Should Pre-Seed Startups Have Detailed Financial Plans?

There is an ongoing debate about whether pre-seed ventures require detailed financial plans. Some argue that they're a waste of time, while others insist that they're essential for attracting early funding. While there are valid arguments for and against, it's worth noting that early-stage funding sources, such as university pitch competitions and grants, which can sometimes be the earliest source of funding for ventures and are often seen as less rigorous, interestingly require some form of financial outline. Let's examine both sides of the argument.

Case for Pre-Seed Financial Models:

Disciplined Planning: Even basic models force founders to confront the financial realities of their business, promoting disciplined thinking about cost & assumptions, revenue potential, and resource allocation.
Investor Communication: A financial model, even a simplified one, shows investors that you're serious about your venture. It signals that you've considered the financial implications of your idea and have a basic grasp of business fundamentals.
Identifying Red Flags: The process of creating a model can highlight potential risks or unsustainable spending patterns early on, allowing you to course-correct before they become major problems.
Setting Benchmarks: A financial model provides an initial roadmap. It helps you track progress, measure key metrics against your initial estimates, and make adjustments as needed.

Case against financial models for pre-seed startups:

Unreliable Data: Market assumptions and customer behavior are difficult to predict with accuracy at this stage, making models prone to significant errors.
Prioritizing Execution: Focusing on building the product, validating it with customers, and iterating quickly is often more crucial for pre-seed success.
Focus on Vision: Investors may care more about the founder's passion, problem-solving ability, and market potential than highly detailed but speculative projections.
Time Investment: Complex models can be a time sink distracting from critical early-stage activities that directly impact the business's chances of survival.

Do you think pre-seed startups should have financial models?

Yes, it's proves thoughtfulness and builds logic.
No, pre-seed founders should focus on other priorities

Finding the Balance

While pre-seed startups might not need the most intricate financial projections, some basic modeling provides immense value. The key is striking a balance between financial awareness and the core activities of customer validation, product development, and refining your business model. Overly complex models at this stage can be a distraction, potentially doing more harm than good.

In this article, we'll explore the essential financial metrics that should be part of any pre-seed startup's plan. These metrics will help you think critically about your venture's finances without sacrificing focus on the elements that drive early-stage success.

Key Financial Metrics for Pre-Seed Plans

1. The Startup Cost

As a pre-seed company, you are either in the idea stage or the proof-of-concept stage, but definitely pre-revenue. Even before generating revenue, pre-seed companies face expenses. As a founder, you want to create a projected cost for setting up and running the venture. This would demonstrate to investors that you have conducted thorough research and understand the requirements for starting and operating the venture you intend to pursue.

Crucial items to include in your estimate:

Incorporation and legal fees: Setting up the legal structure of your business.
Office or workspace setup: Costs related to physical workspace if needed.
Equipment and technology: Essential tools like computers, software, and any specialized machinery.
Initial marketing and branding expenses: Getting your venture's name out there.
Founding team salaries (at least for the first few months): Compensation for yourself and key co-founders.
Other operational costs: Insurance, licenses, permits, or additional fees specific to your industry.

Understanding your startup costs isn't just about fundraising. It creates a strong foundation for managing your finances as your business begins to grow.

2. CAC/LTV

Another crucial metric to include in your pre-seed financial plan is the Customer Acquisition Cost (CAC) and the Customer Lifetime Value (LTV). Understanding how much it costs to acquire a customer (CAC) and the potential revenue they generate over time (LTV) is fundamental, even at the pre-seed stage.

You want to be able to show investors that you have put some thought process into how you are going to acquire customers and how long you are going to generate revenue from those customers. This demonstrates to investors that you're thinking strategically about sustainable growth.

The CAC (Customer Acquisition Cost) represents the total cost of acquiring a new customer, including marketing, sales, and any other related expenses. The LTV (Customer Lifetime Value), on the other hand, estimates the total revenue a customer is expected to bring throughout their relationship with your business. By calculating the LTV/CAC ratio, you can demonstrate the efficiency of your customer acquisition strategy.

The Key Ratio: LTV/CAC A ratio above 1 means your customer revenue outweighs the cost of acquiring them, signaling long-term profitability potential. While precise LTV figures can be hard to come by in the earliest stages, thinking about these concepts forces you to consider your customer acquisition strategy and its impact on the financial health of your business.

3. Revenue Model

Alongside the startup costs and customer acquisition metrics, you should also include an estimated revenue model in your pre-seed financial plan. This shows investors that you have an idea of how you would generate income from your customers.

