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Fundraising 101: Financial Questions VCs Will Ask Startups

Fundraising 101: Financial Questions VCs Will Ask Startups

A Comprehensive Guide To Answering Financial Questions VCs Will Ask During Fundraising

This is the fourth part of a series on venture capital startup interview questions on fundraising financial questions. We cover almost every question an investor will ask you when you are pitching to raise money, so you are totally prepared.

Unlike resources on the internet that just provide a few questions, this resource is unique as:

  • We provide the insight into what the questions actually mean (They can be sneaky).
  • Almost all the questions you will be asked, rather than just a few indicative ones.
  • Examples of what to actually say!

This instalment is on your fundraising financial questions. There is no way in hiding from these investor questions! You are guaranteed to be asked most of them. The tough thing is this area is not simple and you simply have to dedicate time to have a good answer. It’s only resources like this, or the alternative of learning the hard way that you will learn how to answer! Learning by failure is for dummies. If you read all of these and do your homework, you should be able to deal with every curveball thrown at you!

Financial Questions VC Investors Will Ask

Question: What Is Your Burn Rate?

What They Mean

This means how much money are you spending per month? If you’re achieving a lot with a small amount it is very impressive! If you have a huge burn rate they will wonder what the hell you are doing! There are natural implications of having a high burn rate, including how much you need to raise to stay alive. There are two types of burn rate, gross and net. Gross is your straight up spend. Net deducts your revenue. Gross is the safer number to plan on, since you can’t guarantee revenue.

What You Need To Say

“Our gross burn rate is $60k per month. On a net basis it is $40k. Considering we are doing $240,000 run rate after 7 months, it’s not too bad right!”

Question: How Will Your Burn Rate Increase After The Round?

What They Mean

A prudent CEO will think about the burn rate constantly. Once they raise money they are not having cocaine and champagne. They we’ll be thinking how they are going to manage and grow their business. If you fumble to come up with a number, you have not been thinking about your financial plan in enough detail. The best answer will probably break it up into phases since you will not bring up your burn rate to the max immediately.

What You Need To Say

My plan is to hire department heads first, so that they can build out their own teams. It will take them some time to acclimate to our company and to start recruiting key members of the team. Until this happens we will not be ramping up our marketing spend. Our burn rate will stay relatively similar to what it is now for the next four months. From then on we will take it from $60K up to around $120k pm. If we see a lot of traction, we may push more heavily on marketing. In any case, we will ensure we get a full 8 months of execution before having to go back to investors.

Question: What KPI Are You Focussed On?

What They Mean

The KPI of your company will be different to others, mainly dependant on the industry that you’re in and the stage of your evolution. They have asked you what you are focused on. You are not to pull out a dashboard of 200 numbers. Give them the 3 to 5 key numbers that you are actually tracking. Examples of these could be sign-ups, revenue, growth rates, retention, referral rates. You should know what these are already, or you should not be raising.

What You Need To Say

“We recently changed the KPI that we focus on since we are moving more to scaling than identifying product market fit. The ones we discuss daily, weekly and monthly are the following three: 30-day customer retention, sign-up growth rate, and referral rates. We picked these as we are heavily focussed on retaining and getting our customers to refer us. Of course we track the NPS through exit polls, and periodic in app pop ups, but this is a secondary KPI to us.

Question: If You Could Pick Only One Non-financial Metric To Measure The Success Of The Business, What Would It Be?

What They Mean

Your response to this question can be telling. Revenues and profits are a great, fundamental way to measure success of your startup, so asking for financial metrics will not elicit anything insightful. This question instead is more interesting. What you focus on for your non-financial metrics can be very revealing as it shows what do you care about? If you were to say the amount of PR you personally get, then you are an egotistical tosser. Answers which are customer centric are safe. Depending on your business, you might pick something product related?

What You Need To Say

“Without a doubt it is NPS. To have a high NPS requires us to do so many things right. And success is not one thing, it is 2,000 little things that you pay attention to and get right; those little things are the experience the customers have. We could drive ourselves crazy thinking about each one of them, and tracking them, or we could just see how much a customer love us, or not, post hoc!

Question: Walk Us Through The Fully Burdened Unit Economics Of Your Product Or Service?

