Startup Cafe: Troy Henikoff - Financial Modeling for Entrepreneurs

Welcome everybody today to our Startup Cafe here at Enterprise Works. We're happy to have you and we're very pleased to have Troy Henikoff joining us from Chicago and Techstars today. Just want to tell you a little bit more about his background, which I'm sure he'll tell you as well. It's one that's quite impressive. He has a long history of working in the startup and investment community and currently in, in a couple of capacities. Yeah, thanks for Troy having me. is managing director of Techstars, and I think he's going to talk a little bit about Techstars today, mostly at night when he lectures on campus. Techstars is really known, I think, in the U.S. as the leading accelerator program that so many want to get involved with since it got started in Boulder. And it's now in several cities, including Chicago. Fewer than 1% of the startups that apply actually get into Techstars, and they've had collectively tremendous success with 1.3 billion raised and much accolades that their companies have gone on to do great things. Troy is also, in addition to leading Techstars, involved with several funds. But before Techstars, there was Accelerate Labs. There was a lot of buzz in Chicago when that program began. It's very competitive, and their hallmark has been the demo day that they have. It's really impressive to see the startups coming out of that accelerator program. So I think they're still accepting applications. tends to have a lot of digital media types of startup companies, and it's something that I'm sure he can tell you more about. In addition, he's been working on a new venture group called Math Venture Partners, which is a venture capital fund focused on technical and digital companies based in Chicago. He also has been a lecturer at Kellogg speaking on entrepreneurship, digital marketing, and he has also been with Firestarter Fund. He's on the board of the Chicagoland Entrepreneurial Center. And before all of those activities, he was a successful founder of companies. And so he got there, I think, through his own credibility and being very experienced and successful. Most recent one was OneWeb. And before that, probably best known for his role as the founder and president of SurePayroll, which is now America's number one internet payroll service provider. So he brings a lot of experience on all those fronts. And today he's going to go a little bit deeper on actually a lecture that he might give in another setting where he's asked to speak. So this is a treat, I think, for us to get this So please join me in welcoming Troy.

So can you guys in the back hear me if I don't use the mic? Jed, I got a thumbs up. All right. If you can't hear me, I'm happy to switch to the mic. It'll just slow me down a little bit, and I don't want to get slowed down. We have a limited amount of time, so normally when I do this session on financial modeling, first thing is I have all the attendees do a bunch of homework. Which I didn't ask you guys to do, so that you're thinking about the problem ahead of time. And the second thing is I usually spend an hour and a half on it and I'm told I have 40 minutes. So I'm going to try to buzz through this really quickly. Hopefully you'll get the high level of it. I'm happy to stick around and answer questions, whether it's about this, whether it's about Techstars, venture financing, whatever it is, shortly. But as I tell our companies in Techstars, you should never start a meeting without an objective. And so I want to highlight what my objectives are. So the first is I want you to walk away here seeing the power of a financial model. You've probably all heard about financial models but may not understand why. I'm going to tell you that it's going to help you raise money, it's going to help you run your business better, and I want to teach you how to build one yourself. Is that fair? Yes. So I'll give you some best practices, we'll use an example, and let's get rolling. But before I do, what is a financial model? That was a question. Testing, oh, this is working. Okay, yes?

It's a financial simulation of your business.

