If you’ve been paying attention, you may have noticed that I’m not a fan of arbitrary processes and meaningless exercises, despite how many people say you should be doing it or how good/productive/accomplished it might make you feel. As an early-stage founder, your scarcest resource is time, and you should be spending it on things that actually matter.
But there’s one process I’m not a fan of that may surprise you: the “five-year plan.” Anyone who has ever raised any amount of money has been asked the question, “where do you see this company in five years?” The investors want projections — and for good reason — but it’s ultimately a trivial exercise because of one thing: it’s based on time.
There’s just no good way to predict what will happen when time is a factor. The world moves in unexpected ways, and everything from the stock market to the newest social media platform to who is sitting in the Oval Office will have an impact on what the next five years will look like. More than that, it allows you to make easy assumptions based on growth projections compounded over months. Eventually, the numbers start to look ridiculous, and I challenge anyone to present them to investors with a straight face. It also shows little to no knowledge of how your business will operate at scale.
The first time an investor asked me what my five-year-plan was, I responded with the above perspective. Except it sounded more like “I don’t know, I’d just be guessing,” in the pompous, arrogant tone I was fond of in my 30s. Thank god I said it to someone as patient as Brad Feld, who walked me through the reasoning behind the question rather than just walking out the door.
Brad explained to me that no one is looking for a crystal ball, and no one expects exact projections. Investors are looking for a solid framework of how your company will grow and succeed, and they want to understand all of the assumptions underpinning that framework. Still, there’s a better way. I didn’t come up with it and Brad didn’t either. If you did, Constant Reader, please let me know so I can give you credit.
It’s called The 1-10-100 Process, and it meets all the same criteria as a five-year projection, without the arbitrary time variable. Everyone who is even thinking about raising capital needs to do it. Let me say that again for the people in the back: If you are ever planning to ask someone else to invest in your business, you need to do the 1-10-100 process. Today. Right now.
Here’s how you do it:
First, imagine first that your company is at $1M ARR. I’ll even do the math for you; that’s $85,000 a month. If you made that much money *this month* selling your service, what would that look like? How many customers would you have? How much did they each pay? How did you acquire them? How much did it cost to acquire them? How much churn are you likely experiencing? How big of a customer success team would you need? How many engineers? What are the cost of goods sold (COGS)?
At $1M ARR, you most likely have just one type of customer (for the love of god, please only have one customer type at this scale), so it shouldn’t be too complicated to go through every cost and contribution to your business. And yes, I mean EVERY. ONE. This is a process to be completed over several days because you will miss things the first time around. Bring the whole team in to review because you’ll still miss things the fourth time around and extra eyes help here.
When you’re done, you’ll probably realize you know way less about your business than you thought you did, and the things you do know are mostly just assumptions. That’s ok. That’s how you identify the assumptions that are necessary for your business to work. Now that you’ve identified them, you can eventually prioritize them and derisk the ones that are business critical.
Next, copy everything you just did into a new tab, and do it again for $10 million ARR. If you just multiply everything by 10, I will personally come to your office and harass you. Certain things immediately become evident. There’s a decent chance you’ll no longer have a homogenous customer base. Your customer acquisition strategy will be different for each customer type, meaning different resources and costs. Other costs may benefit from economies of scale and get cheaper. Go through all of that.
Then, do it again for $100 million ARR. That’s $8.5 million a month — and usually the point that a lot of companies realize their market is smaller than they expected. You’re forced to look your co-founder in the eye and say “do you really think there are 18,000 companies out there that will spend $6,000/year for our service?”
Getting to $100M in sales off a single product or service is MASSIVE, which why we have horizontal and vertical product extension. Maybe you believe the market will top out at 9,000 customers? Awesome! In the above case, you have 9,000 customers paying you $50M/yr, so what else could you sell them? Or what other markets could your service grow into?
On the flip side, maybe you only believe there are 3,000 companies that would pay for your service. That’s still a $16M business and that’s no small potatoes, but it’s probably not something venture capital will be interested in. Figure out how to bootstrap that business and then laugh at all us shmucks running on the hamster wheel.
Unfortunately, a lot of people don’t take me up on this. Too many people start a business and then go for years without looking at the assumptions they’re operating under. They never sit down and consider the future. It’s not until they talk to a friend, a coach, or most likely an investor, that they slow down and realize there are some major risks that might not make their business viable.
A good friend and client of mine went through this last year. Next week, I’m handing off the mic to him. Stay tuned for our second client case study, Walkthrough.
— Eric Marcoullier
Coming up with a financial model on the fly can be a pain in the ass if you’ve never made one before. Luckily, it’s not really that hard. Start with your least granular assumption — how much are customers paying — and divide that into $85k. Then start asking yourself how you’d acquire them. And how you’d keep them. And how much it would cost to fulfill the service. It’s about being inquisitive.
If you run into problems, that’s what I do. I’m professionally inquisitive and I’ve done dozens of these models. If I can be helpful, just send me an email at eric@marcoullier.com or visit my coaching site at marcoullier.com.
(Photo by Luuk Wouters on Unsplash)