of course, forecasting is not an exact science but a mix of fact-based analysis and judgment. Placing some rigor around the process of deriving credible revenue figures also serves the entrepreneur by enhancing their awareness of some of the key drivers for revenue growth in their business. It will also help them to produce a more plausible business plan, and ensure that the author is confidently able to answer questions regarding the market opportunity
Anyway I hope the above contributes to the debate. On a personal level I would not take any business plan seriously if it had no forecasts in it. I do not agree that forecasting is not possible for seed investments (although it is clearly more difficult). I can understand that with a modest investment, due diligence may not be that rigorous, so the business plan can be ‘basic’, but for those looking to assess the opportunity for a more meaningful investment amount the inclusion of financials should be a prerequisite.
thanks
Alan
This is actually the best post i’ve seen on early stage investing and crowdfunding. As a startup in the natural resources sector, we realise we will be cash flow negative for a period of time as most startups are, yet we are driven to create financial models that are dependent on the price of a commodity, the legal and taxation framework etc. This means that apart from self funding, equity or debt finance is only available for projects that are advanced, and have industry names, rather than less advanced projects with huge amounts of technical data from reconaissance (aerial, aero magnetic, satellite, artisinal mining trend paths etc). The natural resources sector is highly inefficient, and in the mining sector at the junior end, its not data driven. Coming from a computing and finance background, we like to think of ourselves more as a tech company that is in the business of natural resources and we despair at this situation. on the flip side it also leaves huge opportunities on the ground.
At Last!
Someone in the real world, with a modicum of common sense in the financing arena.
Giving financial projections for a start-up is like betting on how much it will rain next August. Who knows!
Everyone that has ever started a business knows it is pure conjecture – if I get X clients and sell Y no of products/services at Z, I’ll make W. If I don’t, er… then I’m not sure what will happen – I’ll probably try something slightly different and see what happens then. That is the reality of start-ups.
Sure, you need to work out your fixed/variable costs to see if the project is feasible, but beyond that is guesswork.
As an investor, nearly every start-up’s figures I’ve looked at have been farcical.
Anyone who expects otherwise is frankly naive and possibly shouldn’t be looking at investing in start-ups. They should stick to something more reliable and predictable …. like say banks! Oh that’s right, their figures are fantasy too.
In the end, you back someone who you think will knock down walls to achieve their goal – or some other goal. If you are just backing what you think sounds a good idea or a nice upward trajectory graph of sales/profit on their projections – don’t. Good ideas/spreadsheets alone aren’t enough.
Full marks to Seedrs for being so open about this.
Denis O’Donnell
As an individual looking for funding on a new media project, I know I could put together a very convincing set of figures based on readily available stats – but I also know that ‘nobody knows anything’ ( sic William Goldman). I believe there is a potential market for my product that could return grosses in the tens of millions – but the huge sums are dependant on a single factor I, nor anybody can predict – the reaction of a few ‘maven’ consumers. The chances are we’ll do okay, but we may ‘go large’.
I’m also in the luxurious position of being able to do much of the work needed to get my business off the ground myself – but obviously to move things along quickly I would rather employ outside freelance staff. The dilemma here is, do I put together a set of figures based on me doing all the work: slowly for the first two or three years – at minimal cost – or speed things along, perhaps even seeing a significant return in year one, but chewing up tens of thousands on a weekly basis, requiring a bigger initial investment?
Any sensible person would opt for the ‘damage limitation’ option – but there are other factors: Being first in the market. Creating the brand. Testing principles. These are all open for discussion too.
I also know I can achieve a lot through ‘good will’. But I can’t predict when people may be available or how long their good will may last. A positive variable, but how best to present it?
My problem is not that there are no solid figures I can put together, or that there are, but that there are just too many choices on how I could proceed – and each way throws up a whole new set of figures – all as plausible as the last.
If I was to present these options and the stats to go with them, I’m sure it would indeed confound investors to the point where they would simply step away rather than make the choice. Not because they are naieve, but because people instinctively take the easy route.
Rather, I intend to mix and match as I go along, tipping money into an area that needs progressing NOW, which is subject to its own set of variables. I’m also aiming to save money wherever I can by doing things myself, but not to the point of exhaustion – and who can predict that? (As a runner I can’t tell you at what point in the race I’ll need water or a sugar boost, and sometimes I don’t need it at all. The weather, my pace, a blister on my heel, will all affect the outcome. Or not.)