That is probably the best first answer I've ever gotten in a talk like this. Awesome, financial simulation of your business, right? What's key about that is he didn't say it's projections, he didn't say it's a pro forma, The analogy I make for people is that, you know, in the 1950s when we were building automobiles, people would build life-size models. I don't know if any of you have ever seen the movie Tucker or any of those. They would build these life-size clay models and they'd build life-size actual models of cars and they'd take them out on the track and they'd run them around the track and, oh, it flipped over in the turn at 30 miles an hour and they crashed it. And then they'd go back and they'd start from drawing board and they'd build a whole other life-size model and they'd send it out with a driver and hopefully the driver doesn't die when the car flips again. Today we use CAD, CAM, we do all this stuff where we can do it really quickly and simulate it. We don't have to take all that time, spend all that money, or put all those lives at risk driving those things. Wouldn't it be cool if you could do the same with your business? If you could have a simulation of your business that was accurate enough that you could tell, hey, if I went down this path, will I be successful? If I go down that path, would I be successful? And then you could do that in the safety and comfort of your office without having to waste hundreds of thousands, millions of dollars, and years of your life. That'd be cool? Yeah. That would be cool. Simulation. So financial projections are different. Financial projections are the output of the model, right? You can have a model. Models have inputs and outputs. You can have the same model have multiple outputs, right? I could put in a set of conservative— Inputs. Inputs, a set of more aggressive inputs, I get different outputs. Many times I see people who when they present business plans, they present an optimistic, pessimistic, and realistic projection or pro forma. Same model, just slightly different inputs. Does that make sense? Okay. So buzzing through this, the output from the model should be a set of financial projections. Income statement, balance sheet, statement of cash flows. Hopefully all of you know what those 3 statements are. Why do we use those 3 statements? Why does it matter? Anybody have an idea? What did I say we were going to do with the model? What's one of the objectives of the model? Objectives of this course, of this talk? To understand the financial statements. Who here cares about fundraising? Anybody here going to be fundraising for their company? Okay. So part of the reason you're going to build a financial model, I said, was to make it easier to fundraise. Let me tell you a short story. When I was raising money for SurePayroll, we did our pitch to our VCs and we had a lightweight summary of our projections. And inevitably, it was so great, it was It was like I threw them a softball. Inevitably they'd say, oh, I want some more detail on that. Tell me more about your customer acquisition costs. Tell me more about your COGS. Tell me more about how your— whatever it was. And I said, oh, I have a little bit more detail, and I'd flip right to that slide. I said, but if you really want to understand it, I have this sophisticated financial model that I built, and I would love to sit down with you and one of your analysts For 90 minutes and go through the model. And every single one of the VCs said the same thing. They said, oh no, just email it to me, we're really good with Excel. And I said, no, I want to save you time, I want to make this easy, I want to walk you through the model and then I'll leave you with a copy of it. And they pushed back and say, no, no, no, just email it, we're really good, that's what I got my associates for, they're, you know, MBAs, all this. I said— and I never let go. I said, nope. I'm going I to do it. said, I've done this before. I'm going to save you and your associate a ton of time. Let's schedule a time. Do you have time on Wednesday or is next Friday better? 100% of the investors who made the time to sit down with me and go through the 90-minute model either invested in the company or made an offer to invest in the company. 100%. And one of the two reasons, one is it was a self-selecting group. They had to have some interest in order to invest 90 minutes. But two is when they walked out of there, they said, wow. Do they understand their business? I now, as the investor, understand the risks in the business. The financial model is a tool to communicate to the investors in the language they speak, and the language they speak is income statement, balance sheet, cash flow. You have to talk their language. By the way, that also means, do you think investors speak Google Docs or Excel? Excel. Excel. Excel. You may love your Google Docs, but I'm telling you, you want to speak their language. Send them an Excel spreadsheet, not a Google Docs spreadsheet, right? Label things. You should understand a little bit about accounting. Alright, so that's what the output is, the 3 main statements. Profit is a matter of opinion, but cash is fact. Cash is the most important thing. All of you who are starting businesses here probably know that viscerally at this point. There's nothing you can do to substitute for cash. And there's only one reason investors are going to give you cash, and what is that?

Make profit.

They think that they are going to get more in return while minimizing their risk. A big mistake people make is they think venture capitalists are big risk takers. The reality is good venture capitalists, Yes. Are good at minimizing risk in an inherently risky environment. By the way, I'm happy to share these slides and the spreadsheets and stuff I'm going to use today, so you'll get— I'll share them with you and you'll distribute them. They're all about minimizing risk, and the way they do that with a model is understanding where the risks are, sensitivity analysis. If you can make that easier for them, demonstrate that you understand where the risks are, you are a less risky investment. All right, we're going to start, so details. Financial model, first tab is all about assumptions. You're going to have— first sheet of the workbook is all about assumptions. You got to get data for these assumptions. Some of them you can get from publicly traded companies. Some of them you can get from common knowledge and talking to other people. One big mistake that I see MBA students in particular, I don't know why, but make all the time is they pick the wrong things for assumptions out of the publicly traded data. So we were starting a payroll company. There were 2 big publicly traded companies, Paychex and ADP. We saw all their financials. It would have been a huge mistake to go and look and say ADP spends 15% of their gross revenue on marketing, therefore I should spend 15% of my gross revenue on marketing. Why is that a mistake?

Because you're not the size of ADP.

I don't have any gross revenue. I'm a startup. That means I spend zero, which means I get zero customers, which means I'm in an infinite loop of zero, right? A startup, you may spend 10 times your revenue in the first 6 months in marketing or in sales, right? So ratios like that, useless. What we did learn though is, for instance, how much ADP and Paychex made on interest on deposits per company they were processing. Interest is a big— there's a lot of float and carry. What we did learn is how much they were compensating sales reps. What we did learn is how much revenue they get per account. Those were useful. Does that make sense? Be careful of the ratios. And this is your opportunity to demonstrate clear and logical thinking. So, sort of like, how many of you have written code before? All right. So when you write code, you know, I remember a friend of mine, I used to complain, he's— The code was so hard to debug. And he said, well, it was really hard to write, it should be hard to debug. And— but developers who you really liked working with took the time to structure things, to use long variable names that made sense and were logical. This is your job. Your job is not to make the financial model hard for the investor to understand. Your job is to make it easy. So, use really clear text descriptions, no acronyms, right? Use Excel labels. If you don't know what the label function is, I won't have time to cover it today, go look it up, it's awesome. We'll see it in the demo, I guess. But think about this as your opportunity to demonstrate clear and logical thinking. As an investor, I've invested in 28 companies as an angel investor, 60 companies through Techstars and Accelerate Labs, 23 through MAP Ventures, another 20, 15 or so through Firestarter Fund. So I've invested in a lot of companies. So you know what? I love clear, logical thinkers. All right. So what's the most important thing? So when I look at— so someone sends me projections, someone sends me a financial model, what do you think the most important thing that I look at first is? What is it?

