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Storytelling: Putting the Parts Together

Part 5 of 5 in the “Financial Modelling for Startups” Series

In the startup lifecycle, receiving external funding is only an intermediate step within the bigger picture. An investor who is financing your startup certainly likes your vision and wants to support you throughout your journey, but, above all, he expects that the journey will end in a profitable exit at some point.

So far, this article series has mentioned suggestions for improving your model and the preparation for discussions surrounding it. I argued that founders should rely wherever they can on proven fundamentals in the form of historical data, KPIs, and grounded assumptions.

Once again, coming back to the analogy that successful fundraising means selling a bet on your business case, you could say that the individual parts aim to help investors define the odds for that bet.

However, where the betting analogy misses the mark is that it is virtually impossible to combine these parts and objectively quantify the odds, meaning the probability that a venture will be a success (however you want to define success). This difficulty is the main reason why storytelling in fundraising for a venture business case is so important.

The last parts discussed how you can use your market sizing, measuring and projecting KPIs, as well as alternative scenarios to present the business case as a way to show off your thinking process as a founder and manager that such that investors want to finance your business.

At various points, I have provided suggestions on using your rationally derived foundation in each part to develop a compelling narrative about future market developments (i.e., trends and drivers) and business model dynamics (i.e., multiplier and network effects) that together form an attractive growth story.

The last part of the series will discuss a few more general suggestions on aspects surrounding storytelling and related topics in fundraising and precisely what to focus on and what to avoid.

Step 1: Think about your endgame

Especially in the early stages of building and managing a business, thinking and talking too much about the potential big exit can be an enjoyable distraction for founders to get a little space from the day-to-day, sometimes dull and tiring, todos and problems.

In preparation for fundraising, in contrast, putting considerable thought into this topic to round out a deep dive into your business case and financial model is not a distraction but a necessity. It is necessary because, for investors, an exit scenario is the logical consequence of the hypotheses you have presented about your business case.

Not having an exit opportunity makes an attractive business case irrelevant since investors could not cash out of an investment and get repaid. In this sense, thinking about an exit scenario belongs to developing the overall story that potential investors will evaluate when considering an investment.

Similar to the financial projections prepared, the purpose of formulating an exit scenario is not to be entirely precise with regards to timing, purchasing price, or acquirer. At least partly, factors outside of direct control such as market developments and luck drive exits and thereby make them impossible to foresee or plan at an early stage. Thus, the thought process should result in potential exit opportunities or scenarios, not set in stone outcomes.

Instead, discussing exit opportunities with investors is another part of the assessment of the founder’s industry knowledge and critical reasoning skills that can positively or negatively affect the impression and confidence investors have when considering the deal.

There are two fundamental principles that you should take into account when formulating and communicating your thoughts about exit scenarios to investors.

First, an exit scenario is not something you want to display in a pitch deck or financial model openly. Similar to valuation (coming in step 2), you should only discuss exit scenarios if an investor has asked you for it. Investors will want to hear that you have thought about where the path outlined in your model might lead you, but it should still be a distant goal in the back of your mind rather than part of your immediate focus.

In fundraising discussions for early rounds such as Seed or Series A, presenting such a distant and continuously evolving possibility without being asked for your view can give the impression that your focus is not on the tiny, daily improvements that will ultimately accumulate to a successful business.

Second, if investors ask you for your thoughts concerning an exit scenario, replying with “IPO” is superficial and simply not enough. IPOs are not only very rare, but the answer also does not have any real informational value to investors.

M&A transactions are not only the primary type of startup exit, foreshadowing potential combinations of acquirers and the determining drivers for their purchasing decision is a way more insightful thinking exercise.

A great starting point when formulating such a scenario is looking at your base case and hypergrowth projections of KPIs alongside financials at the end of the forecasting horizon — meaning evaluating the situation you plan to be in 3 to 5 years from now. Assuming you will achieve the milestones you have set for yourself, ask yourself which of your company’s determining assets will most interest potential acquirers.

