I can’t tell you how many pitch sessions I have sat through where the entrepreneurs show some incredible “hockey stick” revenue increase in years 3-5 in their business plan. Nobody in the room believes the numbers including the entrepreneurs. So why do it?
Some would suggest you need to show the hockey stick so the prospective investors will apply a better valuation on present value of the future earnings. I have sat on the investors’ side of the table and consistently more than halved the revenue projection before applying any discount to the present value.
Others suggest it is necessary to show the hockey stick to convince the current employees to trade current income (salaries) for the future value of their stock options despite massive dilution. This myth should go down with the one where the CEO convinces the board they need to split the stock so the new hires feel like they are getting more value when they join the company. One has to wonder about the intelligence of the new hires if they fail to understand that these two philosophies are nonsense.
When was the last time a start up company, you reviewed, come anywhere close to hitting their revenue projections? In a recent sample of 100 of the top publicly traded software companies only 28% reached $50m in revenue in 6 years or less (the sample was adjusted for inflation). In the same sample, 50% of the companies took more than 9 years to reach the same milestone. On an inflation adjusted basis, Microsoft took more than 8 years and Oracle took 10 years to reach $50m in annual revenues. [Source: http://www.ipo-dashboards.com/wordpress/2009/08/how-long-does-it-take-to-build-a-technology-empire/]
This may be a shot in the dark, but it seems to me that realistic financial plans would be more efficient and provide supportable valuations. In a world of FAS 157, it certainly would make the venture capital firm’s CFO’s job a lot easier with their audit teams.
Mark Greenough is President of Greenough Consulting Group, a Northern California based firm providing financial consulting and services to emerging and middle-market companies as well as to private equity firms. He can be reached at email@example.com or 650-548-6900.