Brett Sharenow is a trusted advisor on raising capital from VCs, PE, and Angel investors, for start-up, growth, pivot, and exit. Since 1995 he has helped companies raise more than $750 million and have facilitated exits valued at more than $6 billion.
Some of Brett’s client companies:
Venture and Private Equity Backed
• Verio (acq. by NTT) • Viator (acq. by Trip Advisor) • Dial Page/Dial Call (acq. by Nextel)
• Switch Lighting • Vistard • VirtualLan • Ethernetworks • GroWiseBeWell Academy
• Puronyx • Skylights • Husk Power Systems • Yonder
Private Companies
• King’s Hawaiian • Astrology.net (acq. by iVillage) • MagniGyro srl
• MarCom International • Putnam Consulting • Strozzi Institute • Skyline International
• SensoryScapes • Say it Better Center • Indy Electronics • Generative Somatics
Public Companies
• USWestDex • Pacific Bell • Pacific Telesis
• BFGoodrich • Fujitsu • Bay Area Cellular Telephone
• Olin Corporation • Pacific Bell Mobile Services
This episode we talk about:
- How does a founder/CEO know that their strategy will work?
- Should a company’s strategy be influenced by a financial model?
- What are the typical inputs and outputs in a financial model?
- What can a good financial model do for a company?
I want to thank Shmuel Silverman who made the introduction to Brett allowing this interview to happen.
Guest:
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Pre-Intro 00:00
You’re listening to the Silicon Valley podcast.
On today’s episode, we follow up with Brett Sharenow, who is a guest on Episode 29. Well, we talked about financials for a company. Who is Brett Sharenow? He’s a trusted adviser and raising capital from venture capitalists, private equity and angel investors for startup growth, pivot and exit. Since 1995, he’s helped companies raise more than 750 million dollars as facilitate exits valued at more than six billion. On today show we talk about. How does a founder or CEO know that their strategy will work? Should the company’s strategy be influenced by financial model? What can a good financial model do for a company? And much, much more. This show is like a synced NBA that I know you’re going to enjoy and listen to many times. And also, Brett is given a special offer for people that write a review and share its ultimate pitch debt blueprint. All right. Now let’s start the show. Enjoy.
Intro 00:57
Welcome to the Silicon Valley podcast with your host Shawn Flynn, who interviews famous entrepreneurs, venture capitalists and leaders in tech. Learn their secrets and see Tomorrow’s World Today.
Shawn Flynn 01:14
Now, your last episode, last time you were here. Episode twenty-nine, we went into great detail about financial modeling, the three Cs, a lot of things that people came back to us and ask questions. Hey! you know, we really want more information. I mean, that was great. Like scraping the surface. But can you go into more depth? Because I know this can help my company. I know what I’m an invested in company. This will help me look at it. And there’s been a lot of people asking a lot of questions. So thank you for taking the time to be back on Silicon Valley.
Brett Sharenow 01:43
Thanks for having me, Shawn. Had a great time last time and it was just like, oh, sure. Love to come back.
Shawn Flynn 01:49
So talking about the three Cs in Episode 29, that was one that was emphasized. But can you talk about more of how important this is for a business strategy? And once again, briefly, could you go over the three Cs, the compelling case for customers?