What They Mean

There are two implications of this question. Firstly do you know your business, and secondly, what does your business look like when it grows up? So dealing with the first part, this is a pretty tough question if you do not know your business well! For a SaaS company, this would include fully burdened CAC, salesperson compensation, expected lifetime revenues, churn, expansion, upsell, etc.

You are looking to show that the unit economics are positive, ideally sexy, and you know your ass from your elbow, AKA does the CEO understand his business and can he communicate it?

Now, for the second part. Financial statements and metrics illustrate what a company looks like historically and presently. You hire staff, you get AWS, you pay for an office and all the other line items in a PL/BS. These things can’t illuminate the future, it just shows what an unprofitable start-up looks like. So if you can express your unit economics well, such as that you make more money from a customer than it costs to acquire and service, if you spend more money and scale, you can get an idea what you look like grown up. To understand you as something desirable to acquirers, you have to understand what you look like sub-scale. Otherwise you are just more of not very pretty.

What You Need To Say

In the words of a founder of Redfin For us, this meant explaining what Redfin made this summer on a single home purchase, with a per-transaction account of what we spent on marketing to get customers ($27), on local data ($153), on customer service ($2,906) and so on. We also calculated how much annual revenue we got for every monthly unique visitor.

We knew our margin before, but hadn’t broken the numbers down into their most easily handled form. This is important. Numbers are just numbers if they aren’t simple enough to act on; a line-backer with a simple playbook can react rather than think during the game. Knowing that the big number is how much we spend on our customer-service team refocused us on making sure we hired the right team and invested in its happiness.
What the Redfin dude said, sort of.

Question: When Will You Be Profitable?

What They Mean

This is a loaded question. Where do you start? Laughing out loud and smacking the table with your hand is not the way to deal with this. The ideal answer would be based on demonstrating optionality and the trade-off between growth and profitability. You could assert that your key focus is to grow to a point of scale at which point you have the option to continue scaling, of to focus on profitability. That’s a nice place to be since you are not dependant on the investment climate for your survival. Remember that, privately at least, VCs only care about growth.

What You Need To Say

At present we are subscale. There is no way for us to be profitable until we have approximately 1,500 customers, and an adjusted cost base. Once we have reached this customer milestone we have an option between scanning up to a significant company, or focussing on profitability. Naturally there are consequences to our valuation and exit options. Once we have better insight into our payback period and LTV, we should be able to have a clear line of sight on what it would take to become profitable. This would give us the option to be profitable if the investment climate was negative. I believe it would take us two years to be profitable, if we took that route.

Question: Are You Focussed On Growth Or Profitability?

What They Mean

This is the same question we just went through, but phrased differently. Frankly, this is something a smarter investor would ask. When you will be profitable is something a neophyte, traditional investor, playing tech investor would ask. If you’re talking to American investors it’s more likely that they want you to focus on growth. Growth is what investors care about. If you respond profitability, they may wonder if you really are a venture-capital type business and founder.

What You Need To Say

We are trying to build a real business with fundamentals, but we are aware that we are building a venture capital funded business. I have studied how analysts value publicly traded companies too, and it is clear that the highest r2 is growth. So our focus is on growth but being frugal where we can. Bezos has shown that margin is opportunity. Being able to get profitability if we need is something that we have to considered, of course. We want to stay the course.

Question: How Can You Reduce Your Break-even Rate Point Up Six Months In Your Plan?

What They Mean

This the most devious question I have read. Some famous VC likes to ask it. You can’t answer if you don’t really know your model. What can I say other than knowing your stuff, or get your CFO to help you!

What You Need To Say

“To bring our break-even point closer means we either need to make more revenue, or spend less. Marketing spend impacts revenue, so that’s a delicate balance. Give that we break even on customers in six months and then start generating profits on them, we will have to make this decision a year in advance. Decreasing marketing a year earlier would prove profitable cohorts. We could also be more judicious in customer targeting to reduce… Next…

Question: How Large Is Your ESOP Pool?

What They Mean

At Series A and beyond, you will be required to have an ESOP. This will vary between 10-15%. To understand this, read my blogs here and here. The ESOP comes out of the pre-money, meaning you the founders and previous investors are the ones getting diluted. If you don’t have an ESOP, or it is very small, they we’ll just tell you how large they expect it to be in the term sheet. The way you manage this is through a hiring plan.

