Hard sci-fi vs fantasy: Pre-Revenue Financial Modeling
This write-up was originally sent to subscribers as a part of our Mission Control weekly insights, a series where we share wisdom and quick breakdowns on topics from our entrepreneur support network.
Your pre-revenue financials are made up, but they should at least obey the laws of unit economics.
Yes, founders essentially invent the numbers in their initial financial models and forecasts. But the discipline and methodology behind creating these projections delivers genuine value to both the founding team and potential investors. Your financial fiction should be hard science fiction—built on logical principles and plausible assumptions—rather than pure fantasy.
Why your pre-revenue financial model matters, and what it can show investors:
A startup without customers, revenue, active users, or even a product can still get a ton of value out of putting together a financial model even though most of the assumptions and formulas will be fabricated. A well-conceived model can demonstrate the potential scale of the idea, provide sanity-checks on growth channels and expenses, show when and why fundraising is needed, and establish a healthy relationship between customer acquisition, revenue, and margins. If your hard sci-fi story demonstrates enough rigor and reasonableness to be plausible, you’re way better off than just charting a “number go up” fantasy, or never telling your tale at all.
What are the benefits of financial modeling as an early stage startup?
Investors and founders both know that an early startup’s financials are aspirational at best. So why would a founder spend their time creating a fictional 5 year forecast of their nascent startup’s imaginary financials? Because it helps you build your own belief in your business and be able to communicate it to potential investors. Here are some of the bigger benefits about taking your own fiction seriously:
Scale that Drives Returns:
With startups, investors and founders are both looking for a significant return on their investment. For investors it is a clear financial gain (30x+, etc.) and for founders it is a return on their efforts that results in life-changing kinds of money. If the potential growth of a startup does not point to significant returns for either party, why are we doing this? This is why 5 year projections—while seemingly outlandish when just getting started—are the norm. If after 5 years your projected growth is only 2x investors won’t be interested and maybe you won’t be either.
Scale that Doesn’t Rely on Insanity:
While anyone could chart out 5 years of 10% month over month revenue growth and say, “there, huge growth potential”, having a more rigorous model allows you to find the limits of assumptions and reality. If you build your revenue projections based on their fundamental drivers (acquiring customers, how much they pay, over how long, accounting for churn, etc.) rather than just top line growth, you can see when the model “breaks” or when your big vision is based on impossibilities.
Chart a path to $100M and then look at the underlying drivers, does it require you to have 8 billion customers? With 0% churn? Or does it imply you’ll need to hire 100,000 sales reps in 5 years to build that kind of growth? These are the impossibilities that easily creep into abstract modeling or just looking at market sizes and assuming you’ll capture x% and we’ll all be rich.
You can also look at industry wide stats and see if you’re being too ambitious or conservative. A great metric is average revenue per employee, many founders undershoot headcount and end up projecting they’ll have 1/10th the staff of where Google or Mailchimp were at the same revenue numbers—unlikely to say the least.
Fundraising Justification:
Since a good model has both revenue growth and expenses it can clearly illustrate when funding would be required to continue operations or seize an opportunity. Additionally, it can show how the funds raised will be spent which builds confidence for investors as it shows you’ve thought out—even if just as a hypothesis for now—how you’ll use the money to grow, e.g., “If we can raise $X by the end of the year, we can hire these sales and marketing roles and start to scale revenue on these channels”. It’s still a guess as to how it will really work out, but it’s an experiment now, not magic growth.
Building and Analyzing Healthy Unit Economics
A company needs not only to grow revenues, but to eventually become sustainable and profitable in order to provide those fabled returns. You can easily “make” $1M by paying every customer $2 for their dollar, but you’ll never actually make money—you’ll lose $1M. That sounds like a silly example, but swap raw cash with a product that costs more money to make (over its lifetime) than people will pay for (over their lifetime as customers) and you’ll find many founders can delude themselves for a long time even when “making early sales”.
Putting the work into the unit economics of your product and services and how they’ll change over time can provide a lot of insight into uncertain areas of a new business. You can find floors and ceilings of important components like price, customer acquisition cost (CAC), cost of goods sold (COGS), and churn.
Founders often wrestle with how much to charge and spend on advertising, or even how many calls/emails/events to tend to. By modeling them out and playing with the assumptions you can have both solid starting points as well as known “break” points where a given channel isn’t worth continued investment or a price you’d lose money at. It can even let you know how long you can sell at a loss to get into a market before running out of cash, or when you need to raise prices.
Gust's New Corporate Diligence Review Tool can identify preventable corporate structure issues that come up in diligence, and help guide founders towards fixing them.
Take the Time to Build A Sane Financial Model
There are many more benefits to modeling even before you have actuals coming in. It takes some work, research, and creativity, but it is usually well worth it and often a great differentiator from other startups in the space who haven’t.
It’s not easy! Projecting things is far easier when you have past data to rely on. In sci-fi land, you’ve got to pull from multiple sources, hedge some assumptions, and work with ranges more than absolutes. That’s why we do regular financial model review sessions in our Mission Control program. Founders can get expert and community eyes on their assumptions and help spot red flags, impossibilities, and opportunities.
We’ve also just launched our Corporate Diligence Review tool – a free tool that evaluates how investors will perceive your corporate structure and history. While not directly about financial projections, it examines the structural business foundation of your story so far. Just as your financial model needs to follow the laws of unit economics, your corporate structure needs to follow best practices that investors expect.
If this kind of support sounds valuable for your startup, check us out. We’ve opened up new spots in Mission Control to support more founders. Want to try us out? Just fill out this form for a free sample session of our weekly Office Hours.
To your logical, but ambitious goals! 🖖
Gust's New Corporate Diligence Review Tool can identify preventable corporate structure issues that come up in diligence, and help guide founders towards fixing them.
This article is intended for informational purposes only, and doesn't constitute tax, accounting, or legal advice. Everyone's situation is different! For advice in light of your unique circumstances, consult a tax advisor, accountant, or lawyer.