Brett Sharenow 02:04
Absolutely. About five years ago, working with clients, I realize that so many of my clients were missing the three Cs. And it’s one of the questions I ask a client at the beginning of an engagement. What are your three Cs? And of course, the three Cs are a compelling case for customers. The reason it’s so important is that there’s always competition in the marketplace. And no matter what is happening out there, you have to position your product or service so that you can actually sell the product in a way that’s going to get traction. So, let me give you an example. When I give a simple example and then maybe I’ll give a comp more complex one. So let’s assume I’ve just invented a new brand of ketchup. And this ketchup comes from these amazing tomatoes that come out of Sicily. They’re organic and they’re grown next to herbs that the same grower uses. And this ketchup tastes amazing. It’s like no other ketchup out there. But we know if we go to the grocery store tomorrow, there are tens, if not hundreds of types of ketchup out on the marketplace that are going to compete with my ketchup. So, I need to develop the three Cs for my ketchup. That’s a direct competitor when I’m looking at other ketchups on the marketplace. Why is my ketchup so compelling? How am I going to have people buy that ketchup over anything else? Once I’ve developed my three Cs for the competitive products, I then need to look at substitute products. And this is a place that many companies don’t realize. For ketchup, there are many substitutes, I for instance, like ketchup on my French fries. But you may like vinegar or another friend of mine likes mayonnaise. Those are substitute products. They’re not direct competitor with ketchup as a ketchup competitor, but they can substitute for the ketchup. If I am counseling the company and that company doesn’t have a compelling case for customers for their product. There are others that are going to come into play and potentially move us out or not let us get the traction we wanted. If I look at a more technological example that everybody’s familiar with, it’s the not it’s the iPhone. And if you remember back, I’m going to date myself now. But when car phones originally came out, there was a big radio in the trunk. And, you know, you had a little handset up in the driver’s compartment and you picked up the handset and you talked to an operator who dialed a telephone number for you. And you could then talk to whoever you wanted using regular radio. And then cell phones came out and we graduated to the point. We had the little tiny flip phones. So both competitors for one another. And then now comes the iPhone and the iPhone now does things that cell phones do, plus hundreds of other things. And Steve Jobs saw this and said, I want to make a competitor to flip phones to small phones that are out there that do many things that those phones don’t do. So, when his product first came out, his compelling case for customers was easy to articulate. Right. It did email. It did calendar, it let you book reservations. It lets you send text messages in a much easier way than flip phones and on and on and on. So, the iPhone did have a compelling case for customers. Got it out there. Great. What happened? Part of the compelling case for customers, you have to look at intellectual property IP. And when somebody comes up with a new product, that company usually files IP on the product itself, let’s call it a widget. So Apple did that. They filed patents on the iPhone to protect various aspects of the phone, which was great. And with the length of time the patents last, hopefully in a situation where the iPhone would be protected for that entire amount of time and nobody could compete. But what happened? Google came up with an android. Right. And now you’ve got a competitor for the iPhone. And lawsuits went back and forth between iPhone and Google and Android. And the Apple won some. Google won some at the end of the day. The patents that were filed, were filed to protect specific versions of the widget, specific aspects of the widget. The patents that were filed did not protect what I called the value proposition of the widget. Had Apple filed those patents, they may have been able to protect the iPhone much better than they did. So, part of the compelling case for customers is looking at the intellectual property that you’re filing. And the reason it’s so critical is if you have competitors in the space with a very large market, billion, five billion, those competitors are going to spend tens or hundreds of millions of dollars to circumvent your patents. They’re going to figure a way around, if at all possible. And when you spend that kind of money, in most cases, you can do that. So, when you look at your compelling case for customers, you have to look at current competitive products, substitute products. And then is your compelling case for customers protected? So, that competitor is not just going to come in in six months or a year and duplicate what you’ve got. You do a lot of work offshore. And China is famous for taking things from United States. Right. Replicating them, getting around IP and producing them much less expensively. That’s also part of the compelling case for customers. How do you protect that? So, critical part of every business, doesn’t matter whether it’s a startup or a mid-market company that wants to grow. They have to be able to define and market their compelling case for customers to the audience.
Shawn Flynn 08:13
So then can you go into a little bit more detail about how the three Cs fit into the business strategy? I mean, you did cover that some there. But anything more?
