Anyone familiar with banking probably knows this stereotype: the guy or gal fresh from undergrad who loves to “crush” models. They get excited when they tell you about “that time they built a model from Book1.xls” and they use the word “haircut” frequently. As in “I think our downside case simply involves taking a moderate haircut to our basecase.” They don’t believe that a WACC analysis done in banking is obsolete (which I do, since most times it involves an MD telling an analyst what they think the discount rate should be, and the analyst justifying some way to make that happen). They’re probably also the people who explained their personal investment portfolios at age 8 to their interviewers and mentioned that banking was the only real career a person could reasonably explore after college.
That was not me.
Given the aggressive nature of these Number-Lovers (we’ll call them NLs), I tried to take a backseat. I was too timid and afraid of making mistakes that I much preferred keeping quiet on anything modelling related, until someone called me out. Banking is an intimidating atmosphere for someone in their early 20s who is underslept and lacks a serious amount of confidence!
While this isn’t the entire picture, I only got excited about modelling and numbers on rare occasion. I hated the minutiae of it all. In banking and in the public markets, I found that anything numbers-related meant that we were toying around with tiny changes here and there that might possibly reveal a larger truth to us (NLs think this tinkering is reallllly important). I worked on a restructuring debt deal in which we must have run at least 20 scenarios, all involving some slight breach of certain covenants. We then layered on various debt waterfall schedules just to see where things would break. This wasn’t earth-shattering to me. I’d spend all day in a model tweaking various things, some of them non-sense, just to see what could be.
The only time I really got excited about the numbers was when I was building a model from scratch with the intention of seeing the “bigger picture” of the company and how its valuation might be perceived to different investors. This I could get behind, because I thought we were actually telling the company’s story. I was thinking about the various levers that could be pulled (both on the revenue side and on the cost side), and how they might affect the value and acceleration of a company.
With no disrespect to the great work that investment bankers are doing, I didn’t get pleasure out of extensive modelling and tweaking small details. However, my investment banking training is presenting itself in my new career. While I constantly try to absorb as much as possible from my former-operator colleagues, there’s a certain financial perspective that, I think, can prove incredibly valuable.
Here are some of the things I’ve looked at, and why I love thinking about the numbers now:
1. Establishing a “downside” scenario.
So much of what we do in VC (and especially seed-stage investing) is binary: either a business takes off like a rocket, or it fails. In other words, we are constantly making educated guesses. But given some of the business models we look at, and in particular physical goods and eCommerce, thinking about a downside scenario can provide comfort and make an investment worthwhile. I have done a couple of analyses in the eCommerce space to back into a minimum cumulative monthly growth rate in order to achieve a minimum 3x money multiple. It might not be sexy, but if you end up with a minimum cumulative monthly growth rate of 5%, all of a sudden, that business looks a little more de-risked.
2. Exploring sensitivities.
While it’s relatively difficult to forecast into the future in ordinary situations, it’s especially difficult for a company that is 1-2 years old and could have monthly growth anywhere between -100 to +100%. In thinking about a company’s drivers, the model’s sensitivity towards various levers can play an interesting part in analyzing their potential viability. What matters more to me is the sensitivity of a founding team’s projections, after certain levers are pulled, versus the accuracy of the forecasts themselves. Because the world is so unknown, it’s incredibly helpful to figure out what the bottom line is under an extreme case in either direction. This can then help to narrow the riskiness and think about what I’m truly risking at the end of the day.
3. Qualitatively and critically assessing a founder’s projections.
If saying that the sensitivity of the business model to input factors is more important to me than projections, than what I find most important is the way the founder thinks about their projections. I’ve heard many founders say “I just want to caveat that we’re a new company and things could change a lot.” My answer is always this: I care much less about whether your revenue next year is $5 million or $6 million. What I care about is how you get to that number, and how you’re going to work your tail off to make it happen, to the best of your abilities. The way that a founder thinks about building their company, from a financial perspective, matters a lot. It comes into play in almost everything else: hiring and budgeting, marketing, sales, margins and unit economics, etc. It ultimately tells me how strategic they are in managing the financial health of their company.
While some of these are no-brainers, I find myself often thinking about the financial health of a business, for the long-term, where it’s too easy to only think about product, market, founders, etc. As we move into a difficult financing climate, it’s worthwhile to think about a potential investment’s path to profitability and their liquidity, should they need to be more prudent. It just makes cents (get it?).
Thinking about the bigger picture and how a company can grow and create value is really exciting. It’s what makes me look forward to the start of a new day, every day. Wrapping in numbers and thinking about value accretion within this is an exciting part of the investment process. As they say, “you can take the girl out of investment banking, but you can’t take investment banking out of the girl.” And I’m happy for it.
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