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November 02, 2006

The Art of Projections in a Dotcom 2.0 World

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The world is running amok with entrepreneurs pitching every sort of Web 2.0, social networking, user-generated-content startup. It’s the attack of the bull-shiitake startup projections, so I’m losing my hearing; there’s a ringing in my head, and I get dizzy every once in a while. Before the world implodes (again), here is a top-tenish list of ways to create realistic projections in this Dotcom 2.0 world.

  1. Under-promise and over-deliver. I have never seen a company meet or exceed its initial forecast. Entrepreneurs come up with numbers that they guess investors want to hear, and everything goes down hill from there. As a rule of thumb, dividing sales forecasts by one hundred and adding one year to the projected shipping date is about right for startups without a prototype. For startup with a prototype, dividing by ten and adding six months is about right.

  2. Forecast from the bottom up. Figure out how many business development and sales meetings you can get per week--that is, four or five. Then multiply this number by the percentage that will be successful. Then add six months to close the deal. This forecasting method yields a much smaller number than the “conservative” method of assuming that you can get at least one percent market share.

    Once you’re done with the plan, show it to the rest of the management team and demand honest feedback. This is the only way to make a bottom-up plan truly bottom up. Don’t let anyone--for example an ego-maniac chairman--make the company sign up for a plan that isn’t achievable with at least eighty percent certainty.

  3. Don’t go too far out: twelve to eighteen months is the maximum. Anything beyond that is a waste of everyone’s time because you really don’t know when you’ll ship, and you can only fantasize about customer adoption. If you’re into five-year forecasts, go to work for a nice consumer packaged-goods company that’s been around for fifty years.

  4. Plan to re-forecast every three months. Otherwise, forecasting is a joke: You get approval for an annual budget and then re-forecast it in the following board meeting. It’s better to know that re-forecasting is necessary once a quarter than to pretend that “this time we got it right.”

    However, there is a danger in the rolling three-month forecast: Employees will start to believe that “investors don’t mind” constant shortfall (I hope you’re not this clueless). In a startup, everything is “near term.” The long term for a startup is a year--get used to this mentality.

  5. Don’t let costs get in front of revenue. I know, I know: Your startup is going to be the fastest growing company in history, so you need to build an infrastructure to support the onslaught of customers. Dream on. Always run leaner than you think is necessary because your challenge will be creating demand, not fulfilling it.

    Specifically, keep your net burn under $250,000 per month. How can I pick a number like this out of the air? On the other hand, what good does a vague answer do? You don’t have to believe me, but $250,000/month is the magic number for a “typical” venture-capitalist deal. Anything above this, and you’re probably throwing money away building infrastructure for non-existent customers. Just once in my career, I would like to hear, “We ran too lean and sacrificed growth” instead of what I hear all the time: “Costs got ahead of revenue, so we need to cut back but we’d prefer you tell us we don’t have to because it will harm morale.”

    If the $250,000 guideline isn’t appropriate, then at least do a sanity check. Look for insane assumptions like achieving the fastest growth of any company in history and doubling your salesforce in a month. It’s tactical and practical to think like the salesperson on the street trying to make quota and an HR manager trying to fill positions because these functions are easy in Excel but hell in reality.

  6. Collaborate with your investors. It’s just plain dumb to show your Holy Grail of a forecast to investors for the first time at a board meeting. You should feel them out in advance, and never be in the position of guessing what you think they want to see. Collaboration is especially important if you have bad news. Surprising venture capitalists with good news is never a problem.

  7. Think in terms of per-unit profitability. It may be acceptable to lose money on every unit for a time, but at some point you have to make money on every unit. And don’t count on Google to buy you out because “getting lucky” is not a viable strategy. Also, you need to know exactly how much you’re losing on every unit so that you can measure progress towards profitability.