Brett Sharenow 08:21
Yes. So, business strategy. I look at business strategy as being an overall view of what’s happening in the company and in what’s happening in the marketplace. And I differentiate that from tactics which is operating in the details. So, let me see if I can give an example. Let’s go back to our ketchup. The ketchup I made. If we’re looking at the details of the ketchup and the tactics of the ketchup, I have to deal with my supplier. I have to deal with where our manufacturing it. I have to deal with. Am I selling it at the local farmer’s market to get people to recognize how good it is? All those kinds of things down in the details. But when I’m looking at my business strategy, I literally almost have to get in my helicopter and get up to five or ten thousand feet above the details and look down and take a look not just at the details of the manufacturing and the distribution, but now I have to look at a broad brush of what’s happening. How does my compelling case for customers fit in geographically? So, if I sell my ketchup in Sonoma at the farmer’s market, that’s great. But had a people in San Francisco find out about it or Southern California or Texas or wow, if I really want to expand back East New York or North Carolina. So, my strategy has to take into account the tactics of the individual things that are going on locally plus geographically and from a much higher level. What’s happening in the marketplace? How am I going to compete? How do all the different pieces fit together strategically, including the financials? Is the business profitable marketing and sales? How do I get the product out there? Operations. Can I actually make this product and then distribute it to back east? Or do I really need to have two manufacturing plants, one in Northern California and one in North Carolina, for example, to handle the East Coast. So, that gets into a lot more of the strategy questions. But the three Cs are a key component of the overall strategy.
Shawn Flynn 10:32
So this sounds basically like too much stuff for a founder to think about. So how should a founder? What should they be focusing on when they’re just starting or grow in a company?
Brett Sharenow 10:43
That’s a great question. A lot of my clients get stuck in that exact situation. They’re focusing on their widget, whatever it is, product or service, and they need to focus on the widget in order to be able to build it, design it, manufacture it, and then market and sell it. The difficulty is that they have to be able to be in the details of the tactics and the good founders and the good CEOs. Doesn’t matter whether it’s a startup or a bigger company that’s looking to expand. They need to be able to move between strategy and tactics easily. And I’ve found that most founders are stuck in one or the other. Many founders are engineers like they came up with a fabulous idea and they have something that’s amazing and they can talk about all aspects of it and how much it weighs in the color and what PMS colors on it. And how does it work and how much power does it use? And all those kinds of things. Those are the details. They need to also be able to get above the details and deal, as we were talking about a couple of minutes ago, with the strategy components. There are also CEOs and founders that are the reverse. They are the strategy people and they come into the office every single day with a new idea or two or three or four. And in that case, there is a situation where the team looks at what they’re doing and says, wow, they just came up with all these ideas. But what happened to the ideas that they came up with two, three, four days ago? So, that’s where that all fits in needs to be taken into account when you’re looking at strategy, compelling case for customers and how you run the business.
Shawn Flynn 12:39
So wait, how does a founder know or CEO that this strategy is even going to work?
Brett Sharenow 12:45
That’s probably the biggest place that companies fail when they’re starting. When you develop a new product or service and I’m going to use product from now on, but service can be substituted. When you develop a new product. You have an idea of what this product is going to do, and hopefully you’ve got the three Cs, you have a compelling case for customers and you are solving a problem that either is known by the majority of population or that may not be known, but you know it’s there and your thing is going to solve it. The iPhone is that example. People weren’t even aware that there was a problem with cell phones until the iPhone came out. And then they realized, wow, I can do email and text and all these other things navigate on my phone. So really important. But the key piece then that comes in is, is the business viable? In other words, can you do everything you need to do with this business and return a bottom-line profit and return on investment to whomever has invested in the company, be it yourself putting your own money and to start the ketchup company that we were talking about? Or be it a product where you’ve got investors coming in and you’re trying to grow it very, very large. A billion-dollar total available marketplace kind of thing. Something like that. So that has to be taken into account, the peace then that needs to be done is once you got your strategy, you need to build what I call us a strategic financial planning model. Some people call it