Huh? Profit.

Profit.

Profit. Nope. Cash flow. Cash flow, yeah, no. None of these early stage companies are going to have cash flow or profit. I saw a hand way in the back.

The process they use to develop it.

I am very interested in the process they use to develop it. Growth. Growth is interesting. What kind of growth? Revenue. Revenue. Revenue, I want to see that top line. I want to understand how that grows, right? I said profit is a matter of opinion, cash is a matter of fact. Without revenue, nothing else matters, right? And we can do— here's the problem. One of the reasons we're entrepreneurs is we love to be in control. We love control of our destiny. You're building a financial model, you can control how much you spend on pencils, And on printer paper and what kind of computers you buy and how much they cost, and none of that matters if you don't have revenue. It's really hard to control customer behavior and we're not comfortable with that because we can't control it, so we shy away. So we spend 90% of our time on the financial model on all those little details that we can control precisely that really don't matter. This is the most difficult thing to predict. It's the most difficult thing to control, it's the reason most businesses fail, and this is where you need to spend your time. Formatting the income statement, you're going to get a copy of this, so whatever. Revenues, direct expenses, get your gross profit, indirect expenses, notice I do not call them fixed expenses, which many people do. If you are of the mindset that any expense in your business is fixed, you are setting yourself up for failure. I have a 3-year lease for my office, that is not a fixed expense. If it turns out I need to blow up that lease, I got to go to the landlord and blow up that lease. Nothing is fixed in a startup. All right, so here's what happened. I was teaching at Kellogg and I had the opportunity to teach a— take a course in new venture development and squeeze it from a quarter down to 10 days and teach in Croatia, and with one of the professors, Barry Merton. And Ernst Young was going to sponsor this, and so they gave us this book, and they said, hey, use this to teach your class. We'll give you some money. We'll give you books for all the students. And Barry, who's a great guy, he was the CEO of Drescher Beds, he's done a lot of stuff, he's been a professor for a long time, isn't as good with the numbers. So Barry asks me to do the financial modeling piece. And I said, sure. So we're on the plane going over there and I start thumbing through this book and it was horrible. So Ernst& Young, right? It's like one of, at the time, the Big 8 accounting firms, I think it was. But anyway, it's one of the biggest accounting firms in the country and it was the worst. So I actually, on the 12-hour plane ride, built all of the structure of this example and what we're going to use today. Mm-hmm. Live from this book, so let's see. So what I did is hopefully you can all read this, and I want you to read this. This is the summary of the business we're going to use as our example today. So when you're finished, if someone's finished and wants to share with the group what the business is, raise your hand. Pretty simple business. Alright, so what's the business?

Selling these foods to parents. Yeah,

they're selling baby food to parents. They have 2 product lines. How are they selling? Are they going door to door?

Retail outlets.

Retail. So they're operating these retail outlets? How are they selling it?

The people who run the retail outlets.

Huh?

The people who run the retail outlets.

So they're really a wholesaler who's selling to the retailer, right? And what are their margins?

50%.

50%, because they have a contract that someone's going to manufacture this stuff for half of what they're going to sell it for. Pretty simple business. I'm going to tweak it a little bit to make it— make you think about it as a recurring revenue business because I love recurring revenue businesses. So I'm going to make the assumption that when I sign up a store, a grocery store, a drugstore, a health food store, that they're going to order the same amount of my baby food every single month because their customers are going to come in and buy them. It's a simple assumption. We're trying to keep this simple. So here is what they provided for us in the book. They provided this statement. And who thinks this is a great— good investment? Who thinks it's a bad investment? Seems like almost nobody has any opinion. I think it's a bad investment. Why don't you have an opinion?

I can't read it.

Oh yeah, the old people have to move to the front, that's why I'm up here. Yeah, it's a little small. But, you know, down here it says they're going to have $649,000 in income after tax in year 5, you know, 11%. I don't know, maybe, maybe not. They said they're going to start, they're going to have $511,000 in sales of their first Product and 705 in the second for a total of 1.2 million in year 1. Who believes they're going to have 1.2 million in year 1? I think it'd be more, less?

Less.

OK. So you're like me. I just— I hear a number, I say, I'll take the under. But let's see, where did that 511 come from? Oh, it was typed in. How about the 705? That was typed in also. I'm very proud that the 1216 was actually the sum of those 2 numbers, right? But there is no way that I have any ability to dig in and understand and have confidence or not confidence in these numbers. It's 511. How did you get there? I don't know, right? And— oh, there's this number in gray. Let's see what's going on there. That number actually refers to something, the marketing detail. There's going to be some backup. This is awesome. There's a tab called marketing detail. Let's take a look. There it is. Notice it doesn't even tell you what time period that spend is over, let alone what results you're going to get for it. It's not tied to anything. If I change the marketing detail to make it be $4 million, do any numbers change in my revenue on this page? No. That's not a model. What was the phrase you used? It was a great phrase.

