How a financial model helps you raise capital like a boss

Raising capital is a crucial chapter in the story of every growing startup. Whether you’re seeking seed funding from an angel investor or trying to close a big Series A with the world’s leading VC firms, a solid financial model can help you plan your raise effectively and attract investors who match your profile.

A financial model is a tool that helps you forecast your business’s financial performance based on your historical accounting data along with assumptions about your anticipated growth and churn rates.

A well-structured financial model that is grounded in your company’s actual financial data lets you tell your story to investors in their native language, numbers. You can use a financial model to craft a compelling numerical narrative that will capture the attention and interest of investors who are primarily interested in risk and return. In this post, we’ll discuss five ways a financial model can help successfully raise capital at any stage.

Key takeaways: 

• A financial model is essential for fundraising: It provides a clear, data-driven narrative about your business's financial health, helping to attract investors and plan effectively for capital raises.
• Accurate capital requirement planning: A solid financial model helps founders accurately determine how much funding they need by forecasting cash flows, expenses, and potential scenarios, minimizing the risk of underestimating costs.
• Understanding valuation and equity: Financial models support valuation discussions, showing realistic revenue projections and helping founders negotiate fair equity terms with potential investors.
• Streamlining due diligence: A well-prepared financial model simplifies the due diligence process by providing a comprehensive, accurate view of the company's financials, instilling confidence in potential investors.

Table of contents

• Identify your capital requirements
• Understand your valuation
• Craft a pitch deck
• Negotiate terms
• Prepare for due diligence
  

Identify your capital requirements

Before you start raising capital, it’s important to analyze how much capital you need to raise to achieve your various goals. Your capital requirements will depend on several factors, including your market opportunity, your growth strategies, your historical growth rates, and your overall financial position.

A financial model can help you quantify each of these factors. With a solid model, you have a crystal-clear vision of your cash flow, revenue generation, and expenses. You see your historical data alongside projections for the foreseeable future, which gives you an accurate expectation about how much capital you should be seeking.

It’s essential to approach any raise with a realistic understanding of your capital requirements that includes an exhaustive accounting of the costs associated with running your business. Overlooking factors like future salaries, expanding overhead, and new marketing expenses can cause you to underestimate your requirements. If this happens, you’ll likely come up short on the promises you made to your investors, and you’ll find yourself back out on the fundraising trail sooner than expected.

A financial model allows you to create best-case and worst-case scenarios so that you can account for risk in your plan and uncertainty in the marketplace. This ensures that your investors have a realistic expectation of their risk and return, and are less likely to be disappointed when you report your actual performance.

Understand your valuation

Once you have a good idea of how much capital you need to raise, you’ll need to start creating a working estimate of your company’s valuation. We always recommend that founders allow their investors to determine the final valuation, but you need to enter that conversation with a realistic expectation about how your valuation will be calculated.

Your valuation is an important factor in determining how much equity you’ll need to give up to raise the capital you need. Investors frequently use a multiple of revenue earnings to value a company, so you must present a thorough and accurate representation of your past, present, and projected future revenue.

A financial model can be very helpful in this exchange, allowing you to break your revenue down into individual streams, visualizing performance and projections for various acquisition channels, subscription tiers, and product life cycles. For each channel, the investor sees that your projections are grounded in the reality of your historical performance. 

If the investor has questions about the assumptions and growth rates that are driving your projections, a model facilitates that discussion and ensures that any objections are limited to the individual revenue streams where the objection is relevant.

It’s also important to keep in mind that an investor’s valuation will consider more than just these financial calculations. Qualitative factors such as the strength of your team, the architecture of your technology, and the perceived size of the market opportunity will also come into play. By including all of these factors in your financial model, you can earn the investor’s trust, and leave them feeling confident that you’re likely to deliver on the promises you make.

Craft a pitch deck

Your pitch deck is the visual backdrop that you’ll use when you pitch your startup to potential investors. It should be brief, compelling, and beautifully designed.

Most financial models are neither brief nor beautiful, but they do play a critical role in crafting a successful pitch deck. Your model informs your decisions about which metrics and benchmarks you should accentuate in your presentation. And it serves as the backstop you fall back on when questions arise about those metrics.

Use your pitch deck to create a compelling narrative about your startup. Highlight your unique value proposition and the strategies you will use to succeed in the market. 

Your financial model should never be the focus of your pitch meeting. That’s what your pitch deck is for. But when the investor shows interest and starts to ask questions, that’s when your financial model becomes the star of the show.

Use your financial model to translate that narrative into the investor’s native language - financial numbers. A good model allows you to isolate the metrics that best support the story you’re telling. It also lets you validate that your story is grounded in reality and based on realistic assumptions about the future. When done correctly, you create what we like to call a “numerical narrative.” A good numerical narrative is convincing and enticing, and investors will be happy to hear it.

Negotiate terms

When you start booking follow-up meetings with interested investors, your financial model becomes a useful tool for negotiating terms. It’s important to have a clear understanding of the terms you’re willing to accept before you start.

You can potentially use your financial model to justify adjustments to your valuation and to negotiate the amount of equity you are willing to give up. With realistic projections that are grounded in reality, you can negotiate every deal from a position of strength, using your minimum acceptable terms as a target.

When you’re negotiating terms, it’s also important not to overlook the non-financial factors of partnering with an investor. Every investor has a network, a management style, and a set of past experiences. Some investors can bring valuable connections and mentorship to your business, which can potentially be just as valuable as the capital they provide.

Working through your financial model with a potential investor can provide a great glimpse into what it will be like working with them on an ongoing basis. Some investors will identify opportunities for improvement, potential networking opportunities, and other resources that might be used to improve your operations. Others will be skeptical and negative, identifying problems but never offering solutions.

The degree to which an investor will contribute to your success is one factor in striking a balance between raising the capital you need and giving up an appropriate amount of equity. And the day-to-day reality of working with an investor who aligns with your goals and vision may also be an important factor in your eventual success or failure.

Prepare for due diligence

When you have an investor who has shown interest and is considering investing in your startup, they will almost certainly perform some degree of due diligence before they write you a check. Due diligence is a comprehensive review of all aspects of your business.

Due diligence can be a lengthy and complex process, and you need to prepare ahead of time to facilitate the movement of funds as quickly as possible. This means you should have all of your financial statements, contracts, legal documents, and marketing collateral organized, ready, and waiting in an online data room before the process even begins.

Your financial model will be a critical component of this review, so it’s essential to have a solid model that’s based on accurate historical data and defensible assumptions about your future growth. Be prepared to explain every detail, provide every supporting data point, and answer every question.

Providing a professional,  buttoned-up model is the best way to speed this process up and inspire confidence in potential investors. So, dot your Is, cross your Ts, and present what we call an “investor-grade” financial model that stands up to any level of scrutiny.

Raising capital with a financial model

Raising capital is an exciting time in the development of any successful startup. A solid financial model can help you navigate every stage of the fundraising process, from planning to due diligence, all the way to executing your growth strategies after the funds have been transferred to your account.

If you take one thing away from this post, let it be this: fundraising is not just about the money. It’s about building relationships and finding partners who share your vision and want to help you achieve your goals.

At the end of the day, raising capital is always going to be a complex and challenging process. With an investor-grade financial model on your side, you can share a clear and compelling narrative that resonates with the investors who align with your goals and want to help make your startup a success.