A key part of getting a startup off the ground is securing funding, and in many cases, this means wooing investors with an enticing pitch. Any pitch to seed investors will likely include encouraging stories relating to the founders' histories and their vision for the business. This is all very important, but the rest of what investors need to know is contained within the company's financials.
Documents like balance sheets and income statements give investors a detailed look at how a company has performed or where it plans to be in the near future. But just as important is the story that isn't told on paper, and the one that investors will scrutinize in any pitch meeting. Without putting together comprehensive financial statements and understanding them from all angles, founders may find themselves coming away from pitches empty-handed.
For entrepreneurs looking for funding in a private business venture, standards vary in terms of what exactly to include. However, most investors will likely expect a balance sheet before signing any checks. This can either be current or pro forma, which is reserved for companies that have not yet been created and whose financials are based on assumptions. The balance sheet should list what a company owns and what it owes – its assets and liabilities. Subtracting the latter from the former provides an estimate of the equity owned by shareholders.
Whether the company has already been founded or is presenting these statements pro forma, the balance sheet should give investors a glimpse at the prospects of a company. But beyond face value, prospective shareholders are sure to scrutinize the balance sheet in any of the following ways:
- Can the company pay its bills? Having more liabilities than assets is an obvious red flag for investors, but there are other ways to get a pulse check on debt. Having little to no working capital, for instance, will tell investors that you'll need a quick influx of cash or risk running out of time to pay off debt.
- Where is capital coming from? A balance sheet should include the debt to equity ratio to show investors how capital is divided between loans and investments. But it won't tell you how exactly to interpret that number. More equity means less debt to pay off, but also means less ownership in your own business. A high amount of debt could spell trouble in other situations but might not be an issue with a good loan repayment plan and enough collateral.
- Is inventory moving fast enough? Assets on a balance sheet should also include product inventory, if applicable. But again, there is no magic number or ratio for determining ample inventory. Too much of it means running the risk of spoilage, but this isn't much of a problem if you deal in durable goods like paper, for example. Too little inventory means stock could run out, or it might allow the business to run more lean than the competition.
Of course, investors will want to know how you plan to make money before extending financing. This part of the story can be told in the income statement, but even with minute details on earnings and losses, this document needs to stand up to intense scrutiny.
- Earnings per share: Usually calculated from net profits and distributed among shareholders according to their equity stake. However, this might not tell investors what their true return on investment would be. Specifically, how will they get a big payoff? Is your company planning to go public or be acquired?
- Valuation: Whether or not these statements are being presented pro forma, you may still need to project the overall value of your company. Other than book value, there is no certain way to estimate the total value of any company when future performance, brand capital and other unknowns are in play. Still, investors will want to know this, and without a full understanding of your financials, you may have trouble estimating it.
Investors will ask tough questions of even the most confident pitches, and without a full understanding of your company's financial standing, answers are hard to come by. Talk to Consero about how they can provide more than meets the eye in financial statements.