lições para Business Angels

A edição n.46 da britânica Angel News traz-nos mais uma lição sobre investimentos por Business Angels.:


How to make money out of angel investing part 5 – investing in the right financial model



Turning to the section in any business plan on the financial prospects for an investment opportunity will, these days, almost unfailingly show a remarkably similar picture of J-curve cash flow projections and stunningly healthy levels of profits once the business has matured.

Financial modeling of a new business is definitely an art based on logic and too often that logic is based on showing the potential for financial strength to justify not only the valuation the entrepreneurs are demanding, but also the level of investment funds being sought. After all, argues the typical entrepreneur, we need the money (plus a bit) to grow the business and we need to make the numbers look fantastic to prick the interest of the investment community: is it not just a big game where we all know we are playing with Monopoly money until the cash arrives into the company’s bank account?


But, once the money is in the bank account, we know you can be sure that the financials will either be ahead of or behind the projections upon which you invested but are unlikely to match it.

I come from a background in corporate finance in the City and spent the early years of my career pouring over profit and cash flow projections of much bigger and more established companies than those we see in the angel world. Two key things linger in my mind from those days. Firstly, it was deemed necessary by everyone in the market that quoted companies should have sufficient working capital facilities for at least 12 months (including accommodating for peaks and troughs), before taking into account cash required for “extraneous” activities such as acquisitions or exceptional expansion. Secondly, you always modeled future financial performance based on historical results and how the competition was performing.


In the angel world, these concepts take on a different order of magnitude, but they make an excellent starting point for judging the financial model.

Take working capital requirements. In the angel world this would typically translate into general running costs and the time lag between paying suppliers and receiving money from customers. These days, to rent a small office, put in a couple of phones and computers and employ one or two admin staff, allow the founders to travel around a bit pursuing the opportunity would typically cost £5,000 a month. This is before any expenditure on product development, marketing, capital expenditure etc. So the very first thing to think about is how these core costs will be met. Very few start-ups really go anywhere in terms of profit generation in their first 1-2 years, so you are looking at costs of say £120,000 just to ensure that someone is in the office to pick up the call you make to find out how things are going on. Bear that in mind when you see a company that believes it can build a business on less than £150,000.


Secondly remember that small companies, whilst agile at doing things “on the cheap”, don’t have the negotiating power of larger established companies. Customers will tend to pay when they want to and the larger the customer the more likely you will have to stick to their standard terms of trade which may mean payment up to 45 days after presentation of an invoice (with a purchase order reference – which in itself may take a month to obtain). Likewise suppliers will not necessarily stretch credit terms and late payment can mean a quick learning experience in how to keep the bailiffs out of the office. All small businesses stretch payment, but as an investor, have a think about whether this is really the way for management to spend their time.

When it comes to financial modeling remember that spreadsheet software should make the numbers come out perfectly. If they have not, this suggests not only financial illiteracy, but also challenges general competence. Entrepreneurs spend hours, days and weeks struggling over the financial projections – possibly too much time in some cases where they would be better off going to a sales meeting. It’s a good idea to find out what the entrepreneur really believes it will take to get the business off the ground – they probably have these numbers “top of head” and they may not bear much relation to the numbers in the business plan. Remember to dig hard into the assumptions behind projections as well, but do not get hung up on having 58 types of sensitivity analysis.


There are other broad rules to follow when looking at the numbers. Assume, like my bank manager that all sales will take at least 6 months longer to materialize than is on the plan, but that costs will stay the same. Assume that surprise costs will turn up – three of my favourites are unexpected employees costs (e.g. getting rid of a bad hire – both cash cost and time cost) critical IT maintenance and, last but not always least, underestimation of travel & expenses.

When you are digging into the minutiae of the numbers take a look at the costs you hardly think about – annual renewals of software licenses have a habit of turning up – well, once a year! Double check insurance policies – many entrepreneurs just buy their insurance from their bank and it may not be offering what is actually needed.


When taking a global view of the projections focus hard on gross profit margins. This is where the pressure first hits in a small business. There is always downwards pressure on sales – getting established customers to pay more for the same product is challenging and competitive forces will help new customers negotiate hard. Meanwhile suppliers will always be pushing to pass on costs and the company will be unlikely to have the negotiating power to resist and indeed may be totally dependent on that supplier as they cannot offer the volumes to merit running more than one supplier.


Wise angels tell me that you should also look very hard at how the overheads will grow – think about who will manage the managers for example and check if that has been costed into the wage bill. Have business rates been considered and service charges or is it only the rent?

It is always worth checking out the financial models of similar businesses, especially if there is little or no trading history. Take a typical software company. As a rule, gross margins should be amazingly high; so if your software investment opportunity is showing a lower gross margin than average is it because it is selling consultancy services or because the management has got something wrong? And if EBIT margins are unbelievably high it probably means that the financial model does not include all those overheads that come with being a bigger business. Remember, many fine companies are justifiably proud of a 10-15% pre-tax profit margin and there is probably something fishy (or not scalable) about a business that has profit before tax in excess of 25%. However, 20% is a good target to aim for.


When you are looking at the cash flow, a major area (beyond the obvious), is to look at tax – many, many small companies use the VAT they receive to pay other bills, rather than to save it to pay over when the VAT return is done. So check that the cash flow adjusts for the movements in VAT. The other big tax issue will be employment taxes, which typically equate to 30% of a net salary.


Last, but not least examine year on year growth rates. Most projections are prepared on the basis that it will be possible to grow equally high quality resources as the business grows, but this is rarely the case. If you do nothing else, look at the financial projection for year three and assume that 30% of the sales effort fails because a bad hire is made on the sales team or the star performer walks out to go to the competition. Assume that the situation i
s not resolved for a further 3-6 months. What happens to the projections thereafter?


In terms of looking for the best financial models to back here are a few tips:

  1. Back businesses with very high gross margins – less than 50% is a no-no unless volumes are astronomical.
  2. Look for: Businesses where a significant proportion of future revenue is from existing customers tied into a contract of 2-3 years.

    A financial model where more “product” can be sold to existing customers and processes are automated as soon as possible leaving (expensive) humans for the important bits like building new relationships or product enhancement

  3. Avoid financial models that do not offer an appreciable financial benefit to the company’s customer and look for models that align themselves more closely than the competition, with the financial interests of the customer.
  4. Remember that typically 10% of customers will pay a premium for something that the other 90% will probably never pay for
  5. As businesses mature they are more able to negotiate harder terms with suppliers and customers, but they require more resource to keep functioning. These are not always correlated.
  6. A business will be sold on its overall asset value as well as profitability projections, so don’t ignore the balance sheet, think about justification of intangible value and hammer out the lease vs. capital purchase and patent vs. trade secret debates early on.

Licenciado e Mestre em Gestão de Empresas. Presidente da Gesbanha, S.A., especialista em capital de risco e empreendedorismo, investidor particular ("business angels") e Presidente da FNABA (Federação Nacional de Associações de Business Angels). Director da EBAN e da WBAA

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