  8. Plan for marketing costs. Don’t depend on wishful-thinking marketing based on virality, buzz, TechCrunch, and a demo at Demo. It’s true that some companies do achieve success this way, but we’ve heard of them because they are few and far between. To use a sports analogy, we all know who Michael Jordan and Wayne Gretzky are because they are rare examples, not because their story is common.

    You need to explain your demand-creation process in a mechanical, not magical, way: ad rates, click through rates, unique visitors per month, conversion rates, revenue per customer, etc. Ultimately, the underlying assumptions in your marketing model is the key to the fundability and viability of your startup. “We’ll get it on TechCrunch and then viral marketing will be easy because we have such a compelling product” doesn’t cut it.

  9. Create a one-page report and stick to it. It seems like thirty minutes of every board meeting is spent explaining a new way to report revenues, costs, and metrics. You would think that you could pick a few numbers that indicate what’s happening at the startup and see the historical trends--but not if you change reporting methods every month. One innovative way to fix this might be to reduce the CEO’s and CFO’s stock options by ten percent every time they change the report.

    You’ll impress investors if you present your projections and your results in the same format. For example, if you use QuickBooks categories for your general ledger, then use these same categories for your projections. The good news is that your numbers will be much easier to understand; the bad news is that you’ll be a lot more accountable. :-)

    Finally, you’ll astound investors if you show up with what’s called a “Waterfall Forecast,” a report that shows how your forecast has changed over time. (Full credit to Josh Kopelman for blogging about this.) I would add one more calculation to Josh’s model: showing the variance between actuals and projections so that the depth of your fantasies (or achievements) is more noticeable.

  10. Never miss a cost projection. It’s relatively okay to miss a revenue projection because forecasting for a startup is truly a crapshoot. If you miss a cost projection, however, then you’re entering the realm of cluelessness. There is no excuse for it, barring an act of God like a factory burning down that produces the raw material that you need. Even then, you should have had a backup source. You should be able to come up with numbers like twenty percent for payroll taxes; $500/month for employee benefits; $3000/employee for equipment costs; and $25/square foot per year for rent.

  11. Think big. Build on small successes at first, but if you go five years out, find a way to get to $100 million in sales. If you can’t imagine this level of sales without being high on crack, then you should face the facts: your company probably isn’t a “VC deal.” It may be a perfectly viable business, but it probably isn’t one for venture capital. The only way you’ll get to this five-year point is hand-to-hand combat with a ninety-day outlook at the start, but it’s important for everyone that a pot of gold can be at the end of the rainbow.

While writing this blog entry, I referred to a book by Bob Prosen called Kiss Theory Goodbye: Five Proven Ways to Get Extraordinary Results In Any Company, which helped me considerably.

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Comments

#5 is dead on! It is so much cheaper to startup then it was just two years ago. With opensource, offshore and viral marketing.

Great post Guy.

theme site lince looks nice

It seems to me that if you under promise and over deliver that you haven't been very realistic in your approach to Venture capitalists. My own belief is to make a ten percent contingency allowance in business plans.
There are those who have two plans on the go A and B in case plan A doesn't work. I can state catergoricaly that if someone presented me with a two plan proposal then alarm bells would ring.
Make plan A so clear, compelling and full of realistic enthusiasm. Its people that make companies great and profitable not pragmatic nit pickers that spend time finding reasons why something wont work and wait to see what happens. While the pragmatics are waiting for market changes the successful are the ones making the changes.
Make your own decisions. Remember you never saw a statue to a committee.
While you are following others advice so are your competitors. Too much of the same.
The Baldcehmist

Good article. I like the idea of bottom up forecasting. Can the VCs not give just enough money for the first year, just to try the concept, and then more for really scaling up? the problem is that VCs also dont want to deal in small amounts.
Btw, i also feel that for a web 2.0 idea, $250 k a month is a lot in the initial days. Same problem- the VCs wont give you anything less than a few million, and you ought to spend it in a few years...