Simulation.

That's not a simulation. The simulation should logically say if I spend more in marketing, I'm going to get more in sales, right? That's what we want. So here's what I did. I took basically these numbers that they gave us and I created what I thought would be an appropriate model for this business. And it looks sort of like this. And at one point, if I go back to the annual income statement, these numbers actually tie out to exactly what the numbers were on the sheet I just showed you. I've done this talk so many times and tweaked it so many times it no longer matches. But believe me, I can get it to tie. So what in the world is all of this? So I have relatively little time to go through it, but I think I can illustrate the simulation and I can illustrate why this is so important. So what this is, you are looking at 2 views of the same spreadsheet. I'll prove it to you by clicking on that little tab that says assumptions. On this view, you'll see that it's identical to the one over on the left. I'm just giving you 2 views So that we can see what happens in real time. I have a series of assumptions here about my business, right? So how much monthly sales per store, ages 6 to 12 months. Hopefully this is clear, right? That's a good long description, you guys all know what that is, right? Yes. New stores per sales rep per month, okay, 1.5, I get it. And what happens is the end is that all of these assumptions are the inputs to the simulation That say this will be your output, this will be your results. I'm going to anchor you on this $1.3 million. This is a statement of cash flow, cash is king, 5 years. Now hypothetically, if instead of $1,500 per store per month of that category of baby food, the sales reps turn out the demand is higher and it's $2,000. When I hit enter on 2,000, what is that going to do to my ending cash balance?

Go up.

It's going to go up. How much?

Times 5. 25%.

I increased this by 33%.

It'll go up by more than that.

33%. More than— who thinks more than 33%? Who thinks less than 33%? A lot of undecideds. Let's see. Oh, it went from 13 to 2 point— 1.3 to 2.1, went up over 50%. By the way, I only increased one of the 2 product lines 33%. Why did that happen? Well, we could dig into the simulation and understand, but basically we have a lot of indirect costs that we have to cover. This is the cash that's left over at the end. We've already covered that cost with the first— Umpteen million dollars of sales, and on the incremental sale we make a lot more profit, right? But let's go back. So we— I'm going to undo that. Now I'm going to say what happens if I change this number instead? We increased the sales of a product by 33% and we went to $2.1 million. If instead of doing that we increase the number of stores that each sales rep signs up each month by the same percentage, 33%. From 1.5 to 2. What's it going to do to this number? How many people think it'll make it bigger? Smaller. All right, everybody thinks more— selling more stores will get you more cash. That's good. Now, does this have a bigger impact than increasing a product or a smaller impact?

Smaller.

I hear a lot— how many people think smaller? How many think— people think bigger, right? This is why we need a simulation. $2.9 million.

Oh.

Wait a minute, that's more than double. All I did was increase the number of stores I added each month by 33% and I more than doubled the amount of cash I had. By the way, the other thing, Oh, the other thing is that I didn't point out is that my cash balance goes to a low of about half a million dollars here, when before my cash balance got down to about $100,000. Not only did I have more than twice as much cash at the end, I actually didn't have to raise as much capital during the process, so I could keep a bigger percentage of So I could keep a bigger percentage of the company and have a lot more cash at the end. That's a really good outcome. But that doesn't come for free. I'm going to go back to it, 2.9. It doesn't come for free because I can't just go to my existing sales force and say, hey sales force, you have to sell 33% more. I got to upgrade my sales force. So let's look at the next assumption. I'm paying a base salary of $35,000 to my sales reps. That might be good for someone who's a year or 2 out of school, whatever. At Sure Payroll, that's actually what our base was. We had people who would sell copy machines for a year or something like that and then come to Sure Payroll, sort of a stepping stone sales. But, you know, good salespeople are expensive. Maybe $35,000 base isn't going to get me the quality salesperson I need. Maybe I need to double it. If I offer a base of $70,000— That's a I lot of money. can attract a higher caliber salesperson with more experience. And remember, they're getting commission on top of that. So their all-in comp will be higher. But maybe now that's going to get me the kind of salesperson— so now wait a minute. I doubled my cost of my salespeople. What's that going to do? That's clearly going to cost me a bunch of money. But am I better off or worse?

Better.