a financial model. I like strategic planning because by definition, the strategy must be incorporated into the financial model and the financial model must relate to the strategy so that as you put those two things together, strategy and financial model, they’re influencing each other. So, to know that the business will work, you have to build what’s called a bottoms up financial model, which means you are building the model based on individual units that you’re selling. It’s relatively common for a startup company to build a financial model from top down. That means for the ketchup example, again, they look at the marketplace and they see that there is this mini bottles of ketchup sold in their geographic area per year. And it’s valued at this many dollars, and they think based on the quality of their ketchup and what they’ve got, that they can get. Let’s just say five percent of that market within five years. So, they take a percentage of the revenues for that product. Multiply by five percent. And there they go. They have their revenue number. And then they put their cost of goods sold. What it’s going to cost them to manufacture that ketchup, including the direct product costs, the indirect product costs, labor shipping, any kind of licensing that’s required, taxes, all those kinds of things. And then there’s SG&A sales general and administrative, which includes marketing and maintenance and operations and all that. Then they come up with a number and that financial model maybe, let’s just say 25 or 30 lines in an in a Microsoft Excel spreadsheet. That kind of model is great for checking whether your assumptions are OK. But it would never work to really look at a business strategy and let you determine is this really going to work? And it will never work for raising money capital from either venture, angel or P. E. Private equity investors. For that, you need a bottom-up model where you are going to look at how many bottles of ketchup can you sell in each geographical area for each week at each farmer’s market. And you build from there. And how many people do you require to do that? Wow. I need this many people at my booth to sell it. I need this many people at the backend packaging it. I need this kind of sales and marketing this many bodies, this much marketing and sales cost to do it, this much publicity. And you literally build from the ground up. That kind of a model will let you then assess whether your strategy will work. So, let’s say you build the model and you realize, wow, this business isn’t profitable as it currently exists and it’s not profitable for your one or your two and it’s not profitable for your three, four or five. So, the financial model at that point tells you, you either need to change your strategy or you need to do something else with the business, including not start it like that happened some, businesses fail. Majority of startup businesses do. And it’s because the financial modeling wasn’t done well up front. To tell the founder, look, the strategy you’ve got probably won’t work. So let’s go ahead and do something different. So that’s the way, you know, whether a strategy is going to work. And of course, no has quotes around it. A financial model is forecast. We’re doing our best to forecast what’s going to happen and the financial model that allows you to forecast what you think will happen and how you’re going to deal with what happens going forward. So, it’s an integral part of the strategy. You must have strategy. You must also have the strategic financial planning model.
Shawn Flynn 18:01
So, when you bring in the financial model, you’re really laying everything out. And then that can really mean not only influence the business. It could make it so either close the doors, completely pivot, maybe even pour more capital. How much does this financial model, good financial model influence a company? You know, you talked about the strategy, but how much should you rely on this piece of paper versus maybe how you feel?
Brett Sharenow 18:31
So there was a lot there. I’ll see what I can do to address each one of those. So, yes, in order to really start a business and raise capital, you have to have what’s called a grounded strategic financial planning model. And when I say grounded, that means that for some of the inputs in the model that we call fax, there are no numbers. So, you can put them in back to my ketchup example. If you can find data on how much ketchup is sold in the individual area right now. That’s a fact. You know that that many bottles of ketchup are sold and it costs this much and there’s this much revenues from that. So, you can use that as a check. You also have things called picks, which are your best guesses, hypotheses about what’s going to happen with the business. And they could range from how much you’re going to spend on marketing and sales, how much you’re going to spend on social media, how much you’re going to spend on the booth at the show, or you’re going to put up a big booth or small booth. All those kinds of things are picks. Both of those are needed. And yes, you build the financial model from the ground up in detail outlining the inputs that you need to build the business. A well-constructed financial model has all those inputs on one workbook tab so that anybody that’s looking at the model can look at the tab and know immediately what you are assuming for your business. This comes