The Redfin real estate financial model posted by Guy Kawasaki assumes a worst case scenario and bases all its assumptions and financial statements on that. The model presents artificially low financial projections, which may not be realistic but will ensure that the startup gets additional funding easily. The purpose, as Glenn Kelman says, is to be able to say the three magical words “we outperformed projections” and guarantee a constant flow of funds to continue operations. If, on the other hand, the financial model had been realistic enough to include higher projections, the out-performance would have been missing, leading to difficulties in raising more funds. This would eventually result in a liquidity crunch for the startup.
Financial model planners in this case are focusing on what drives venture capitalists to invest in a startup. Most venture capital firms aim to generate tenfold returns in five to seven years and, thus, invest in businesses that have the potential to outperform. But is it that simple? Can investors be easily manipulated into believing something? Do they really invest their money on the expectations of a startup outperforming the worst of projections? Most venture capitalists and investors are smart enough to know where to put their funds and what returns can be generated. Most savvy investors looking to fund startups discount the startup financial projections and assume a worst case scenario.
Although it is appropriate to be pessimistic in terms of revenue recognition while assuming the highest cost scenario, venture capitalists also take into account the chances of the worst case scenario actually happening. Financial models are based on assumptions that create most of the variation between the actual figures and the projections made in a financial model. In this case, the actual figures reveal that, despite the conservative approach adopted by the Redfin real estate financial model, some of the costs, such as the rent per employee per month, the annual payroll increase, monthly travel and telephone costs per employee, were higher than the estimated levels.
The Redfin real estate financial projections also suggests that the assumption of economies of scale is not correct. Financial model planners should bear in mind that the bigger the business, the higher are the per employee costs, which is somewhat counterintuitive. Moreover, Redfin suggests that financial model planners should not take it for granted that the startup’s product will sell. Instead they should base their revenue projections on “if the product sells.” As Redfin puts it, a financial model should provide the startup adequate time to grow without hoping for too much.
And it is of utmost importance for a startup to outline the assumptions of the financial model clearly, so that investors have no doubt about the message being conveyed.
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Tags: Financial Model, Guy Kawasaki, Redfin, startup