I don't know. Let's see. Okay, so it cost me $400,000 over 5 years, but if I believe that a $70,000 salesperson could sell 2 stores when a $35,000 would sell 1.5, that is a net huge gain for me. Is all this making sense? Mm-hmm. You see the power of the model? Now, when you present to an investor and you walk them through the model and you say, here are my assumptions, And you tell them what each assumption is. The first piece of advice I have for you is to get yourself on the same side of the fence as the investor. So if I come up there and I say, here's my model, it's perfect, it's all about our business and it's going to project the future, you're going to have an adversarial conversation. But if you're more humble about it and you say, investors, here are my investors, I'm Presenting to these 3. You guys, I'm excited to share this with you. But before we go forward, the thing I want to let you know is the only thing I know for sure about this model is it's wrong. Our job together— I want your input— is to go through the assumptions. Help me validate these assumptions. And if there are ones you're curious about and you think are wrong, let's put what you think is right in and see what the output is. See what the results are. And let's get to somewhere where we have a set of assumptions that you're comfortable with. Are you good with that? We just— I just put myself on the same side of the table as these 3, right? She's not going to feel like we're combative, but we're working together towards a common solution. And it is very disarming when the first thing I say is, the only thing I know about my model is it's wrong. And by the way, it's wrong. SurePayroll, I spent a lot of time and built a really sophisticated model And it had all kinds of detail, way more detail than this. And in hindsight, it was actually about right if I had stretched my 3-year model out for 11 years. So we got to the numbers I had in the model. What I thought we'd do in 3 years took about 11. That's amazing. And that's typical, by the way. We're all entrepreneurs. To be an entrepreneur, you have to be optimistic. To be optimistic, you're going to have optimistic projections. So we don't have time to go through all of these assumptions. I will leave you— Postmaster card. All right. Is that better? All right. I will leave you with a copy of this model that you can play with under one Condition. And the condition is that you promise me you will not try to use this model to shoehorn your business into it. Here's what happens. I'm not doing it because I have any intellectual property. I'm not saying that because I have pride of authorship. I'm saying it because I'm trying to save you a lot of time. You can't shoehorn your business into this model. There's so many interconnected cells That it will break, you'll try to figure it out, try to figure it out, try to figure it out, you'll get frustrated, you'll be swearing at me, and after 2 days you'll throw it out and start from scratch and do it the right way. When I built— very detailed, we ran it for a year, and then I had to do my model for the next year because I had learned a lot. And when I went to do it, of course I started with my model from the same business. Oh, but I have a bunch of new assumptions. It turns out that my sales reps don't all get paid the same amount. I have sales reps in category A, B, and C, and I need a distribution of them, so I need 3 3 different kinds of sales reps, and it turns out that their commissions aren't all the same, and it turns out whatever it is. And I started tweaking it, and after 2 days of frustration, I had to throw that out and start from scratch. So if I couldn't do it with the model that I built for the same business, you certainly won't be able to do it with somebody else's logic in a business unrelated. More attention, more time. So I'm happy to share this, and what you should do with this Is put it up like I have it here, play with it, have a blank spreadsheet to the other side of it, and start building cell for cell, if you want to do that, your model where you know what all the cells represent and how they're interconnected. Do not try to just start putting your numbers in here and expect that you're going to get a model that will work for your business. It will not work, I promise you. So let's talk about a couple other things. Real quickly, so as I'm talking about fundraising, I'm going to show you a little trick. So you have a lot of detail behind each of these. So going back to how I was making fun of the original model, let's go to the annual income statement. Here's the annual income statement. So the question could be, do we— do you believe my $252,000 in revenue? In line item revenue or my half a million in total revenue? You might say no, and I'll say, well, let me show you where that came from. When I highlight that cell, each of these cells, you can see that it came from a detailed statement, the monthly income statement. So I can go to the monthly income statement. You can see that there is detail behind here that all rolls up into that number. This goes on and on. If you say, well, wait a minute, Where did this sales revenue come from? How did you get $3,000 that month? That was a function of this input and how many sales reps. So I had sales reps are selling 2 stores, $1,500 per store. If it was $1,600 per store, you'll see that all the numbers change. It's now $3,200, right? So it's all interconnected and it's all driven by the— I'm going to go back to my base. It's all driven by the assumptions. As a matter of fact, when you go through here, there is not a single number typed into any one of these cells. Every single cell refer— is a formula that refers back to assumptions. The only exceptions are I'll let you type in the number 7, 12, or 365 as long as they represent days of the week, months in the year, days in the year because those aren't going to change. But you really should never type anything into the detail pages. They should all be formulas that are driven and all of your numbers that you type in are here. I'm going to go show you a couple other things. As soon as I gave you a rule, I'll give you an exception. So I have detail behind each of these and one of the detail here is the sales detail. So this is Driven off of— here's where we said we're going to get 1.5 stores per month. Again, if we were to change our assumption to say we got 2.2 just for kicks, you'll see that all those numbers change, right? It's all interconnected. But this row here, number of sales reps, I actually did type in the number. It would not make sense. I'm doing a 5-year model for me to have 60 assumptions. How many sales reps in month 1? How many sales reps in month 2? How many sales reps in month 3? So I highlighted in green that row just like I did green as inputs here and that's an input across the top. And then I have— do you see this kind of shaded row that says average annualized comp? What do you think that's there for? I'll go a little further down mine. What's going on there? Why do I have that row? To calculate the average. What do you think? Yep. Some months are going to be better than others. Some months are going to be better than others? Yeah, it's not really why I put it there. So when I increased my comp to $70,000 base and my sales reps were making 2 sales, so let's go back over here and do that. When I put $70,000 base, And they're selling 2 stores a month, like how much money are these guys making?

$70,000.