into play both as you’re building the model and then as the model is being looked at by somebody, an investor typically who may want to be putting money in. They really want to understand what assumptions you’ve made. How much are you assuming is going to be your accounts receivable days before you get paid? Did you take that into account on the balance sheet? Because even if I sell four cases of ketchup today, I may not get my money for those four ketchups for a week or a month or three months. So, those are parts of the inputs that need to be considered when you’re looking at your model and what comes out of that model should be an income statement, a balance sheet and a cash flow statement that you can look at and that the investor can look at. Now, to deal with your question about a company that’s already in business and may want to look at what the business is going to do going forward, it’s another place that a strategic model really comes into play. I work with clients all the time that are established businesses. They’ve raised their money. They’re moving. And to your point, they either want to pivot because the growth isn’t what they think it should be or they’ve just come up with a new product or they want to take the existing product and significantly grow it. So, a great place to build a financial model to have that model reflect the current business conditions, because now they’ve got a whole many, many months of actual data that they can look at and compare. And then what does the models show is going to be the future. What could they potentially change? To significantly increase the value of the business at the end of the day and the financial model, if. Well, Bill will allow them to ask those questions and you can then put inputs in and change the inputs in the financial model to allow you to reflect different outputs. So if you say what happens if I sell my ketchup at three different farmers market instead of one? And of course, if it’s on the same day, I need three times the personnel. If it’s on three different days, maybe I can have the same booth personnel move booth to booth and farmer’s market to farmer’s market. If the models built well from the beginning, you can actually put those assumptions in and in 30 seconds after their model recalculates, take a look at the value to the business. What is the business worth between those scenarios? And then you can say, well, it’s probably good for me to sell to three farmers markets and it’s even better if they’re on different days. So, can I find three farmer’s markets that are on different days in Sonoma to sell my ketchup? So, the model can tell you a lot about the business, a lot about how to run the business. And again, go back and forth with strategy interactively to figure out what you should be doing best for the business.
Shawn Flynn 22:58
OK, so let’s give it a little bit forward. So now the company. The rate to go out and raise some capital. How in the financial model helped them raise capital as a startup?
Brett Sharenow 23:08
The financial model is really the pivot point that lets the company know, first of all, that they can raise money and then lets them know, of course, as we just talked about, what’s the best strategy? And then the third pieces, how much money do they need in the current round and how much money are they going to need? And when in subsequent rounds? And this is actually critical to raising capital. That last point, current round and the next two rounds I always look at for a client. Why, if the business valuation looks good for the strategy we’ve come up with. We take a look at it. The models shows that the business has, let’s just say one hundred and fifty million dollars in revenues that are realistic and that pass what I call is the straight face test, which paints the founder can stand up in front of investors and with a straight face, walk them through the story. Not a fairy tale, but the story of the business from the start until the point they are now and the place that they are going to reach that hundred and fifty or so million dollars in revenues. That’s a large enough business for most investors to put money in. You’re looking then at a valuation, let’s say, of 400 million to a billion dollars, depending upon what the business is and what the multiples are and what’s going on in the external marketplace at the time. You know, from the financial model, again, with quotes around, no, it’s a forecast that the business is going to be big enough or could be big enough to raise capital. That’s the first step. The second step then is how much money do you need now? And when I say now, let’s have a quick side conversation about timing. It’s relatively common that a client or a potential client will call me and say I need to raise money. And of course, I will screen them and go through all my screening criteria of are they viable, does the business have a compelling case for customers? How much they raised? Are they capable of raising money? Is this CEO and founding team capable of raising money from, let’s just say, venture? To all those questions. And then I will take a look and say, OK, looks like they can raise some money. That’s great. How much have they raised to date? So once we know that the firm can raise money, the valuations large enough in theory and the firm’s going to be big enough, then we have to ask the question, how much money do