It’s all beginning to sound vague isn’t it? And you are judging me on that aren’t you?
Would a set of validated stats and figures make it any clearer?
And what would that tell you about my personality or how I work?
What was the question?
God bless economists.
re John Eccleston’s comments.
Sticking with the running analogy. I’d look at backing someone I thought would keep running, despite the blisters, despite the weather, despite the pain, despite the thirst.
Numbers won’t tell me that. Obviously, I’d want to check a few numbers, but I think I’d learn more about whether John could run the race, by spending some time with him over several meetings.
And that obviously raises the issue of remotely judging a proposal. It’s interesting, looking at other funding sites, the ones that start to get some investor traction, often then build a head of steam and everyone piles in. Often, I think, based on the wisdom (or foolishness) of crowds – “everyone else seems to think it’s a good idea, I’ll have a go too”.
I’ve not backed anyone I’ve not met. That said, I’ve not backed some things I thought I would, which had interesting numbers, after having a few “deep and meaningful” chats with the entrepreneur, as I decided (gut feel frankly) they didn’t have what it takes.
GENERAL:
I would like to post figures – with a similar caveat to the one that appears all over the Seedrs site.
But again, I would find myself wanting to present ALL the scenarios, as I’m inclined to stream of conscious – and that, I fear would muddy the pitch.
How do you best present a constellation of figures in one place without them being blinding?
Ironically, it is face to face dialogue that best serves all issues. I would hope with time the FSA and (the technology) would allow a ‘video link/conference call’ facility where four or five investors could quiz the entrepreneur and allow that free form dialogue to expose the individuals real understanding of their subject and objectives.
But can investors not commit a small sum initially, opening dialogue, which then may or may not lead to a greater investment based on that dialogue?
Here’s an observation: of the 24 pitches currently on the site who have questions on the Q&A, 20 (83%) include financially-based questions that would be substantially addressed or pre-empted by a well-constructed financial model. (Let’s all try to stop calling them ‘forecasts’.)
The omnipresent question is ‘what’s the valuation based on?’ which we all know in these circumstances comes down to little more than a highly speculative multiple of future profitability – in other words: the projections, however fanciful they may be. Rightly or wrongly, these people are saying: “show me the numbers”.
After that the main questions are around revenue modelling, short-term operating budgets and opening balance sheets – however meagre they may be in these pre-revenue businesses.
It’s an simple tenet of presenting information for this purpose that you pre-empt obvious questions. The simplest, most coherent way to pre-empt and answer financially-based questions is through a properly constructed and integrated profit and loss, cash-flow and balance sheet model at a reasonable level of detail and with some accompanying commentary. Badly produced financials can cause more harm than good, but proscribing financials entirely achieves nothing positive.
Now it’s not easy getting an early stage business to arrive at a coherent view even of their current financial position let alone a future one. I know this because I spend all week doing it. But I still can’t help feeling that if someone wants to act as a filter for investment opportunities and claims a certain amount in respect of ‘due diligence’ on behalf of its investor-base, that perhaps some consideration of the numbers isn’t in order? Is telling both the entrepreneur and the investor they should be taking no account of the numbers really such good advice?
Remember Jeff isn’t just saying “financials are not the most important thing” he’s saying that taking them into account will turn your mind to jelly and make you re-mortgage the house. Bad investment decisions WILL result.
All of which makes me start to wonder if there isn’t something else going on here? Is it perhaps a regulatory issue? There’s a lot of care taken on the platform over what is part of the ‘offer’ and what isn’t, that is to say what Seedrs will endorse as the regulated promoter of the pitch, and what they won’t. It’s such a massively strong position to take and clearly in the face of so much received wisdom (or at least opinion!) that maybe it’s about what can be done, rather than what should be done.
And by way of a footnote I think from what I’ve seen if I were running a crowd-funding platform I’d be finding a way to give my investor-base the most complete, transparent and user-friendly financial information I could, regardless of whatever caveats should go with it. They clearly want it.
PS. Not sure if I’ve used the words ‘baby’ and ‘bath-water’ in this reply. Must be an oversight.