What You Need To Say

“We set up an ESOP of 10% in the last round. We have issued staff 2%, so there is 8% left. According to our hiring plan in this round, we will need to give 6% to staff, so our ESOP has us covered already.

Question: What Percentage Of The Company’s Equity Do The Employees And Founders Currently Own After Fundraising?

What They Mean

This is sort of the same thing as asking how large your ESOP is, but they are also asking how much the founders own. Let’s skip the ESOP part for now. How much the founders own is really important, since investors want them to be motivated to make a lot of money. If the founders do not make money then the investors will not make money. Simple equation! However, since there’ll be future rounds of investment, there will also be future rounds of dilution. Dilution means the founders own less. If after an angel round, the angels’ already own 40% then the founders have 60%. A successful company may have 5 rounds of dilution at about 20% per round. That 40% the angels got is bad news. I have seen seed stage investors tell the angels there is no deal happening unless there is a recap.

What You Need To Say

We have done two rounds of funding so far. We are doing our A now. The founders own 60% and the ESOP is 10%, of which 3% has been issued. Pretty standard.

Question: What ESOP Is Left?

What They Mean

This is a rose by any other name. They want to know how big of an ESOP they need to ask you to swallow before they invest.

What You Need To Say

We have issued 3% out of the authorised 10%. We have a hiring plan to issue 4% more this round, so we are covered.

Question: Do You Have A Model?

What They Mean

Do you have a financial model? Have you spent a long time making an excel model which shows every little detail of your company? The answer is always yes, even if it is no! Think about series 1 of Silicon Valley where Jared needs to come up with a business plan overnight…

What You Need To Say

Sure, I can send it over to you once we are done. The key financials are in the appendix of the deck.

Question: What Are The Key Assumptions In Your Model?

What They Mean

If you read nothing else, read this: under no circumstances tell investors your numbers are conservative! This is super cliché.

Your numbers will not be right, they can be wrong though. In order to answer this question, you need to know what the assumptions are in your model, surprise! Tell the key ones. Double shock!

What You Need To Say

Cool, let’s focus on the key drivers. We are a SaaS company. We generate revenue by the number of customers we have, how much we charge them per month and how long we keep them, meaning the churn rate. Our profitability is determined by our COGS, to get to gross profit, we deduct our operating expenses. Given the stage we are at, the top line and our COGS are our biggest focus. Now to be more specific, we assume we have three pricing packages…

Question: What Are The Key Drivers Of Growth?

What They Mean

This is very much the same question as the one we just went through. The investor is trying to understand whether or not you understand the model that you apparently made, as well as what you should be focusing on. To get an A in this exam, you need to show an understanding of what matters. The only costs related to growth are your marketing expenses and your COGS to support them. You should focus on acquiring and retaining customers.

What You Need To Say

Adding and retaining customers with strong unit economics are what matter. If we can profitably acquire customers with a low payback period then we will print money….” This will depend on your company.

Question: What Do You Do If Your Top Line Expectations Do Not Match Expectations?

What They Mean

This is another test to see how the founders respond under pressure, and how well they have thought through their business. There are real ramifications of not growing your top line; growth is what investors buy into. If you do not grow your top line, you may not be able to receive additional funding. If you cannot raise on the terms you want, and you’re not profitable, you are default dead with a D.

There are a number of ways to respond to this. There isn’t a specifically correct answer. What matters is that the response is logical. You of course can disarm this question by making a joke, but you are still likely going to have to give a response.

What You Need To Say

Well, I don’t think anyone will be happy, including me! The team and I, have put a considerable amount of our sweat and tears into building our baby. We have mapped out how we believe we can best go to market and scale. We believe that we have a firm grasp on our unit economics, but of course, no battle plan survives contact with the enemy. The market is considerably large and we believe this is the best timing for us to penetrate the market with our differentiated product. There are already warning signs. You don’t suddenly hit a binary test point as to whether or not we have succeeded. Meeting expectations can be done weekly and monthly. If we are not meeting our monthly target, then we adjust our burn rate and scaling plans, and consider options including pivoting.

