💰 Don’t Try To Fundraise Without These Docs - Part 2

Toby Egbuna
February 1, 2024

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CREAM:

1. Consider if VC fundraising is for you

2. Ready your documents

   1. Part 1 - Pitch deck and communications

   2. Part 2 - Financial model, market calculations, and data room ← today’s newsletter

3. Establish an investor pipeline

4. Activate your fundraising round

5. Maintain relationships

The five things you should have at hand before you go out to raise VC

Now that you’ve considered whether VC is right for you, let’s get your documents ready.

You can read more about what you’ll need for items 1 and 2 in Part 1 of this section.

1. Pitch deck

You’re probably familiar with this. Your pitch deck is the a 12-15 slide representation of your company and your vision.

2. Communications

This is where your email templates will come in. You will want to have the following on deck before you start raising:

1. Forwardable email

2. Follow up after first meeting

3. Declined investment - warm intro request

3. Financial model

The most nebulous of all of the documents, your financial model should include actual numbers from the last 6-12 months your company has been in operation, and also projections for the next 12-18 months.

4. Market calculations

Your market calculations are projections for the market you operate in. This spreadsheet shows investors know how you think about your addressable market and how much of that market you believe you can capture. Calculations are optional, but they do a lot to build investor confidence in you.

5. Data room

Your data room is a virtual folder that contains your company’s documentation. Here’s what should be in your data room:

1. Pitch deck

2. Financial model

3. Market calculations

4. Cap table

5. Employee roster and background

6. Legal docs (certificates of incorporation, stuff like that)

7. Customer lists

8. Financial statements (P&L, balance sheet, income statement)

Your financial model

There are a number of reasons why you want to have a financial model tor raise VC:

1. Supports your ask - the financial model should lay out all of your spending for the next 12-18 months. If you’re asking for $5M and your model only shows that you’re going to spend $1M, the investor knows something is off.

2. Helps you track progress - though the financial model contains projections, those projections should be realistic. The model will help you track your company’s progress for after you’ve raised the money. Maybe you’re way ahead of schedule and revenue is 2x what you expected. Or, maybe you’re only at 50% of the revenue you thought you’d be at, in which case you might need to consider downsizing the team to cut costs.

1 and 2 above are important, but more than anything else, your financial model builds confidence and trust from investors. A well thought-out, detailed model shows investors that you are the type of founder that thinks things through. Think about it this way: investors can come up with multiple reasons not to invest: they don’t like the space, it’s too crowded, they terms aren’t good, but it should never be because they have doubts about you as a founder. Build that trust by building a strong financial model and being able to speak through it.

How to create your financial model

I wish I could take credit for this, but I found this incredible series by Troy Henikoff of Math Venture Partners in the summer of 2022 when I started working on my financial model, and it’s as good of a guide as you’re going to find. So, rather than reinvent the wheel, I’m sharing the series below with some tips to keep in mind from my experience.

1. Part 1: What is a Financial Model?

2. Part 2: Start with Your Assumptions

3. Part 3: The Income Statement and Custom Detail Tabs

4. Part 4: The Balance Sheet, Cash Flow and Unit Economics

Things NOT to do when building your financial model

• Don’t outsource this - As the founder, you have to build your financial model yourself. You can’t hire someone on Upwork to do it for you, and you can’t use software to build it for you. Someone else isn’t going to understand the nuances of your business, and software is only good if your business is consistent and predictable (and if you’re reading this, it probably isn’t).

  Be prepared to spend a lot of time on this. It will take you at least 6-8 hours to create this, so plan on taking a Sunday afternoon with a nice cup of coffee to crank it out.

• Don’t half-ass this - If you’re not going to take this seriously, you’re better off not doing it. Investors will be able to tell that you half-assed it, and they’ll write you off.

  I’m currently on version 10 of our financial model. It’s been, and continues to be incredibly helpful for forecasting when we should make your next hire and identifying ways to cut costs if need be.

• Don’t use random sources for your revenue detail - When working on the revenue detail tab, build the model on your actual go-to-market. If you’re attending conferences that cost an average of $500 to attend, and you can attend 3 per month, then use that as the foundation of your revenue detail. If you’re spending $100/month on ads, and they convert at a 10% rate, then use that as the foundation. You have to be able to explain your assumptions to investors, so if you pick a channel that you aren’t confident about speaking toward, you’re just digging yourself a hole.