Thanks
Simon
Of course there’s a regulatory issue. The issue is that we’re not allowed to include misleading information as part of the listing. We think financial projections for these companies are inherently misleading, hence we don’t include them. This is one case where the regulation and common sense go hand-in-hand: we think it’s good practice not to include misleading information, and the law won’t let us do it, so it all works out well!
I don’t disagree at all that many investors *want* to see financials, but let’s not forget the famous Henry Ford adage: “If I’d asked my customers what they want, they’d have said a faster horse.” Our goal at Seedrs is to create and deliver what we believe is the most efficient, straightforward and, ultimately, profitable way of investing in startups. There’s lots of stuff that investors would like but that we don’t give them: they don’t get the chance to negotiate terms, they don’t get to work with the entrepreneur face-to-face, etc. We’ve built a service based on what we believe makes the most sense, and part of that belief is that (in the case of seed-stage businesses) financial projections distract from rather than adding to the pool of information on which one makes an investment decision.
Simon puts some good points. Obviously the entrepreneur needs to do SOME figures to show he has a clue about numbers, (having said that, I’ve met a few successful people who didn’t – I believe Richard Branson wasn’t great at this, but had people who were).
The difficulty is, start-ups very often morph into something slightly different than the intended plan – which is the true test of an entrepreneur – can they make the silk purse out of what was looking like a sows ear. I’d still put much more store by the person than the numbers.
I’m new to the world of wordpress forum / blogging – and appear to have posted out of sync above.
I will curse myself for stooping to mention this, but hey: the whole sub prime, derivatives and swaps market is the best example of how a group of intelligent, qualified professionals working with a wealth of substantiated facts and figures ended up – well you know what happened.
The job of any crowdfunding platform is to simplify the process of investing in startups, making it accessible to the broadest possible market. Isn’t that it’s prime function? The clue is in the name.
It has to be taken on faith that the sites founders won’t allow just anybody to pitch – and that as an investor I don’t need to do much more than get a gut feeling for a project.
Why are the economists so keen to see the crowdfunding sites conform to existing markets?
Aha! Finally the real criminal is unmasked! We’ve been after the wrong man. It’s not ‘financials’ we need to guard against: it’s ‘misleading information’.
The question is: are they really automatically one and the same?
Imagine a ‘forecast’ in front of you. It’s for an early stage business but some money has been spent by the entrepreneur before its first month. It’s very minor, say £5k in total, but equally it’s very easy to set out and we don’t need to make a fuss about it. It’s just where we are. I can be confident as an investor that another £20k out-of-pocket expenses is not suddenly going to materialise post-investment because effectively the entrepreneur has made a ‘statement’ (and thank heavens Seedrs will have done some due diligence around this for me). Thus there’s a simple opening balance sheet that shows what’s been spent on costs and capital items and I can see the money sat on a directors loan account. Something and nothing maybe, but clear and transparent.
There’s a monthly P&L for the first 12 months with some projections which even include (gasp) some revenue from month 9. Along with the revenue we can see the drivers (units sold, average price etc), and we can see in a little detail what’s being spent and how it contributes to profit or loss. We can see who’s intended to be remunerated and some idea of whatever fixed costs are being committed to. Perhaps a little office rent, or budget for telephone and travel… It’s a guess, but it’s been quantified. Because we’ve been in business a lot longer than them we can also see what they’ve obviously forgotten.
There’s a monthly cash-flow that takes account of vat and even PAYE issues and shows us clearly the capitalised costs of our whizz-bang disruptive software. We can see the investment funds come in in month 1, and the Seedrs commission fees properly budgeted for. We can see how much we are relying on revenue from Month 9 to stay in the black. We can also see what’s not there: no repayments to directors loan, no other funding in mind.
A balance sheet at the end of Year 1 resolves the lot and tells us where we are. We can see that we’re not relying on creditor balances to support our cash-position, but also that we assume we’ve been paid by all our customers in those last 3 months.
There are some summary figures for P&L cash flow and balance sheet for years 2 & 3 which start to show a healthy profit and some positive cash.
Along with these numbers comes the following commentary. (It’s not exhaustive but you’ll get the gist.)
The opening reserves and fixed assets position represent actual expenses met by the director prior to the forecast start date. The costs have been put on Director’s loan which will not be repaid until the business is in profit.
The projected expenses and capital expenditure for the business represent our current budgets and intentions for the first year. We believe that they can be substantially relied on for the first six months but by their nature they become increasingly speculative over time.