Oh, I'll change that. By the way, you want to see something crazy? If I— at $70,000, I don't know that it will work. At $70,000, I'm out of business. I'm— $700,000, sorry. But like literally even if I paid them $250,000, I have— well, I go out of business almost. If they could do like 3 stores a month, I'm actually better off. Like sales is such a powerful engine. But let's go back to something reasonable where we were, $70,000. And I was trying to get to sales detail. So these guys are making, you know, $100,000 and whatever, $130,000 a year. And what this is, is this is not a number that is in the total. It's a reference because I can't tell, $70,000 base, 3% commission, I wanted to triangulate. Is that a reasonable number? Can I get a decent sales rep for $130,000, right? I had to do a check. And now, that's why that's in there and it's colored a different number because it doesn't add up into any of the totals, it's just a reference. Yeah. But what I'll do is I'll do something like this and I'm kind of hanging out here, you guys haven't said anything yet. Yeah. But usually, an astute investor will say, wait a minute, what happened? You went from $138,000 to $118,000. You got a bug in your model. And this is your opportunity. This is another soft landing. You know what? You're right. I saw that too, and I couldn't figure out what was going on. Who knows what's going on? Dad does. So? 1 o'clock. Thank you. I added another sales rep. I went from 2 to 3. These 2 are certainly going to make about $140,000 in the next month, but the new rep has no book of business and is going to be at $70,000. $70,000 plus 2 of them at $140,000 is going to average out to be about $120,000, $118,000. That's what's going on. Here's what happens. When the investor is Asking questions, they're poking, they're trying to find that soft underbelly. Where's your mistake? And as soon as they think they find a mistake and you have an awesome answer, they stop asking about that category, right? They'll go hunt somewhere else. And so I planted a bunch of softballs in here like that, and that's an example of one of them. There's one last thing I want to talk about before we take some Q&A. Yeah. And that is how do you use this effectively? And the best way that I know to use this as an operating tool is to go to your monthly— so these are just the monthly projections that come off of here. So you can see we said we're going to sell 2 stores a month at $1,500. You can see 2 times, right? You all should be familiar enough with where we are. All of these numbers go in here. And then the end of my first month happens. What should I do? Month 1 is over. I have actual numbers, right? I have results out of QuickBooks. What do I do?

Fix your model. Huh?

You

fix your model.

What do you mean fix my model?

Continually refine it.

So how do I do that?

By comparison of actuals to estimates.

Yeah, actuals to estimates. So here's what— I'll tell you what I do. What I do is I look at these, I insert a row, and I put the actuals. In between these actuals, and then I start tweaking my assumptions. Say what assumptions were off? What how do I tweak these assumptions to get them as close to what really happened as possible? You'll never get it exactly, but you'll get it close. And then I do two things. One is I paste the actuals in here hardcoded because I don't want them never change. They were actuals. Now, and I color that cell gray, light gray, so it's done. And now what's happened is I have a better set of inputs that hopefully will be more accurate in projecting next month and the month after, because they're based on what actually happened in the first month. And the second month, I'm going to do the same process, and I'm going to refine. And remember, because I've typed over these with actuals, they won't change. So in month 2, I'll tweak these further to try to hit the numbers. And in month 3, tweak them further. And by the time I'm out to month 3 or 4, my inputs are so good that I'm really accurate at projecting the rest of how my business is going to go. Many times in this process, you realize you missed a bunch of assumptions. And so you have to add some assumptions. And it is a living model. But if you have the discipline each month— To go back and review your actuals to your projections, change them by tweaking the inputs, you will become much smarter about operating your business. So hopefully in the last half hour or so, you've gotten some insight as to how you can use a financial model to help you raise money and how you can use a financial model help you operate your business better. It's hard. It will take you hours to put this together. It is an amazing learning experience. You will end up asking yourself questions about your business you hadn't thought about. And I believe that as a founder, most of the time the CEO, but as a founder, you need this level of understanding of how your business runs if you're going to successfully run a business. So, I think that's all I have to— let's see, I'll do a little quick summary to wrap up and then we can do some Q&A. So, keep the original. We talked about how to update, how to predict the future. And I'm happy to share it with you. Use it as a reference, not a template. Always build from scratch, even from your own company. So, I'm open to Q&A about anything. It can be financial models, Techstars, investing, finance, bicycles. Love to talk about bicycles. Anything you want. Yeah?

I just want to—

instead of so many numbers, can you also plot figures, curves, showing the trend? How many years, how you increase the change variable, how the curve changes?

Yeah, so the question was, instead of so many numbers, can you use Can you plot and have curves? And there are some some key performance indicators that I think are very good to be used visually and with graphs. So things like numbers of customers, and hopefully you guys have all read Lean Startup and know about vanity metrics versus engagement metrics. So I like to see engagement metrics, those things that change each month, right? I don't want to see a graph of cumulative registrations. That can only go up and to the right. By definition, it cannot go down. I want to see how many registrations you get each week. Some weeks, you know, oh, that was Thanksgiving week, it went down. Okay, I understand that. That's a much better tool to manage by. Churn is the kind of thing I would like to see as a graph. I want to see how churn changes over time. There's a lot of detail in here that when you want to get to the bottom of what's happening, the raw numbers are really important. And remember, you need these raw numbers to produce those graphs. So on a summary that you're giving to your investors or, you know, a man talk, you may want to just pull out some simple graphs. That's fine. But you can't get the graphs if you don't have the numbers. Yep?