Market calculations

Your market calculations are a spreadsheet that shows how you think about the current size of your market and how much of that market you believe you can capture. It should be directly tied to the market opportunity slide in your pitch deck.

Your market calculations are optional, but they do a lot to build investor confidence. Especially for Black and brown founders who are already disadvantaged, we need all of the help we can get.

Top-down vs. bottom-up

There are two ways to calculate your market size:

Top-down

Top-down calculations are good for high-level discussions about why your product is needed. This is generally what people are referring to when they say that they’re in a XX billion dollar market.

Here’s how I’d use a top-down approach when talking about Chezie:

The problem with the top-down approach is that it’s too broad. In my case, not all $8B of those dollars go toward ERG software platforms. So, while this is good for casual conversation, it doesn’t do anything to show an investor that there’s money to be made here.

That is where a bottom-up approach comes in.

Bottom-up

Bottom-up market sizing is more complicated, but it’s the method that investors prefer.

With this approach, you take the number of potential customers and multiply it by your average sale price. That’s your serviceable addressable market (SAM).

Once you have your SAM, you can make an assumption based on other market leaders as to what market share you’ll be able to capture and calculate your serviceable obtainable market (SOM). Your SOM is the amount of money that your company could make at maturity.

Here’s how the bottoms-up math worked for us using some assumptions:

• of potential customers - 57k (this is the total # of companies with ERGs)

• Average contract value (ACV) - $45k

SAM = 57k x 45k = $2.56B

• Comparable market share for other leading HR tech companies - 20%

SOM = 20% of $2.56B = $513M

The bottoms-up approach is preferred because, as you can see, it’s specific to your business metrics.

Are these exact numbers? Of course not; they're all research-based assumptions and projections. That’s the benefit of being an early-stage founder: you can still rely on projections.

How to do market calculations

💡 Find a template for market calculations here.

Your goal for these calculations is to come up with an explainable number for the size of your market. We only need 3 things to do this calculation:

1. of potential customers

2. Pricing / estimated average contract value for your company

3. Assumptions

Let’s dive in using an example of a hypothetical company - Acme - that sells a software product that helps Shopify retailers re-target customers who have visited their sites but didn’t purchase anything.

Step 1 - Create your spreadsheet

Just like your financial model, you don’t want to use software for this. You have to do it in Excel.

To start, let’s create a new Excel file and create two sheets: SAM_SOM Calculations and Definitions_Assumptions.

Step 2 - Create your assumptions section

Your assumptions will help explain how you came to your calculations. This is where you show your work. Break your Definitions_Assumptions tab into four sections:

1. Customers - this is the number of customers you can sell to.

2. Pricing/ACV (use Pricing if you’re B2C and use ACV if you’re B2B) - this is what you expect to charge those customers.

3. Comparisons - this is what you’re using to base your assumptions for market share

4. Links - these are any articles or research papers that support your assumptions and calculations.

Step 3 - Fill in your assumptions

Let’s start with customers. In the case of Acme, we’re going to Google the number of Shopify stores that exist. This number would be our TAM (what we could use for a top-down analysis).

Doing some digging, we can see that there are 4.8M Shopify stores globally.

Let’s add that to our assumptions tab.

Okay, so we have our TAM, but realistically, not all of those 4.8M stores will be good candidates for our product. This is where you need to get specific.

For Acme, let’s assume that we’re only targeting Shopify stores that do $250k or more in annual sales because these are the stores with owners who take things seriously enough to invest in a product that could help them re-target customers.

Now we need to figure out how many Shopify stores make $250k or more annually. We can Google this, but we don’t get a specific number:

But, we do find a page on BuiltWith that tells us that 81,850 stores do over $100k in annual revenue.

Digging deeper and after creating a free account… we get hit with a paywall.

It’s $295 to get access to the full list. In some cases, you might have the money and think this is worth it, but for demonstration purposes (and to save my wallet) I’m going to work off the first 100 results I get).

If I copy and paste the results from the two 50-item lists I have access to into a spreadsheet, I get a 100-store sample that I can base my assumptions on. Not bad.