they need now and how much money do they need in the future? And this then, of course, has to circle us back to the strategy, because let’s just say the company that we’re working with right now need twenty-seven million dollars in a series, A round. Well, twenty-seven million dollars in a series A rounds. A lot of money. Biotech companies get twenty-seven million all the time for A round because of the way their business works. They’re binary product that they’ve come up with, goes through FDA testing, and it works. Then the value of the company is astronomical. And the investors win. But most other companies. Twenty-seven million dollars is on the far tail of the bell curve for an A round. So, part of the work with the business has to be looking at the current round. Does it fit into what I’ll call VC standards for the round? In A round today, usually starts off it let’s just say two and a half million and goes up to let’s just say 20. Now that doesn’t mean that companies don’t raise 25 or 30 or there are some companies that have raised over one hundred in an A. But averages right now. So you need to look at the average raise and doesn’t fit into the VC standards. And then you need to look at how long that money will last you before you need the next round match where your financial model comes into play. Because, again, a well-built model, you can look at the cash flow statement and you can see month by month how much capital you need to keep the business afloat and to do the research and development you need, the marketing you need to do to gain traction. Everything you need to do to eventually get to what is hopefully what’s called cash flow positive. When does the company no longer need infused capital from investors? That’s what you want to know and that’s what you want the investors to know. Now, as a quick aside, there are many companies this past year that went public. That are not meeting their profit requirements or profit projections. And if that happens after you go public, that’s one thing the stock goes down. But if it happens when you’re a private company and you don’t reach the milestones you need to get that next round of money. That’s when companies either run out of business, go out of business because they run out of cash or lose control of the business because they didn’t meet the milestones. So, looking back, we have to look at current round and we have to look at the next round. So, let’s call current A, the next round B. For the B round. How much time are we given ourselves to meet the milestones that we are in agreement with investors are right for this particular business. And that number is typically in the 18-to-24-month timeframe. Yes, there are some companies that can raise after 12 because they’ve significantly improved their position in the marketplace based on traction. In other words, sales or revenues that they can demonstrate they met. But for most companies, that A round is the 18-to-24-month kind of timeframe. So, when we look back at the financial model, are we raising enough money in A to get to that 18-to-24-month timeframe to raise a B? What are the milestones we need to meet in order to get that next round of money and those you have to decide now? Because we’re going to be presenting those to venture capitalists or whoever the investors are in the A round so that they understand, OK, we’re going to give them this much money within, let’s just say, 17 months. Notice I went down by a month. But 17 months variable to meet these milestones. And if they can meet these milestones, we believe as investors that this company is viable. And based on that belief, we are willing to put in the money at A at a specific valuation, knowing that coming up 17 or 18 months from now, they’ll meet their next set of milestones and we’ll be willing to add some money and we may be willing to lead the next round or we may help find a new lead for the B round. So, critical when raising capital that you look at current round next round and really the next round after that, you need to have some vision for how much money this company is going to need in total. The reason that’s so important is that let’s say this company that we’re talking about needs a hundred million dollars, but the valuation of the business doesn’t pencil out in terms of a return on investment so that you could raise that hundred million and provide the oral why to the investors at the follow-on rounds. That’s the place where you have to go back and look at your strategy again and say, OK, what can I do to either increase my valuation or decrease the amount of capital I need in order to get to my end point, because the investors really aren’t really care about the exit. And at that exit point, do they have enough return on their money to make this viable?
Shawn Flynn 31:15
So how can you forecast how much money you need, especially so far in the future? I know we talked about this a little bit in your last interview, episode twenty-nine. But I mean, as you’re talking right now, I still can’t see anyone being able to visualize three, four years in the future. And also, I mean, especially with the economy, the world, everything things change so much. Also want to say, I mean, the feelings of the company, the dynamic shift as it grows from, you know, 50 employees, 100 employees, five employees. All that changes. Can you even predict that for forecast in the future?