I was wondering how you deal with unforeseen events like Whole Foods goes out of business.

There's a lot of unforeseen. This is part of the reason that entrepreneurship is so hard. So, you know, you'll do things, as your numbers get bigger, you do things that you can predict. So, in the payroll business, we had an allowance for doubt— you know, you see in many companies, allowance for doubtful accounts. You know, statistically, you know, 0.5% of your companies aren't going to pay, whatever, I made that up, but whatever it is. You don't know which ones, you don't know, but you'll have an allowance for bad debt, that sort of thing. When you're very small, it's almost impossible because you're— what's the opposite of very granular? You're very— each customer represents such a big percentage of your business. If one of them goes under, like, oh my God, right? When you get to the point— so SurePayroll today has 80,000, 100,000 customers. You know what? I'm sure that today 200 of them went out of business. Right? But that's okay if statistically you can figure out what that is. When we had 10 customers, if one went out of business, that was 10% of our revenue. Like, that was disaster. It's hard. I don't have a good answer for you. Behind you.

So what factor have you seen in all these companies in terms of how much they say it's going to take to do something versus how much it takes?

It always takes longer. It always costs more.

How much?

A lot. So, and I want to be clear, I say that like I'm making fun of entrepreneurs. So I've started many companies. I think I've signed the articles of incorporation 11 times. Not all of them became real companies. Depends how big they have to be before you consider them real. So, but really run 6 companies that were significant companies. And every single time, I'm too much of an optimist. I will remember, I remember I was— we were starting out something new and I'm sitting in my office at home and I'm building my financial model and I'm like, okay, but I know I'm an optimist and I'm experienced. It's going to take longer, it's going to cost more, so I'm going to dampen my revenue numbers. I'm going to increase my expense numbers. I'm going to give myself a time buffer. And I looked at it and said, no, no, no, but I know it's going to take longer and cost more, so I'll give myself more buffer. And then of course I was way too optimistic. Even knowing, thinking to myself, I'm giving myself more buffer. We are inherently optimists as entrepreneurs. If you knew, if I knew how hard it was going to be to build the payroll business, I never would have done that. That was really hard. There are 4,000 taxing entities in the US and they all penalize you if you don't do it right. And I mean, it's just really hard. People don't come up to you and congratulate you and say, Great job, you got my paycheck right today. But if you're off by a penny, they are on the phone screaming at you. Payroll is really hard. But we were too naive and we just plowed ahead and did it. We made a bunch of mistakes. But the only reason we could do it is because we're optimists, we're entrepreneurs, right? So that's a hard one. That's a hard one.

So I want to ask you a question about evaluation. Especially if you're an angel investor. So you show these spreadsheets and these revenue models and everything. And let's say I've got $1 million to invest in your company. So obviously, I want to participate in your revenue at the maximum extent possible. So how will you, as the owner of the company, and me as a venture capitalist— where is that midpoint where we can say, OK, I'm going to put my $1 million, and here's— The revenue. Going to be what I'm going to be getting or making? I mean, can you project the cash flow for me?

Yeah, so the question was around how do you get to valuation, especially with angel investments? And the answer is, first of all, there— you can't look at just valuation. So in a deal term, when we're raising money, we're raising money for SurePayroll, there are a bunch of deal terms that are really important. Valuation is one of them. Preference is another one. Do the investors get— I don't know if you guys have gone into this, how many of you know it, you know, do you get a one-time preference, do you get a two-time preference, are you buying common stock, preferred stock, is it participating preferred, is there a full ratchet, is it weighted average? There are a lot of things that go into that deal, and you can't move one without moving the other. And so there is no one valuation that's right for the company. And The best way I know to illustrate this is if I have a company and you're willing to invest $1 million at a $3 million pre-money valuation for a 1x preference, you'd probably be willing to do it at a higher valuation for a 2x preference. It's the same company. They were 2 different valuations, and we could put 2 different valuations on it. The misnomer is that people think valuation or pre-money valuation Is a valuation of your company because that's what the word says, valuation. It is not. It has nothing to do with what your company is worth today. As a matter of fact, that hypothetical company that you were going to invest in at a $3 million pre, there is— I guarantee you there's no way you could have gone out and sold the company as is for $3 million to a third party. Even though you have a term sheet that says there's a $3 million pre-money valuation, That does not mean you can go sell that company for $3 million. What that really means is that the investor did some calculus and said, okay, what Troy built plus my million dollars and my help, I think we can grow over time. And my expectation is I want a certain return on my money in a certain time. So, if I want to get a 10x return on my money, it was a $4 million post, so we got to sell for $40 million. Can I get that with $1 million and this time can we get it to $40 million exit in 8 to 10 years? Okay, if I can, that's a great deal for me. But it has nothing to do with what it's worth today. We're buying the future and it's all a calculus about risk and reward. If you guys want to learn more about this, the best book by far on it is a book called Venture Deals. Written by Brad Feld. I think it's volume 2, it might be on the 3rd revision now. It is an awesome book. It lays out all of this stuff and what you should care about. And it's the least dry of all of the books about this. But if you're raising money for your company, read Venture Deals. Like, Brad is one of the best VCs in the country. He's very transparent, he's awesome. Great. Yep.