Even though the rationale for buyers varies greatly and could include financial goals (e.g., acquiring an additional revenue driver) or strategic goals (e.g., closing a product gap, eliminating a strategic threat), your projections will give some indications on the asset that will most likely be the primary determinant for an acquisition.

For example, for a multi-sided platform business at an early stage that is focused on increasing customer engagement to leverage network effects instead of direct monetization, the access to a broad customer base and its associated data will be the key asset that acquirers are most likely to be interested in, rather than simply financials.

In contrast, a SaaS business that has achieved its milestones in customer traction, has continuously built up its MRR, and is now cashflow positive could be a target for acquirers interested in the business from a purely financial standpoint.

These high-level examples are only two out of an endless range of possibilities. As mentioned, the intention is not to be necessarily correct but to go through these scenarios to show investors that there will be opportunities for exiting and that you have the foresight to structure and operate your company to develop the asset that drives the value of your business in these scenarios.

If some of these transaction scenarios involve a strategic acquisition rationale, a potential next step would be to research concrete companies that could be potential buyers and their acquisition histories and, if applicable, past and recent exit transactions in that industry.

Following these two principles, your answer when asked what you consider a potential exit scenario for your company should include:

  • Statement signalling a long-term commitment to building and scaling the company (not a short-term oriented, quick payout)
  • Assessment of the asset (i.e., financial strength or strategic asset such as customer base/data) that will most likely be interesting for potential acquirers
  • Historical exit transactions of those potential acquirers within your industry that, if applicable, give information about the strategic direction and multiples paid in that industry)

Step 2: Be rational about valuation

Valuation is the summarizing price tag on the overall story of your business case. In this sense, it is not only the determinant for the exchange of capital and ownership rights, but it can also be either aligned and supportive for your story or misaligned and distorting.

Intuitively, it would make sense to conclude from all the points surrounding storytelling and business projections that attaching a hefty price tag to the deal would be a means to show your confidence in the base assumptions and thus further back up the image of an ambitious and committed founder.

However, similar to fundraising in general, proposing and discussing valuation is a balancing act in which various factors besides the confidence in your business have to be taken into account to support a coherent story and increase the chances of successfully closing a deal.

Although determining valuation is an extensive topic that could (and potentially also will) fill a similar article series, there are two main principles founders should keep in mind to guide their considerations.

First, contrary to common misconception, the valuation in venture fundraising rarely involves putting variables into a formula. Traditional valuation methods such as DCF do not suit companies without historical data and high uncertainty in future projections.

And although alternative methods such as the VC method might be more relevant, they still have their shortcomings and are seldom used as an argumentative foundation in fundraising discussions.

Every investor will reference the disadvantages of the method used or doubt your forecasts’ reliability if he wants to argue against your proposed valuation. Therefore, it makes sense to wait for investors to start conversations surrounding valuation and not implement a valuation section in your financial model using one of these approaches.

The determining drivers of the valuation in fundraising besides your ability to successfully present your case are twofold.

On the one hand, as in every transaction, leverage in negotiations is determined by optionality. An excellent company will attract more funding and be more independent towards valuation proposals from investors.
In this sense, the inability of established valuation methods to reflect a venture’s characteristics might not always work against you as a founder. If industry multiples on core KPIs and financials (e.g., number of customers or MRR) give you a 20 million valuation and you have ten bullish investors lined up that offer you funding, you might be able to double that offer without any difficulties.

On the other hand, an even more intuitive but often overlooked factor is the investor’s general willingness to pay for certain kinds of deals. Investors evaluate deals not on a standalone basis but in the context of their current portfolio, their view of the respective market, general investment strategy, or biases.

If an investor tells you that he is not willing to pay more than ten million in Pre-money valuation for a Seed round, there is usually not much you can do about that, even if your business case could reasonably be valued at a higher price.