Revenue projections reflect our current view that we should see revenue begin in Month 9 of Year 1.
Projections for direct costs are based on the relationships to revenue shown in our drivers and assumptions and demonstrate our current view of gross profitability. The costs for warehousing and fulfilment cannot be properly quantified at this stage and is our best guess.
Revenue projections in Years 2 & 3 are highly speculative and assume that the current business-model remains unchanged (subscription plus merchandise sales). They represent our targets for the period and we cannot substantiate that they will actually happen
Direct costs have been modelled to assume some economies of scale over time and overheads have been scaled to demonstrate a plausible cost-base for an operation of this size.
The numbers are purely illustrative and achieving them, or anything like them, is contingent on a great many milestones being reached in the short and medium term. It is also possible that the business-model may alter and both revenue and costs may be substantially different in structure.
Is this information ‘misleading? I struggle to see how. But more importantly, is it useful? As an investor I can tell a few things from this:
Someone’s at least thought the numbers through. At least as a starting point. I can see what they currently think.
I can see exactly where we are now financially, however simple or complex that position may be. Even if the opening figures were all zero it tells me something clearly.
I understand what they think they’re going to spend the money on in the short-term. I can see the burn rate and when sales revenue (or more funding) is going to be needed. I can also immediately see that they currently think they’re going to get to market without any more money (I’ll need to think about that, or maybe ask a question…)
I can see some longer-term revenue projections presented in terms of volumes (members, units, average spends etc) and I can draw my own conclusions as to whether there’s a snowball in hell’s chance. (Oh-oh, I think I can see a hockey-stick…)
I can see they’ve got a faintly realistic view about scaling their overheads, but frankly if they’re remotely successful it’s just not an issue.
I can also see from the commentary that they’re entirely realistic about the future.
Some of this stuff is useful some not. Depends on the case. Because it’s in a competent P&L, cash-flow and balance sheet structure it the most accessible it can be, and I don’tt have to trawl or interrogate to get these answers.
So would I make an investment decision based on these numbers alone? Would I fairy-cakes. Like any investor with half a brain I’m overwhelmingly concerned with the idea and the market. (Personally, in this environment I think the issue of the ‘team’ is a bit overstated.)
But would I make an investment decision without the information these observations provide? Almost certainly not. Could I get this information from what’s written in the pitch? Some of it but financial information works best in numbers, not words. Would I take the trouble to ask all these questions and request financials for a £1000 investment? Probably not. I’m afraid you’ve lost me…
Take two identical pitches and give one of them a set of caveated numbers like this. Those who take the Seedrs position can cheerfully ignore them. Those who are going to ask these questions (affecting currently 83% of Seedrs pitches) get their answers.
Mislead or better informed? What do you think? The answer is not to jettison financial information even if it is projected. We need to work on how to make it more useful, more relevant and stop it being misleading. If there’s a regulatory reason why Seedrs can’t put numbers on the pitches at all then oil the wheels to allow it (and even encourage it) to happen some other way. (Remember how many people are asking for it.)
Don’t go telling everyone to do away with this information because it’s tricky to deliver.
Simon
Just in reply to Simon Thompson’s last paragraph but one – as I understand it (having discussed this point with Jeff) – whilst, due to regulation, Seedrs is not permitted to post financials within the on-website pitches themselves, there is not restriction on the companies engaging in separate direct communications with investors, initiated from the Q&A section of the site, and several companies are doing just that. (Jeff – hope I have summarised that correctly).
To my mind it is obvious that thinking investors will have all sorts of requests for information which is properly part of their private discussions with investee candidate companies, and there is nothing in Seedrs policies that prevents that.
I think this (Simon Thompson’s) extended and detailed response is a perfect example of why there is a need for simplified, but FSA approved crowdfunding sites.
All the fun of the punt was bled out by paragraph 7.
I am neither an accountant, an economist or very good at book keeping. (I have been with a respected accounting company for some 25 years who will attest to that)
But I have been a very successful writer and performer with a proven track record in my specialist field. I have an idea for a project that capitalises on the very new and ever changing world of digital production and dissemination. I know there is a window of opportunity to get the project up and running and there are costs to proceeding. How we proceed and exactly how that money will be spent will change. That much I do know.