So I could see this being a really useful tool for even evaluating whether or not to go into a particular business.

Absolutely.

But the risk I would see is that without those first few months where you actually get to validate or invalidate all of your assumptions, the effect that those assumptions have on whether or not—

Well, here's what I didn't have time to go through. What you should do for sure— So what you do is you build this model of what you think you're going to do and then you spend a bunch of time with these inputs and you quickly realize which ones matter and which ones don't. So I know that how much I pay a sales rep doesn't matter that much. We discovered that, right? By $75,000? We doubled the salary, it didn't really have that big impact. But how much they sell has a huge impact. So when I was doing that little trick with Sure, payroll. I knew which numbers you can tweak and not have any impact and which ones you can have a big impact. And by the way, so the thing that you do with this before you start the business is you look at it and say, oh my God, this is the critical number of this entire thing is right here, right? Because— and I'm going to demonstrate. If I go back to the cash flow, I'm going to go back to $35,000 just so we're at our base case. And I'm going to go back to 1.5, so we're at our base case, which should— that should take us to the $1.3 million. All right. This is the most sensitive number in this model. If that number is 1.0, the business fails, fails, fails. I'm out of business. I'm done. Wow. If it's, you know, 1.3, I almost scooched by. OK, OK, OK, 1.35. How about 1.35? You see what I'm doing, right? Oh, I'm not quite there. How about 1.4? And you can use Solver and you can use some tools. But OK, so now I know that is a really important number. So now before I start that business, I have to go out and validate, is that doable? Is that reality? What are other similar businesses doing? How can I test this as quickly and inexpensively as possible? Could I go buy some baby food, forget about building my whole infrastructure, but could I go out and try to sell baby food to stores myself, even if I have to go buy it from another store at retail and sell it to them at wholesale at a loss? But if I can prove that I can sell this stuff and how much, and I can sell more than 1.4 stores, I'm in business. And I'll take a loss over a short period of time to learn that piece of information. If it turns out that number is 2 or 2.5, whoo. But so you do a sensitivity analysis and you use the model to figure out what really matters and what doesn't.

You just did something which is backwards from the way a lot of stuff comes off campus. You said I'm going to figure out if this business is going to make money before I do it. Yeah. But the other way things can work is that you get a technology idea and if you develop technology, you generate a market that doesn't currently exist. This is, you know, the Steve Jobs line about people don't know what they want until you show it to them.

Yeah, that's much riskier.

How does that work into this? Where you got to develop technology first and then this will make sense.

So I'm a good conservative Midwest investor. I like to start with a problem. I like to start with a market and solve a problem for a market. I know that you guys do a lot of deep science and research and all kinds— like, there's some really amazing stuff that comes out of here that I just don't know enough to invest in. That's not my job, right? So we, MAP Venture Partners, tend to invest in businesses where there's a pretty well-defined problem, a well-defined market, and we're solving that problem for them. Market. That is a very different world than taking science innovation and saying, hey, I saw something going on with thin film and gold, and I have no idea what that does. We didn't spend that much time with it. It seemed like cool science. I'm sure there are great applications for it. That's a business I wouldn't even know how to value. It's a totally different business model from the investor side. And

so, so what fundraising advice do you have for science companies?

I'm the wrong person to be giving fundraising advice for deep science companies. That's my advice. No, there are people who specialize in this. Who? And we'll do so.

Find similar. That's the exact question that people in this building need to know. Right. Who's interested in helping develop technology?

Right.

So then we use this tool to help us solve the problem.

Right, right, right. No, no, no. That's a great question. So what I do— so people come to me. I had someone come to me the other day who was doing a consumer-facing product in an area we don't have any expertise in. So, well, can you introduce me to these 27 investors? And I said, well, I know most of those 27 investors. I don't think they've ever invested in anything like this. So, well, I'm frustrated. Where do I go? What do I do? I said, okay, find companies that are similar to yours. Use Mattermark, use AngelList, use Crunchbase, whatever it is, and figure out who invested in them. Because if someone has a track record of investing in companies that are similar, they're likely to understand your problem, they're likely to have a rubric, they're— and by the way, there's probably a lot of money to be made investing in innovative technology. I mean, there clearly is, but it's a different model. Right. The risk-reward is going to be different. In my world, you know, I say for every 10 companies we invest in, 4 are going to fail, 3 will tread water, 2 will do well, and 1 will pay back the whole fund. You know, I don't know, is yours— I assume yours is more risky, particularly if you invest earlier. You might have to invest in 100 to get 1 that's going to pay back the whole fund, but it's going to pay it back 10x. It's a different risk-reward model. It requires a different set of knowledge. So I would be looking at who else has invested in similar stuff. That's what I would be doing. Thank you.