Even if you cannot rely on a single formula when preparing your valuation proposal for fundraising discussions, some research into the investor’s investment activity and general valuation trends in relevant markets is good for getting a range of rational valuations to expect.

The second principle to keep in mind when discussing valuation is that even though valuation determines an essential part of a transaction’s economics, it is also a tool for distributing future incentives. The price tag analogy, in this case, has a minor flaw since, in pricing discussions, the buyer and seller will always try to get the best deal from a purely economic perspective.

However, even though the economic perspective plays a significant role (i.e., regarding potential exit value, control, etc.), both founders and investors should also have different agendas than just avoiding underselling or overpaying.

An investor will want to have the founder primarily incentivized through equity ownership rather than through salary. Therefore, a lower valuation resulting in further dilution of existing shareholders will be in a new investor’s interest only up to a certain threshold. Opinions on what a reasonable ownership percentage is to achieve this incentivization vary between investors.

The critical takeaway is that a reputable investor will never try to intentionally undervalue your case during negotiations, that is, not beyond his reasonable effort to get a good deal.

Similarly, a founder’s focus in fundraising should never be solely on getting the highest valuation possible. If you successfully grow and develop your company up to a large exit event, a few percentage points more or less that resulted from the valuation in an early-round will not matter very much.

Instead, your focus should rather be on building the best foundation for your company to reach the exit in the first place. Focusing on the long-term perspective can mean sacrificing valuation to partner with a particular investor that brings critical expertise and network, increasing the probability of a subsequent round, or speeding up the fundraising process to get back to business quickly.

In any case, staying rational when it comes to the valuation proposal as the final piece for presenting your business case to potential investors entails the right preparation and the flexibility needed to align economic expectations and future incentives.

Step 3: Deviate to make it unique

The suggestions here and in previous parts on thinking about your model, its projections, and the overall story should not be taken as a blueprint. Deviating from common standards and patterns is inherent to entrepreneurship.

Thus, even if you see your primary task as reasonably communicating hypotheses and combining them to tell a compelling story, the measures to achieve this might differ from the suggestions given in this series.

You might want to structure the model differently, derive projections through top-down assumptions, or propose a valuation that has never before been paid by your target investor. These are viable options if you, as the founder, are convinced that they better illustrate your investment case to investors.

A unique and individual presentation can make a case equally exciting in the way an unexpected twist can make a great story even more enjoyable.

In the end, fundraising means convincing people of a coherent narrative and making them want to be a part of that.

I hope some of the previous suggestions are helpful for compellingly presenting your case in fundraising.

Storytelling: Key Takeaways

Combining the pieces of a venture investment case illustrated in your financial model requires thinking about the overarching questions of exit opportunity and valuation.

In most cases, some structured research can be very helpful to give investors confidence in your judgment and critical reasoning.

However, as with any other part of your model and the corresponding part of your business case, deviating from common standards and the suggestions given can be equally useful.

The exact route you take to give investors an impression of a long-term committed, rational, and unique founder who they want to support on his further journey does not ultimately matter.

Step 1: Think about your endgame

  • Signal long-term commitment to growing the company
  • Formulate exit scenarios based on your projections and strategy
  • Research comparable transactions

Step 2: Be rational about valuation

  • Be aware that valuation is determined by more than a formula
  • Research a reasonable valuation range and, if possible, stay flexible if it benefits your long-term perspective

Step 3: Deviate to make it unique

  • Deviate if necessary from any suggestion given in this series if you think it makes your case unique, exciting, and maximizes the probability of closing the deal

If you are a founder looking for an investment, I hope you find this article series helpful for your preparation.

Find the additional parts here:

Especially if you are working in the fields of FinTech, Blockchain or AI, I would love to hear about your company so feel free to connect with me on LinkedIn.

Similarly, if you are a VC Investor and have some feedback or additional notes on this topic, I would love to learn more about your views.

VC @ FinLab AG | FinLab EOS VC. Let’s connect on LinkedIN: https://www.linkedin.com/in/maximilian-bruhn-a97608148/

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