How do you verify startup projections?

1 The importance of projections

Projections are estimates of future revenue, expenses, growth, and profitability based on historical data, market research, and assumptions. They are essential for startups to plan their strategy, raise capital, and measure their performance. However, projections are also uncertain, variable, and prone to errors or biases. Therefore, as a venture capitalist, you need to verify the validity and reliability of the projections before making an investment decision.

2 The sources of projections

Verifying startup projections begins with understanding where they come from and how they are calculated. Startups typically use one or more of the following sources: bottom-up, top-down, or comparables. The bottom-up approach starts with the unit economics of the product or service, such as customer acquisition cost and lifetime value, and multiplies them by the expected market size, penetration, and growth rate. The top-down method starts with the total addressable market or industry size and applies a percentage of market share or revenue capture based on the competitive landscape, value proposition, and differentiation. Comparables use historical or current performance of similar companies to adjust for unique features, advantages, or disadvantages. Each source has its own benefits and drawbacks; it's important to ask the startup to explain their rationale and logic behind their choice and calculation.

3 The benchmarks of projections

Verifying startup projections is a two-step process, and the second step involves comparing them with relevant benchmarks and industry standards. This will help you assess the reasonableness and feasibility of the projections, as well as identify any red flags or gaps. You can compare the startup's projections with their own historical performance, such as revenue, growth, margins, cash flow, and unit economics. Additionally, you can compare the startup's projections with the average or median performance of their industry, sector, or category. Furthermore, you can compare the startup's projections with the performance of their direct or indirect competitors. Some of these benchmarks can be found from public sources such as industry reports and databases, or from your own network, experience, or portfolio.

4 The scenarios of projections

Verifying startup projections requires testing them under different scenarios and assumptions. This will help you determine the sensitivity and robustness of the projections, as well as the potential upside and downside of the investment. The base case is the most likely or expected scenario based on the startup's current assumptions and plans, which can be used as a reference point for analysis and valuation. The best case is the most optimistic or favorable scenario based on the startup's stretch goals or aspirations, allowing you to estimate the maximum return or impact of your investment. Conversely, the worst case is the most pessimistic or unfavorable scenario based on the startup's contingency plans or risks, providing an estimation of the minimum return or impact of your investment. You can use tools such as spreadsheets, software, or simulators to create and run these scenarios, adjusting key variables such as revenue, growth, margins, cash flow, and unit economics accordingly.

5 The feedback of projections

The fourth step to verify startup projections is to solicit and incorporate feedback from various sources and perspectives. Doing so can help validate and improve the accuracy and credibility of the projections, while also identifying any blind spots or biases. To get started, the startup should provide customer feedback, surveys, testimonials, or referrals that support their value proposition, product-market fit, customer satisfaction, retention, and referrals. Additionally, expert opinions, endorsements, or validations that support their technology, innovation, market potential, competitive advantage, or social impact should be provided. Advisor input, guidance, or recommendations that support their strategy, execution, team, culture, or governance should also be supplied. Lastly, partner collaboration, cooperation, or integration that support their distribution, marketing, sales, or operations should be presented. You can also use your own network to obtain or verify these feedback sources.

6 The communication of projections

The fifth step to verify startup projections is to communicate and discuss them with the startup founders and team. This will help you build a transparent and trustful relationship with the startup, as well as address any questions or concerns. When communicating, you should be respectful, curious, and collaborative. Respect the startup's vision, passion, and effort. Ask open-ended questions that help you understand their projections. Listen actively and attentively to their answers. Work with the startup to refine and align their projections. Provide honest feedback and suggestions. You can use emails, calls, meetings, or presentations to communicate and discuss the projections with the startup.

7 Here’s what else to consider

This is a space to share examples, stories, or insights that don’t fit into any of the previous sections. What else would you like to add?