While pre-seed projections naturally have some uncertainty, demonstrating that you've carefully considered potential revenue streams signals strategic thinking.

Your model should outline:

Revenue Streams: How will customers pay you? Subscriptions, one-time purchases, freemium models, advertising, etc.
Pricing Assumptions: Realistic price points for each revenue stream.
Conversion Rates: How many potential leads you expect to convert into paying customers.
Customer Projections: Anticipated customer base size over time.

It's important to remember that at the pre-seed stage, your revenue projections will be highly uncertain, but providing a well-thought-out model can demonstrate your understanding of the market and your potential for growth. Even at the pre-seed stage, investors want to see that you understand your market, how your solution aligns with its needs, and have a viable plan for generating revenue.

4. Burn Rate: Your Financial Lifeline

Understanding your burn rate is absolutely crucial for pre-seed startups, especially if you've secured early funding like grants or competition awards. The burn rate indicates how quickly a company is using up its cash reserves, and for pre-seed startups, it's a crucial metric to monitor.

Calculating your burn rate matters because it increases:

Runway awareness: Burn rate helps you predict how long your current funds will last and when you'll need to seek additional investment.
Investor insight: Demonstrating a grasp of your burn rate signals to investors that you're financially responsible and focused on the long-term viability of your venture.

Simple Calculation: To calculate your burn rate, simply divide your monthly operating expenses by the amount of cash you currently have. This will give you an estimate of how many months your existing funds will last.

5. Funding Needs and Runway

This section is where you make your case to potential investors. Be clear, realistic, and demonstrate an understanding of the pre-seed funding world.

Funding Requirements: Don't just ask for a lump sum. Itemize how much you need to achieve specific milestones (building your MVP, early marketing campaigns, etc.). Tie this directly to your plan's "Use of Funds" breakdown.
Runway: Investors want to see sustainability. Calculate how long your requested funding will last based on your burn rate. Aim to demonstrate a runway of 12-18 months, a common benchmark at the pre-seed stage.
Potential Funding Sources: Show you've researched your options. Briefly outline the types of investors most likely to fund a venture at your stage (friends and family, angels, accelerators, grants, etc.).This shows you understand the broader fundraising landscape.

This section isn't just about the money. It demonstrates to investors that you've thought strategically about your finances and have a plan that extends beyond your initial ask.

Importance of Flexibility and Iteration

It's important to note that the financial plan for a pre-seed startup aren't set in stone – they're a starting point. At this early stage, there is inherent uncertainty, and your assumptions and projections are likely to change as you gather more data and continue to refine your business model. Market realities, customer feedback, and unexpected challenges will all necessitate adjustments. Embrace this fluidity.

The key is to create a financial plan that is flexible and allows for regular updates and iterations. This will not only help you manage your finances more effectively but also demonstrate to investors your willingness to adapt and your ability to make data-driven decisions. Build adaptability into your model by:

Regular Reviews: Set a schedule (monthly or quarterly) to revisit your plan against actual performance.
Iterative updates: As you gain insights, make changes to your projections without hesitation.
Investor Communication: This proactiveness signals to investors your ability to handle the inevitable uncertainties of early-stage ventures.

Remember: the purpose of a pre-seed financial plan is not to provide precise forecasts, but rather to show that you have a solid understanding of the financial considerations of your business and a plan to navigate the uncertainties ahead.

Conclusion

Creating a financial plan for a pre-seed startup is not a simple task, but it can be a valuable exercise that helps founders think critically about their business assumptions, projections, and cash flow needs.

By focusing on key metrics like startup costs, CAC/LTV, revenue model, and burn rate, you gain clarity on the financial foundation of your business. You can demonstrate to investors that you have put thought into the financial aspects of your venture.

Remember: Balance is crucial. Don't let financial modeling distract you from your core mission: validating your idea with customers and building a great product. Your financial plan is a powerful tool, but it should always support your primary goals.

Ultimately, A well-considered financial plan is a reflection of your understanding of the financial realities of your business and your ability to adapt to the inherent uncertainty of the startup world. By approaching it with a flexible and iterative mindset, you can create a valuable resource that supports your journey towards growth and success.

Remember, creating a financial plan doesn't have to be overwhelming. For pre-seed founders seeking additional guidance and tools, visit our resource library. You'll find free financial model templates and other helpful resources to simplify the planning process and support your startup journey.