You hit it spot on when you talk about forecasting from the "bottom up." I see thousands of plans that mention getting "1% of a billion dollar market" -- and it automatically raises a red flag.

As always, great advise... Thanks GK!

We're starting to see some crazy business models out there (circa 1998 stuff). This is a practical advice and great reminder to keep it grounded in the Bubble2.0 world.

Phenomenal article very useful for stratups and about to startups. The author has clearly defined the do's and do nots.

Great post, although I think that $250,000 a month sounds crazy for a Web 2.0 user-generated-content startup. Especially if you are still talking about the early days.

We are running www.BlinkList.com, one of the leading Web 2.0 startups in the social discovery space and our monthly spend including labor and hosting is less than $5,000USD per month.

How do we do it? We outsourced ourselves and are doing everything from Kuala Lumpur, Malaysia.

"Under-promise..."

But then you don't get the financing you need.

Guy - this is just an excellent article. You hit it right on many levels. I believe this approach applies to essentially all start ups, not just Dotcom 2.0 ventures. All entrepreneurs/would be entrepreneurs should follow this wisdom. I really enjoy reading and appreciate your blog.

Hi Guy,

I work for a startup that has exceeded aggressive projections from the start. It can be done. You really need a team that is focused on execution.
Also, don't points 2 and 11 contradict each other?

#8 It blows my mind about how many great ideas and applications are out there that don't receive the buzz they deserve. Often times, the startup that is getting all the attention is far from being the best or the first.

Thanks Guy. Met today with lawyer and financial adviser covering much of the above, especially comparisons of budgeted & actual revenues and budgeted & actual costs.

Amazing how one gets smarter the second time around on a start up - with some help from your 'art of the start,' and this blog. Though I do carry a beat up copy of 'selling the dream' in my knapsack.

Guy:

Does your "Art of Projections" apply to all start ups or only those in the "Web 2.0, social networking, user-generated-content" spaces.

What kind of "Art" would you apply to a technology as a service start up in the medical, bioinformatics field?

After leaving college to ride that wave of dotcoms in the 1990s, one thing I swore was to not work at a startup again... And degrees in hand, I'm at a startup again. Something surprising these days are that startups do have to have so many of these accountabilities under control. You can't just run your business on a big idea -- it's about planning, hitting metrics and your business plan.

1, 8 and 11 ring most with me in Marketing; On #8, your product could be fantastic, but if it doesn't speak the user's vernacular or reach the right people -- you won't get that good positive buzz.

The very fact that this article gets down to the brass tacks of what to discuss in weekly meetings, how forecasting works, and how to negotiate with venture capitalists is encouraging. I think far too many sites and blogs out there overemphasize the less mundane parts of the game that are far less important than what you've covered. Nice job.

#6... In 2000 I founded a company and got money from a VC in Italy. I expected that they would have supported us with relationships (partners where all form telecommunications) and advises. My company failed for: 1. our dumbness; 2. VC abandonment; 3. a market much more difficult than we expected (WAP!).
But I've learned that, when you look for a VC, you must figure out what kind of partner you want. Never look only for money: look for a shareholder and collaborate strictly with hime.

BTW, how do you reconcile #3 and #11?

Should an executive summary mention both a 12-month projection AND a 5-year? The former is done bottom-up and the latter is top-down?

Great, great post Guy!

Is this a reaction/response to all the SV Launch submissions? :)

"Never miss a cost projection", and "Plan for marketing costs" are two of my top priorities. Small( or any size for that matter) business needs to be able to forecast cashflow and expenses. In addition, on the marketing point, too many business are sucked in to when it comes to marketing. They do not perform sufficient research at that onset, and more often than not, pay beyond their budgets to attain unrealistic returns. Thanks for the great post..~rick

A startup up exceeding an initial forecast and 5 year projections that look reasonable. That belongs to another world. It is one I would certainly like to see.

Last sentence should be "me" not "my"

cheers

***********

Yes, you're right. Thanks!

Guy

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