The second part of our article about startup unicorns is dedicated to financial modeling, risks assessment and legal risks minimization.
— Talking about Pre-Seed and Seed startups one should understand that their valuation to a greater extent comprises a number of factors, including business idea, technology, team. It’s common knowledge that in most cases startups do not generate any revenue on these stages living on the FFF (Family, Friends, Fools - or the people to talk to first when pitching an idea and attracting first investments - Ed.) financing. It means that there is no operating profit yet. At the same time income method uses this parameter for company’s valuation deducting amortization from it (EBITDA).
Moreover, it is evident that forecasting and planning financials for operating businesses is much easier than of startups due to availability of all necessary historical data, regular clients, suppliers, and an established predictable market. But this is not the case for startups, as a financial plan of the latter is developed based on the founders’ judgments and their vision of the future only.
Consequently, the main question to be analyzed within this parameter is not something like ‘how to build a super financial model’, but ‘how to develop a financial plan which would allocate investments in the most effective way’.
Advice №1. While analyzing a startup financial model make an accent not on the financial numbers and results, but first of all on the calculations, preconditions, and assumptions which lead to such financial indicators. How adequate and rational are monetization hypotheses? What are they actually based on? Let’s take Total revenue as an example, a quantitative measure of this indicator is not enough. To analyze Total revenue more comprehensively you should study what it actually consists of (products and their prices) and correlate it with current market conditions, its aggregate demand and price level. Or for example Cost of sales, this parameter is mostly determined by personnel costs. So an expert should examine how many competent employees are needed and are actually engaged in the project, how competitive are their salaries, are there any avenues for costs optimization.
The same logic should be applied to any point of the financial planning.
And remember to make a summary analysis of how reliable and accurate the financial plan is as a whole.
Startup risk management principles are very similar to the ones in big companies, but with certain peculiarities of course. Unlike big corporations with risks departments or at least internal audit teams in startups all risk management functions are usually assigned to a CFO (at best) or to CEO. What is more, the level of uncertainty in startups is super high, this is so due to the fact that such projects evolve rapidly (well, it is critical for their survival), create an absolutely new product and form a new market.
Advice №2. As for this case, startups should determine basic (or fundamental) risks, choose the relevant means for their reduction and implement a permanent control system which would prevent new risks and monitor already existing ones. Such an approach will let startups respond quickly to any kind of risks taking place on their way. This is always a positive message for investors and a factor that increases its valuation.
— Prior to attracting investments a startup should win the trust of the investor, demonstrate perspective financial gains and legal security measures that are in place. Investor needs to make sure that the startup is not a scam project, is not a subject to: sanctions by the state; lawsuits by team members and partners; disagreements between the founders, which can all lead not only to negative financial and reputational consequences, but also to the project’s breakdown.
It is necessary to comprehensively settle all relations legally in order to minimize the risks mentioned above.
The first step is to register a legal entity after that such a startup falls under the legal field of the country where it is registered what automatically makes all its activities legal and transparent. If there are several founders, it is necessary to regulate the order of decision-making and distribution of profits between them in the Charter of the company or in partnership agreements.
Another important point concerns taxation. An organization should be registered in the local tax authorities, properly pay taxes and have no arrears to them.
All relations with the team members should be legally formalized by singing labor or civil contracts with clear job description and a properly defined procedure of transferring intellectual property rights of the results of the work. Local regulatory (corporate) acts serve the same purpose.
Relations with contragents should be formalized with the help of commercial contracts.
Innovative companies should also register their intellectual property rights to means of individualization (brand name, trademark, etc.).
These minimum requirements can largely protect business owners from negative legal consequences and attract potential investors.
The world’s venture ecosystem is growing and developing quickly. The percentage of high - quality startups is increasing, while investors’ analysts do their work better and better. To succeed a startup should:
follow all recommendations provided in the recent articles
do not hesitate to ask mentors and experts for advice and support
regularly communicate with potential investors
constantly develop the project's team, their skills and competencies
For a quick start of the newcomers in the venture market we have prepared an expert knowledge base with all methodologies developed by our expert community for startups evaluation. Find it via the link.
P. S. If you are an investor and you would like to order an honest evaluation of the projects; or if you are a startup seeking financing and preparing for a fundraising campaign; or if you are an expert looking for alternative expertise monetization instruments - Rocket DAO is the right place for you!
P.P.S The proof-of-work of such an approach is the successfully conducted Due Diligence for a crypto-wallet startup Multy which is available here. We will be very grateful for your feedback.