I have run the idea and my outline figures, (and the variants) past my account manager and although he thinks its terriffic – he openly admits it makes him nervous. He can’t stop thinking about how the shifting sands of the business model can provide anything like the foundations needed to quantify and project realistic figures for what I’m trying to do.
And I can see his concerns. But I’m not sure, at this stage there’s anything I can provide other than a nebuli of the best stats and figures. And he doesn’t see how I can either.
But I am prepared to put in my time, its free. And I’m prepared to risk my reputation – because I believe in the project. And I know I can call in hundreds of favours and trade on the good will and trust of my peers to help things along if I need it.
Economists and bankers don’t like those concepts because they can’t be quantified; they can’t see the bottom line.
But the crowd doesn’t always need to see the bottom line, as Kickstarter and similar sites have proven.
I came to Seedrs because, for me it strikes a sensible balance between altruistic crowdfunding and
those wanting more than a t-shirt or badge if things take off.
Saying that, when things are up and running, and we have the spare cash, I will have a flotilla of economists and financial advisers guiding how we proceed.
Indeed Mike, clearly this is happening because we see it in the Q&A’s. But we have a position which is saying ” don’t do this, it’s not wise. We think financials are a distraction from good decision-making” on the one hand, and “go ahead and ask for them if you want them” on the other which seems a little inconsistent. Surely it’s either valid or it’s not?
And I thought that the whole idea of a platform like this was that small investments are viable because we don’t need the level of scrutiny that say an angel may want for a larger investment. If some of us have to enter into this kind of dialogue to get basic information to make even a £500 investment, does it really work?
I’d value a mechanism which by all means excludes financials from the authorised pitch for regulatory reasons, but which recognises (and doesn’t deny) their potential value, works to improve their value and relevance and helps to make them available in the easiest way. This would seem to be in all parties’ interest (and doesn’t impact anyone who chooses to entirely ignore them).
It’s the whole “either/or” thing I don’t get and it seems a big fuss over not much. I can do these numbers for people in less than a morning. It’s a very minor but positive part of the whole process and in any case even a start-up should have a least the bones of a financial plan however uncertain it may be.
Our position most certainly isn’t “go ahead and ask for them if you want them.” We strongly recommend that investors don’t ask for them, because we don’t think they have value. Part of the reason I wrote this post is to drive home that point.
However, we’ve made the Q&A section available because (as Mike Holt says above) we realise that there may be any number of topics that an investor might like to discuss with the entrepreneur. Some may be perfectly relevant and useful but too specific or unusual to include in a standardised listing format (for example, a question about a specific competitor the business has); some may seem irrelevant to us but matter to a particular investor (perhaps a Liverpudlian entrepreneur’s football allegiance will impact an Everton fan’s investment decision); and others may be thoroughly meaningless, but due to superstition or an antiquated view of seed investing, the investor wants to them them (hence “How much will it rain in August?” as suggested above, or “What do you expect your year 3 net profit to be?” which is the subject of the post). The number of possible questions is infinite, and as a practical matter if for no other reason, we can’t possibly review and make decisions about each one. Hence, we keep it as an open forum.
Do bear in mind that in all of this discussion, all I have said is that I see financial projections as useless for *seed-stage* businesses. As soon as there is a meaningful basis on which to make financial predictions, I’m all for them and agree with everything that Simon says. But I think that one of the great mistakes in looking at seed-stage businesses is seeing them as “dolls’ houses”, that is, miniature versions of bigger companies where all the same rules apply but in smaller form. I believe seed-stage businesses a fundamentally different creatures in a number of regards, a crucial one of which is the value of financial projections.
But isn’t that exactly the point – at this stage of investment the figures are utterly pointless.
I’ll outline my dilemma:
I’m planning to make and distribute digital content for kids. Audio books. Programming, clips etc.
including formats yet to be defined, concepts in development.
Digital content, of course has a capital cost (from almost zero to £1000 000 or £100,000000 you pick a figure).
The means to disseminate are changing monthly. So are the costs of that dissemination. Each month a new website development company springs up and the cost of bandwidth continues to fall.
My ballpark a year ago was £30,000 for the platform architecture. Now it’s nearer £20,000.
The long term value of content can rise, fall or remain static (Gone With The Wind, Citizen Caine still sell on Blu Ray, download etc. / Has the value of Harry Potter fallen because the films have finished and there are no more books in the series? What would you project its future value? What would you have projected its value if you were the first to read it, in biro, in the cafe in Edinburgh?)