After cleaning the data and filtering out stores that make under $250k a year, I am left with 74 stores out of 100. Here are our numbers:

• 4.8M Shopify stores total

• 81,850 stores make more than $100k a year

• 74% of stores that make more than $100k a year make more than $250k a year

Therefore, we can estimate that 60,569 stores make more than $250k a year by taking 74% of the 81,850 total number of stores.

Step 4 - Detail your pricing

If you already have your pricing determined, great! If you don’t, you can compare the price of your solution to that of similar companies and use that as an estimate.

There’s a real company called Retention.com whose pricing is visible on G2:

It looks like Retention.com charges $500/month for its product and offers a different price point for Enterprise customers. Typically, we’d compare pricing across 3-4 companies at the minimum, but we can just use this one for now.

Let’s say that Acme has the following price tiers and percentages for the number of customers in each tier:

1. Basic - $200/month - 50%

2. Standard - $500/month - 35%

3. Premium - $1000/month - 15%

Okay, now we need to update the spreadsheet to include our pricing.

Step 5 - Find comparisons

We need to figure out how much of the market we can capture. That’s where a comparison comes in. When trying to estimate market share, remember that this also won’t be one-to-one. Instead, find a space that’s adjacent to the one that you’re in and see what the market share is for the leader in that industry. In the case of Acme, we can use Shopify as a comparison.

Shopify owns 28% of the e-commerce platform market share according to Yaguara.

To be conservative, we’ll say that Acme can achieve 20% market share at maturity.

Keep in mind that if you used another company to get your pricing model, then you’ll want to include that here as well.

Step 6 - Name your assumptions and do the math

We’re at the finish line. All we need to do now is name our assumption cells and do the math.

Naming your cells will make it easy to reference them in case you add or update your calculations. To name a cell, simply click on it and then give it a name in the upper-left corner of the excel window.

Once our cells are named, we can go ahead and crunch the numbers. We’ll split the SAM_SOM calculations into three sections: Market, SAM Projections, and SOM Projections.

Market

Pull these directly from your assumptions to display the number of customers you could possibly sell to and then the number of customers that are in your target market.

Using the number of stores in our target market, we can calculate our addressable market (SAM):

And finally, we can calculate our obtainable market (SOM) by taking our market share (20%) of our SAM:

We did it! We have our TAM, SAM, and SOM in one easy-to-read spreadsheet:

Some things to note:

1. You can make this more advanced by adding scenarios - so explain what the numbers look like if you capture 40% of the market or if you only capture 10%.

2. Ideally, you would include details about the growth rate of your industry by showing how many Shopify stores get created annually and factoring that into your calculations, but I’ll let you get creative with that 😉

Data room

Your data room is a secure folder that you share with investors when they’re taking a deeper look at your company. There are two types of data rooms that you’ll need:

1. For initial diligence

   • Pitch deck

   • Financial model

   • Market calculations

2. For deep diligence

   • Pitch deck

   • Financial model

   • Market calculations

   • Cap table

   • Employee roster and background

   • Legal docs (certificates of incorporation, stuff like that)

   • Customer lists

   • Financial statements (P&L, balance sheet, income statement)

Note that your legal counsel will likely support you in creating your deep diligence data room as they should have all of this material on hand. The initial diligence room should be handled and maintained by you.

To illustrate, here’s a screenshot of our data room:

Where to host your data room

I suggest using Docsend for your data room because you get notified anytime someone opens the Space and you can prevent people from downloading the content (only people who give you money should have ongoing access to this documentation).

If you don’t want to pay for something, then you can use Google Drive and just house everything in a folder. If you do that, be sure to create new folders for every investor so you can revoke the investor’s access if/when they decline to invest.

When to share your data room

Share the initial diligence data room after a first call with an investor if they say that they’d like to learn more. Try to be prudent with this. Explicitly ask the investor if they’re interested, and if they are, let them know that you’ll send the link to your data room after the call - more on this in the Activate section of this guide.

Share the full data room after a second call with the investor. At this point, you should know that the investor is serious about funding you and you’ll want to give them everything they need to make a decision and do it quickly.

Summary

Set yourself up for success with the comms you need. Next week we’ll dive into your financial model, market calculations, and data room.