Question: How Many Customers Do You Need To Breakeven?

What They Mean

They mean this quite literally. You either know the answer or you do not. Of course there can be variability in this number, but the right answer is the one based on your plan. If you need a massive, unrealistic number than you may have issues. VCs will do analysis of what it takes you to be viable. I know this to be true.

What You Need To Say

According to our base case we break even in January 2019. At that point we will have 1200 customers, and be doing $1.2 million ARR. Of course if we are more aggressive this will change.

Question: How Do You Make Money?

What They Mean

This is a fairly basic question and it’s all about your business model and how you do pricing, how that late to your unit pricing. Let’s pretend that you are Gillette. You would say that you give the razors away for free and charge for razor blades. You would then explain the cost of the razor and then the huge margins that you get on the razor blades. It is best to address this question by explaining your business model, and how smart it is.

What You Need To Say

Whilst Dollar Shave Club did not invent their business model, we were inspired by them. They sold for $1 billion which is not too bad! Subscription is powerful, so we adopted the same key principle. The market for shaving is of course large, but the market for beauty product discovery is even larger. Every month we send our customers a box of five pointless products. Since they are totally pointless, we will never run out of pointless things to send. So on a recurring basis we charge our customers $39. For our first full year cohort, we have a 73% retention rate…”

Question: What’s Your Business Model?

What They Mean

We just brought up the point of the business model. Now they are asking about it specifically. You absolutely have to be able to answer this question, since that is what the investor is investing in. Remember you are in a sales meeting, so saying that we sell stuff on the Internet is not that visionary thing that investors want to buy into. You need to tell them a story. The more that you understand business model strategy the more compelling you’re able to tell the story, and the more simply. Get your story straight.

What You Need To Say

“Some people sell shoes on Internet, we deliver happiness. When you think about your experience any commerce what is the first thing that crosses your mind? Probably a painful, boring experience, with horrible customer care. Before we started Zappos, we hired McKinsey who did an extensive study and found that 73% of people would shop on a site more regularly if they had amazing customer care, and the fantastic returns policy. We acted on this market insight and designed our business model to deliver the happiness they wanted. Of course, the first thing that you are thinking is that this is going to cost a lot of money. And you’re right! However, whilst we lose money on a first three purchases, our customers by 37 times year. I’m sure you don’t need to be an expert to do the basic math. Let me do it for you anyway. We have 34 purchases at an average basket price of $70. The gross margin is 40%…

Question: How Quickly Are Revenues Growing? What Is Fuelling That? What Are The Bottlenecks?

What They Mean

Investors are getting interested in you and so they want to know more information. They may even be getting excited by this point, but they still need to make sure that the fundamentals are here. If you are growing faster than the industry average, then you already have their attention. But if you are growing by doing Groupon every week then you smell. If the “fuel” is word-of-mouth then you’re very special indeed. The question about bottlenecks is merely how can you grow even faster if you can remove them. That investors’ money is one way of removing the bottlenecks. The bottlenecks can be all sorts of different things, depending on your business model.

What You Need To Say

Our one year CAGR is 40%, for the past 6 months, we have been growing at 50% MoM. Things have really been beginning to pop since we started our buy one get one promotion. Customers really seem to buy into the social good that we are doing by giving free Snapchat credits to starving children. I wish that we had thought of this earlier. Really the only thing holding us back is the fact that the starving kids don’t have enough data access. We could improve our sales cycle dramatically with drones blanketing Wifi over….

Question: What’s Your Price Point, And What’s Your Pricing Methodology. Why Did You Settle On Both?

What They Mean

What is your pricing point? How many different pricing packages do you offer? Do you offer an enterprise package? Do you offer professional services? What is the way upon which you’ve settled on the prices, and how did you come to that decision? Are your prices too low or too high? One way or the other you are charging something for your product, so why are you charging those priced? I presume you know, so tell them.

What You Need To Say

“We recently increased our prices, we had a thesis that we were leaving money on the table by any charging $50. We decided to change the prices a month ago but we have seen no drop off rate in our conversion and in our revenue growth. Customers seem to be relatively price-sensitive since we are offering them so much compelling value. We estimate that they are guessing 20x RoI. That means we can still double and offer 10x value. We are still testing, but the results are quite compelling.