Brett Sharenow 31:52
Yes. So, this is where modeling is part art and part science, and the science part is when you’re first looking at your business and defining your compelling case for customers. You really need to understand the marketplace. Is the total available market called the TAM large enough? If your product is successful to support your product and if you do really have the three Cs nailed down and you are providing a value boost solution to a problem that exists, that’s key to being able to say, yeah, I can I can do that. I can take over thirty five percent of this five-billion-dollar total available market. You also need to understand the SAM or serviceable addressable market, TAM is worldwide. What could you sell? SAM is a portion of that something less than that number. And it’s based on geographically as one component, as a subset. And another component being pricing. What of the market can you actually go after with your product? So back to my ketchup example again, which is simple, if ketchup sales worldwide are one hundred billion dollars. But really to penetrate the European market, that’s going to take a huge amount of capital and doesn’t really pencil out. So you’re TAM is one hundred billion. But now you’ve got to reduce that because realistically, let’s say you can only go after the U.S. market. So, you have to look at the U.S. market, SAM, and say, OK, in the U.S. market, let’s say that number is 30 billion. And then you might have to look at. Well, I’ve got a premium ketchup, so I’m not going to be selling it compared to the low-price brands that are that are sold at the stores. The knockoffs and those that are really inexpensive, that have tons of corn syrup in them. So that’s going to narrow my market further. So, you need to understand that first. You then need to be able to build a financial model that forecasts where you’re going with the business. And this gets back partly to the art component of building a model. I found that in order to do this well, I have to be able to coach clients into looking at the business, both from a technical perspective, especially if it’s a high-tech product of any kind. Look at the business from a science perspective and a technical perspective. Where can I really sell this product? Our customer is going to be willing to buy it at my price point. You may have to do interviews with customers. You may have to do focus groups. You may really have to know intimately the domain details of the business in order to be able to predict what your revenues are going to be. Remember, we’re not at that high level where we’re taking a percentage of the serviceable addressable market that won’t allow us to raise money, nor will it really allow us to generate a viable strategy. We absolutely have to build this from the bottoms up. How many of these widgets can we sell to whom? And over what timeframe and how much money is it going to take us in order to be able to build that business? That part some of those parts come from the art of understanding how to build the business from the ground up. And it’s something that takes years to develop and building businesses and financial models dozens and dozens of times. Now, we can forecast, as we talked the last time, and narrow the bounds on the forecast based on what we know. So, if we can really well define the SAM and our strategic financial planning model shows that the business is actually generating revenues that are two times the SAM. We know that there’s something wrong with our model. Right, because we’ve already identified the SAM and we know it is what it is. Let’s just say 10 billion in this case. And if we’re saying our revenues are 20 billion, that doesn’t pass the straight face test by then an investor will look at that and say, wait, you’re selling more than the market is available to you. Even if we said we’re going to have a nine-billion-dollar sales on a 10-billion-dollar market. That’s again. Somebody would question that. And you, as the founder or CEO should be questioning that and saying that doesn’t make sense. We can’t have a 90 percent market share that rarely exists over time. You might have it for the beginning. When iPhone first came out, they had a sense a hundred percent market share for smartphones. There were no other smartphones. But as soon as other smartphones started coming out, their market share started declining. So that’s another piece of what you need to look at with the financial modelling. So to bound it, if you recall the last time, we were looking at how do you bound the case, how do you come up with assumptions that will pass the straight face test? And you as founder or CEO and the team, and hopefully you can convince investors believe what you are telling them. That really gets down to being able to bound the case and looking at standards that are out there. What have other companies done? And is this product such a radical shift in solving this problem that people are really going to be ripping it out of your hands or trying to buy it because it is so compelling. Again, back to the three Cs that we talked about at the beginning. So, the three Cs, the financial model, the strategy all have to fit together so you can actually forecast the business. And as I said, part art, part science, but has to be built from the bottoms up with people that know the domain, know the business, and then, of course, research required to figure out. Could this potentially be viable?
Shawn Flynn 37:47
Now, remember, in our last conversation, we’d mentioned step up and ladder bump valuation. Can you cover that one more time? And also in the financial modeling, you yourself personally when you’ve done one the pat. Has there been an opportunity where there’s been a bigger opportunity discovered once you start penciling things out?
