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Forecasting Best Practices From The Startup Factory's Dave Neal

Industries: Technology

OnFriday July 22, Governor Pat McCrory signed the NC PACES Act allowing NCentrepreneurs to raise up to $2 million in intrastate crowdfunding. Watch thesigning ceremony video here

Thelocal startup community came together to showsupport for this legislation, and now they're coming together with stateregulators to help create the rules to govern it.  

Withthis new funding tool coming quick, I want you to think about this question:Are you prepared to raise capital? As discussed in my first article, beforeyou raise capital you need to develop a realistic financing plan byunderstanding your business, your business model and how it scales, yourmilestones, how much money you need and how long it will last. All that workwill result in a detailed forecast, which will be helpful to your team,investors and other key partners helping you grow your business.

started this conversation backin May with Tim DeBone, director of finance at WindsorCircle. To discuss it further, I recently interviewed Dave Neal,one of the area's entrepreneurial thought leaders who helped support the NCcrowdfunding legislation. Dave is a co-founder of TheStartup Factory, advisor, angel investor and CFO. He alsohas a BS and JD from UNC and an MBA from Stanford. 

Heshared the following forecasting best practices: 

Whatare the benefits to developing a realistic bottoms-up forecast model? 

Abottoms-up model is the most realistic way to project what is likely to happenon the financial side of your business. It forces you to think carefully andexhaustively about the personnel, sales and marketing expenses, softwarelicenses, revenue shares and other uses of cash. A bottoms-up model also can bethe outline of an operational plan and goal set. 

Whatare the risks of not having a realistic forecast model? 

Ifyou don't look at the financial aspects of the business early enough, you mayspend a lot of time pursuing an idea that has little chance of working due tofinancial structure. If it costs $10 to acquire a customer and the lifetimevalue of the customer is $7.50, you can't "make it up on volume." Without thisexercise you are also unlikely to understand how to use your cash mosteffectively. 

Whenin a company's life cycle should they develop a realistic forecast model? 

Myopinion on this has changed since the advent of Lean Startup methodologies forthe pursuit of startup success. The Lifetime Value of the Customer/Cost ofAcquisition ("LTV/CAC") has become a proxy for financial projections at theearliest stages of the company. Obtaining accurate, reportable data of thistype enforces a positive discipline that values customer acquisition at a timein the corporate history when that must be paramount. Once the customer acquisitionand retention engine has reached a mature state, the usefulness of traditionalforecast models once again returns to the forefront again. 

Howoften should a forecast be updated, and what are the best practices whenreporting your actual results during the year versus your forecasted plan? 

Actualresults on a handful of key performance indicators should be compared to theforecast monthly. At the end of the day, there are only a few key indicatorsthat will tell you the health of your business. More in-depth reviews can bedone on a quarterly or semi-annual basis.  

Whatare your lessons-learned over the years to developing a realistic forecast? 

Workhard to assemble quality, unassailable data for your forecast. No matter whatyou put down, investors will challenge you. The ability to respond with crisp,factual backup for the way you've built a forecast goes a long way towardbuilding and enhancing your credibility. Also, making things too complicated ortrying to measure too much, places strains on the organization that are nothelpful. For example, it's fairly easy to collect financial information at thetwo standard deviations or 95% level. Increasing your collection accuracy tothree standard deviations level doesn't help that much with accuracy and it'smuch harder to accomplish. 

Whatmistakes or war stories can you share related to forecasting? 

Thelove of complexity is one thing I had to free myself from. Just because you canmodel something very accurately with Excel doesn't mean that it's worthwhile todo so. Also, the model should be flexible with a generous number of assumptionsthat can be easily modified to reflect changing conditions. Whatindustry-specific forecast issues are there? In my mind, the real issue here isdetermining the purpose of the financial work you are doing. Financial work isintended for certain audiences or specific purposes. Accordingly, how youprepare the financial data is governed by those audiences and purposes.  

Whatadvice would you share with new entrepreneurs that plan to raise capital? 

Focusfirst on learning the cost of acquiring your customers. This will help youremain targeted on the one thing that your business must have in the earlieststages. After some time has elapsed, you'll be able to estimate your lifetimevalue of the customer more effectively, but you can get a rock-solid cost ofacquisition numbers early. This will serve you well. 

DaveNeal's practical advice demonstrates the importance in fully understanding yourbusiness and the due diligence it takes to develop a realistic forecast. Withthis forecast and deeper understanding of your business, you are now betterequipped to take the next step in your fundraising journey knowing how muchmoney you need and how long it will last. 

Next,we will find out what Brett Farabaugh thinks about this subject. As CFOof Tryton Medical, Inc. in Durham, Brett hashelped raise significant rounds of capital from VCs and will provideinsights in forecasting from a medical device industry perspective. 

Note:Raising investor capital requires strict adherence to all federal and statesecurities laws, and consulting a qualified securities attorney is stronglyrecommended.

Brooks Malone, Guest Contributor

Brooks Malone is a CPA and partner with Hughes Pittman& Gupton LLP. He has 27 years of experience and leads the Technologypractice group at HPG that serves bootstrapped and investor-backed technologycompanies. Brooks currently serves on board of directors of the Council forEntrepreneurial Development ("CED"). He is also a listed contributor to theNational FastTrac Tech Curriculum that was funded by the Kauffman Foundation.