Question: How Do Your Customers Think About ROI On Their Spend On Your Product/Service, And What Kind Of ROI Do They Typically See?

What They Mean

The best customers truly understand the value they are offering to the customers, but more specifically the dollar value of that. One of the best pricing methodologies is to do things on a value base, though there are a whole lot of that can go wrong with that. Particularly in enterprise sales when the procurement department is getting near bonus time and want to look like heroes. “I don’t know” is a bad answer. The ideal scenario is to have a deep insight into how your customers use your product to solve a problem and how much that problem was costing them before they use you. In order to sell your products well you need to understand these anyway. The sales team should always be asking. I hope you know, so tell the investor.

What You Need To Say

We solve very specific pain points. Customer care. Our artificial chat bot doesn’t sleep and has an 87% deflection rate which is above the current human rate of 60%. We charge half the amount they pay the staff, and not on a fully loaded basis. So, the simple math is they get a 2x improvement, the reality is far more.

Question: What Are The Profit Margins/What Might The Margins Be Once The Company Reaches Scale?

What They Mean

How much money are you losing right now! You want to explain the contributions to your losses at present, but how when you scale these will be divided over a fixed cost base, but that you have such large gross margins due to your small COGS, that’s the variable cost function is the de minimus. Clearly, this is what is great about software companies. The office is basically free for marginal customers. So set out what your fixed cost base looks like and how it will need to expand, as well as your variable costs. Link your growth to your marketing spend and how you get a payback.

What You Need To Say

“We are not profitable, we will not be profitable for three years as we cover our fixed costs and investment in marketing growth. However things start getting very interesting in year three. We have a very large fixed base in order to develop our product, which many constitutes development costs. But as you know software is marginally free….

Question: If Your Equity/Salary Was Based Completely On The Accuracy Of Your Projections, What Would Your Forecast Be?

What They Mean

This question is a little tongue-in-cheek. They may be calling BS on your projections, they could even be getting a little annoyed that you will not give them realistic numbers? It may be best to get to the point and be honest, or at least a little more open in sharing your logic. Check out our “hockey stick curve” for users, traffic, revenue, etc. It doesn’t mean anything. Right now your numbers are near the X axis, and you are showing that they will be reaching the sky. Most founders think that they have to show this curve or they will not get funded, and so whilst you read that you have to do it, investors see these curves five times a day. They want to know what you really think you will do. Yes, of course, you do not really know what the numbers will be, but they want to understand how you think you will get to really interesting ones.

What You Need To Say

John, we ran three scenarios. If we do not do better than our downside case, I would be better off going back to Google and getting paid a lot more then I will earn here. Of course, most start-ups fail, so let’s just assume this is the baseline, and everything else is a range of upside. Here is what has to go right for us to exceed the baseline. Let’s talk about the key drivers. If we can agree on the drivers, then it’s a matter of…

Question: What Are Your 3 Year Projections?

What They Mean

The investor fundamentally wants to know how big you think this business is going to get in a reasonable timeframe. Three years may seem like a long time to forecast in a business model plan, but time goes by faster than you think. If you pick a number too small, then this is not an investable business by venture capital companies. If you pick a number too large, then your number is not realistic, and you lose credibility. You have to be in between. The best answer is to give a range, but of course, that is mostly what is not in your business plan. In year three you have numbers in cells. Add commentary after giving numbers. Control the narrative, and engage them in a discussion. Funding abhors a vacuum.

What You Need To Say

In year three, we will have $55m GMV. At a 30% gross margin, we are doing $20m gross. OPEX will be around $25m so we are losing $5m. Depending on how things go I think our top line could be 40% higher or 20% lower. We still are figuring out exactly what our CAC will be. That’s such as crucial determinant of our cost and ability to grow the top line. Nasty Gal, our nearest competitor, was doing $20 million dollars in year four, so even in our down case, we will still be very attractive.


[This post by Alexander Jarvis first appeared on the official website and has been reproduced with permission.]

Author

Alexander is the Founder of 50Folds. Previously, he was the Operating Partner at Jungle Ventures. He build stuff, mentor promising entrepreneurs and advise institutional investors on internet companies in Asia Pacific. He used to be an M&A banker in London.

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