Brett Sharenow 38:12
OK, so the first one that the step up and valuation or ladder bump, we were talking a few minutes ago about raising a series A round and then raising a B round and part of raising the next round. And part of raising the current round is looking at, as I said, the milestones to meet before you reach the B. And will the value of the business be significantly increased at the next round that it’s viable and that the investors are excited about putting money in now because they see a significant increase in valuation. That’s the step up. And what you really want dearly like to have a two X step up or two X bump in value between the ending value, the post money value of the current round and the pre money value of the subsequent round. If you don’t have that and have, of course, is relative here, but if you can’t demonstrate that in the financial model and what that means is the investors don’t believe that you can get to that two X or thereabouts. Step up in valuation. It makes it much more difficult to raise the current round. Why? It’s because the investors will look at that and say the bump. Step up and valuation isn’t significant. Therefore, it’s likely that my money putting in at the A round is going to be stranded. In other words, the company’s not going to be able to raise any more money. Therefore, without being able to raise any more money, the company is either going to operate as what I call a middling entity. Earning some profit, rolling along. But not being able to obtain the outsize returns that the current investors need on their money, which ideally is in that five to 10 x range, if you recall from the last time. And therefore, without being able to get that next round to value, your company is never going to be able to return the money to the investors that they wanted when they put the money initially. So, Step-Up is really, really important. Now, I used my two X as my great multiple some companies, 1.5 is enough in step up between A and B. Some companies need more than two. Again, it depends on that timing that we talked about to get to the next raise the milestones that you’re going to meet and traction. And you have to look at all of that, knowing the marketplace, knowing what’s going on to figure out what’s happening. Now, you asked a question about the external conditions. We never know what’s going to happen externally, right? We have a presidential election coming up. Those happen every four years. And we don’t know what’s going to happen when either the existing president stays or a new president comes in. That event in and of itself will have a dramatic effect on the markets or may have a dramatic effect on the markets. We can’t predict that. What we can do is we can model different scenarios, again, using the financial model, look at various growth scenarios and determine, OK, presidential elections coming up. I’m looking at raising money now. Is my 18-month time frame realistic? Based on a potential change in the marketplace, and we would want to look at that and say, let’s decrease our growth rate, let’s decrease our penetration, because we think that if there’s a change in administration, this is what’s going to happen. And the external market’s going to go down. Stock markets is going to go down. People are not going to invest as much. There’s not going to be as much disposable income available. And therefore, not as many people are going to purchase our product so we can factor in and ask those questions. It’s quite common that when either the client with my direction is building a model or I’m building the model for the company. We discover things that really change the complexity of the business. And these are the things that are unknown. When the founder starts or when the business is starting to grow, it’s something that the CEO and the founding team or the CEO and his or her current team really aren’t aware of. Part of the financial modeling process shines a light in areas that were dark before. And yes, we may discover things both on the positive side and on the negative side. In other words, increased or decreased profitability and value that are going to affect the business strategy. Relatively common. So, we really need to as we’re building the model, ask the questions at the detail level. Is this pricing making sense? Are we spending enough on marketing? All those kinds of questions and see what the effects are on the business. And yes, we may discover which has happened in the past. Other channels to sell our product into that weren’t available to us before. That could even be potentially larger than what we thought initially for this business because we were focusing on this particular channel. And another channel is actually a better customer for us at potentially higher margins or higher value for the company. So, yes, that does happen. And it’s part of the financial modeling and strategy exercise to get to the.
Shawn Flynn 44:03
Wow. This episode has been amazing, but we’re going to end it right here. So right now, make sure to subscribe to this podcast. You don’t miss out on any more of this amazing information. So next week, we’re going to talk about the fundamentals of a financial model and how do they work? What kind of expertise is needed to understand a financial model? And how does a model work for startups? Raising capital growth exits and much, much more. And we know you can’t wait for next week when we do part two of our interview with Brett Sharenow. All right. See you soon.
Outro 44:38
Thank you for listening to The Silicon Valley Podcast. To access our resources, visit us at TheSiliconValleyPodcast.com and follow our host on Twitter, Facebook, and LinkedIn @ShawnFlynnSV. This show is for entertainment purposes only and is licensed by The Investors Podcast Network. Before making any decisions, consult a professional.
