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Getting Started

Numbers to wow investors

The most important numbers don’t all come from financial models

Numbers to wow investors

You only need to watch Dragons’ Den to realise that investors are quickly put off by entrepreneurs who don’t know their numbers. Nelson Gray, an angel investor since the early 1990s with over 45 UK and US deals under his belt, shares his thoughts on the most important numbers entrepreneurs need to be on top of.

1. Current valuation

Failing to reach agreement on valuation is probably the number one reason fundraising deals fall apart. Nelson suggests entrepreneurs think of valuation as a way of slicing up the cake, rather than as a precise, quantitative exercise, and that pragmatism is key: “You need to get to a number that is close enough to founders’ and investors’ views so that both are willing to go ahead with the deal, even though both might be dissatisfied to an extent.”

An additional tip he offers founders is that the same valuation doesn’t necessarily apply to all investors. It’s feasible and reasonable for an investor whose ‘only’ contribution is cash - they can’t help in other ways - to invest at a higher valuation than an experienced investor who is also contributing know-how.

2. Target exit valuation

The perfect story for Nelson is for founders to have a clear picture of what their business will look like in the future, what kind of acquirers the business is likely to attract, at what stage in the business lifecycle these acquirers prefer to make their move, and what the business will be worth to them at that point.

To get to that future valuation number, he likes to think about what the pitch to a future acquirer might be. For example: “If my small business has achieved this level of sales with only two salespeople, imagine what your large business, with its sales force of 200, can achieve.”

3. How much investment is needed - in total, until exit

Many entrepreneurs only think about the current round of funding, not about future rounds. But for early-stage investors, it’s important to understand the total amount needed to get the business to a stage where they can exit. They want to know how their stake will be diluted over the period of their investment, which, together with the target exit valuation, provides an idea of their potential exit value.

Nelson says that most good angels will appreciate that this may be a number in the millions, far higher than the current investment round, and that their investment is only the first step of the fundraising journey.

4. How much investment is needed - now

This is the amount of money that it’s feasible to raise from early-stage investors, usually angels or a seed fund, and be sufficient to take the business up to a point when specific venture capital investors are likely to be interested, or when an attractive exit is feasible.

A common mistake Nelson comes across is that the value of investment rounds are determined by EIS or SEIS tax incentives. He says that this is the tail wagging the dog. The size of an investment round should be driven by the requirements of the business, not by tax incentives.

5. Burn rate

This is the amount of cash a company ‘burns through’, usually measured on a monthly basis. In the pre-revenue stage, it can be accurately forecast, as costs are under management’s control. Founders will be expected to have thoroughly researched the costs of staffing and other overheads they intend to spend money on. It’s when companies start generating revenue that forecasting burn rate gets tricky, because revenues are not fully under management control and are notoriously difficult to forecast.

For those start-ups selling to larger organisations, Nelson flags a few mistakes that are often made by founders. They tend to underestimate sales and marketing costs, how long it can take to close a deal with a large corporate, and how common it is for corporate clients not to pay on time. All of these errors result in poor cash flow forecasts.

6. Future gross margin

In the early days of a company, its actual gross margin is likely to be abnormally low, not reflective of what could be achieved in the future (because it does not enjoy any benefits of scale), and, in Nelson’s view, largely irrelevant.

Instead, investors will be looking for entrepreneurs to have a good understanding of the gross margin of the industry and key competitors, what their own future gross margin might be in relation to these benchmarks, and why there is a difference. The answer needs to pass a sanity test. If industry norms are 20%, but 50% is forecast, the credibility of the numbers will be questioned.

7. Founders’ salaries

Investors draw comfort from the aligned interest that results from founders making the bulk of their money from their shareholding, not from salaries. A common mistake founder’s make is to compare their salaries to staff, which doesn’t always make sense in the early stages of a company. Just because a technically skilled staff member has been employed and earns £60,000, doesn’t necessarily mean that founders have to be paid £70,000.

Where the opinions of third parties are offered, these may not necessarily reflect those of St. James’s Place.