We’re offering a share of the company and the 10 projects we’re starting with; not because I’m so very generous – but because I can’t tell you which ones the kids will like. You cannot second guess an audience. I’d be a fool to try. You create something and you put it out there. Let the crowd decide.
There are potential audience and pocketmoney spend figures that make my eyes water – but I have no idea if they’ll spend it on our products because there’s nothing out there like it.
I could quote all kinds of media consumption figures, the rise in cinema revenues since the 80′s despite the growth in home cinema; the take up of new tech, phone and tablet and console sales etc.
I could make a very strong reasoned argument that we could find 1% of a dozen stratospheric stats.
But it is meaningless until we’re able to offer something like the product, in the market place and see what response we get. Even then, the stats will only prove the ‘virality’ of that format, those characters. It doesn’t mean the next project won’t bomb or do better.
But the architecture and the digital content don’t degrade and we don’t need to ‘manufacture’ new stock to keep selling. We could tick over, with no more funding for years. Or we could seek more funding for a big campaign to promote the site: and on and on…
How do you begin to frame the figures in an easily digestable way? And if you can, isn’t the next question still always, ‘how do you know that?’ or ‘what if?’.
Too much process doesn’t let the process get underway.
Too little process and investors wonder why they gave that Zuckerburg guy $5.00 for a shout out.
Isn’t Seedrs the middle ground?
John
Might be serendipity, might come to nothing, but I have two contacts that may be able to help with distribution of kids stuff. Contact me off line to discuss if of interest – dod@xlr.net.
Again – this post above wasn’t as a repsonse to Jeff – but to Simon – Goddam Tech (Goddam Dumbass) ….
Awesome post Jeff! and quite the discussion that has ensued …
I think this is a great move by Seedrs. They are trying to open up a new way of investing, one that is free from all of the fluff created by the traditional system.
As a young entrepreneur, I have been well instructed on how to create a financial model and why it is important. Before learning this, however, I was part of a team that started a business without any financials or formal business plan, and it was a great success. Then I went through business school and spent a semester learning about financial models and old-school business planning techniques. Did it make me a better entrepreneur? No.
The point is that they are a distraction at the early stage … so good move to cut the distractions and focus on the more important components of the business.
Do I like to make financials for my business? Yes. Would I like to see someone’s financials for their business? Depends on the company. Do I think that a mandate for financials at an early stage hinders the development of the seed ecosystem? 100%.
The more entrepreneurs that Seedrs can get on their platform who understand how to innovate and create value, the better, and in my opinion this move will accomplish that.
Joel
Jeff, great that you are highlighting this problem.
As an entrepreneur I have begun to list up my business on Seedrs but have been reticent to publish the listing for precisely this point. I have been disturbed to read questions like these and other “later stage” investment questions being asked of entrepreneurs. It displays a lack of ‘up to date’ understanding of seed stage investing and signals that there will be serious problems with those investors expectations both pre and post investment.
In terms of your service here I think an important aspect will be to educate investors so they are at the level of Silicon Valley expertize in seed investing (If investors are hoping for Silicon Valley sized exits, i.e. Instagram, 12 staff, 18 months, $1B)
The almost immediate success of Kickstarter and other ‘donation’ based crowd funding sites, I think is due to the look and feel of the sites – they are much more about philanthropy and community. That in itself is very compelling. The bulk of donations, I suspect, are from the tech and media savvy young, excited by the chance to say ‘I helped start that company’; the need for pro-active and positive connection greater than the desire for profit.
I think Seedrs, although also a very accessible site in terms of its look, ease of use and neat introductory animation – is clearly attracting INVESTORS (use of capitals deliberate). By their very nature the investor looks to the bottom line. It may take a while for Seedrs to build a significant investor base with a more philanthropic rather than dogmatic approach; its admition criteria, I’m sure, is knocking out a very large proportion of those philanthropic investors that we need to see.
And it’s large numbers of smaller investors (£25 rather than 25,000) that will really makes things happen. That after all is the idea behind crowd funding.
Well this post certainly has stirred up some vigourous comment !
Earlier today I came across an apposite article, referring to Dave Berkus’ (US investor) formula for calculating the value of a pre-revenue startup. This is how he does it (in the absence of measureable revenues):
http://berkonomics.com/?p=1214