"How much for how long?" I asked the twenty-something inventor across the restaurant table from me. He looked like a deer in headlights. Such a simple question. "How much money are you personally looking to make from your endeavor and in how many years?", I rephrased.
After a long pause he said, "I never really thought about that. This is my passion. I guess I could do this for the rest of my life."
"Well", I said, "I'm not exactly sure how I can help you get funded and you're going to have a heck of a time building a financial model for the business. You're really going to have to think more about your answer."
How much and for how long? That is a key question that needs to be answered upfront for setting the course of your business strategy. Critical? Absolutely! Let me explain why.
How much money you want to get from selling your business (assuming you ever want to sell) sets your valuation goal. How long to exit and cash out sets the timeline for your business. Believe it or not but those two answers set pretty much the pace of your entire business model, financial model and business plan. Critical? Oh, yeah.
So your cash out price sets your business valuation. Let's say you want to earn $10 million dollars at the end of it all. If we assume you took in financial investment then your business needs to sell for more than $10 million. How much is a matter of how much equity you give up to bring in the money. Let's assume you were shrewd and executed well. So you gave up 40 percent of your equity. This means your business needs to go for $16.67 million total in sale. $10 million for you and $6.67 million for your investment partners.
Let's call this your destination. Your mountain peak. Your island in the sea.
Now you need to factor in how long? How many years do you want to invest (because your life is an investment) to reach your financial goals?
This is the time to "climb your peak" or "sail the seas".
Now all you need to is work backwards. In your hypothetical business let's assume you want to reach your goals in 5 years. Depending on your business model and valuation method you can figure out how much in revenue (for article click here). Let's assume your business and financial model allow for your business to sell for 2 times gross revenue. Now we know you need half of the $16.67 million valuation you seek as a minimum in annual company revenue (not profits) to achieve your goal. So that's about $8.4 million. At the end of year five you need to do $8.4 million in revenue.
We now have a very specific goal for our ficticious business. How do we get there? Now we need to work both ends of the timeline. How long will it take for you to get your business in a position to make money? This really varies by your business and your model and the business circumstances. Are you working with an existing business? Why not buy to jump start the model? It is something to consider. Starting from scratch? Then you have to factor in how long to raise money, do research and development, get your first customers and launch.
In our model let's assume we want to do a brand new tangible product. We need to do industrial design, research, prototypes, tooling, manufacturing and distribution. We'll factor in 1 year to do it. That is being really optimistic. We now need to grow revenues from zero to $8.4 million in four years.
We need to figure out the scale. $1 million the second business year. $2 million the third year. $4 million the fourth year. $8.4 million the fifth year. Of course there needs to be a WHOLE plan around this pace of financial objectives but it gives you a course. If it all seems too challenging or risky then question your timeline or your financial number. Or, maybe it's the first sign that THE great idea has a big risk you may not have realized.
At that same dinner was another twenty-something. I asked him how much and how long. Without skipping a beat he said $7 million in 6 years. Now that's an answer I can work with.