The financial modeling primer.
105 minutes in bite sized lectures on building financial models.
When I teach the financial modeling course for founders, there are some questions that come up with regular frequency. Much before we get into intricacies of the model, I am often hit by an artillery barrage on valuations, valuations drivers and my personal list of hacks to get to higher valuations.
Two years ago we put together a series of short lectures as a pre-primer for my students at IBA, Nest I/O and Katalyst Labs. Here is a curated list of short lectures from that list for the upcoming batch of IESS (International Entrepreneurial Summer School) at IBA Karachi as well as the next cohort at Katalyst Labs.
Total runtime? 105 minutes distributed in 5 to 19 minute bite sized videos.
Where did these lectures came from?
I ran the financial modeling boot camp for founders at the Nest I/O Karachi for 5 years, working with 200 teams across 12 cohorts. Also taught the Entrepreneurship course at SP Jain Dubai for a decade, the tech management course at Habib University for 5 years and Venture capital and the financing of innovation at IBA for 2 years. Attempted to raise money four time, succeeded thrice. First in 1999, then 2005–7 followed by 2012–15. The final attempt in March 2022 missed the bus by a few months. The world changed in February of that year.
The lectures are primarily based on lessons learnt as a serial founder from 1999–2022. Supplemented by 32 years of building models on 4 different continents across banking, mergers and acquisitions, consulting, risk, fundraising, portfolio optimization and due diligence teams.
As always not investment advise. Please don’t take anything at face value and your mileage may vary (YMMV).
Topics covered.
a) Higher valuations.
b) Valuation drivers.
c) Intent of valuation models.
d) Customer selection filters.
e) Scale multiples and idea selection filters.
f) Building financial models.
g) The Zen of building financial models.
Higher Valuations.
How do you make your business, idea, pitch deck more valuable? Is there a single tweak to your business model that can increase the value you create for your customers, yourself and your investors? The answer is yes.
Acquiring customers is expensive. Don’t sell to them once and let them go. Get them to buy from you multiple times. Sounds simple? It isn’t. Invest in products, ideas and businesses where customers buy from you again and again.
It’s not just about the product. Its about how your product fits into the growth arc of your customers life. And your ability to retain them. Is your product as essential to them as breathing or a more plainer, basic nice to have. Not a short cut. More of an idea selection filter. Pick ideas where repeat purchase is given. You could debate the merits of higher ticket sizes but growth is often a function of purchase frequency, retention and repeat customers. Churn is the biggest enemy of organic growth.
Valuation Drivers.
How does the context change between bullish, normal and down cycles? How fast does the rate environment move? Given the history of our market, how long is the current down cycle likely to last? Another 18 months based on a 19 year history and 6 rate cycles for Pakistan. 2024 is when you should expect markets to come back.
The intent and purpose of valuation models?
From the point we decided to sell, our first exit took 4 years to close. If I had a list of challenges associated with a valuation exercise, we would have saved ourselves a world of pain and time.
The objective of a valuation model is to not throw out number. It is to build consensus. Models are not just about equations, they are also about emotions, relationships and stories.
Understanding just this one thing, immediately ups your game.
Customer selection filters.
2 golden rules. 2 golden filters for customer segment selection for better and higher valuations.
- $ in should be greater than $ out
- 2. Future growth should be greater than current growth
Get basics right. Valuations will take care of themselves.
Scale multiples and idea selection filters.
As founders we often struggle with conventional financial valuation models. We get distracted by the many assumptions it takes to run through our financials and explain how we will disrupt a market to our audiences. Is there a simpler, more founder friendly, valuation engine which is easier to explain and easier to understand?
We introduce the concept of a customer centric valuation model called Scale Multiples. Rather than looking at Discounted Cashflows (DCF) and Free Cash Flows (FCF), walk through a two parameter engine that cuts to the bone of valuation models. Number of customers and Life Time Value of customers.
In Episode one , we walk through the framework and illustrate the mechanics using a simple example and close by answering an important question — what do investors want from a financial model?
The stylized example we use to illustrate the framework? How would you disrupt and grow the life insurance industry 10x in 10 years in Pakistan? What would be your vector of attack and how would you explain that model to your investors, partners and employees, assuming they didn’t have a PhD in Corporate Finance.
In Episode II we look into Lifetime Value (LTV) estimation and examine its link with segment selection, growth dynamics, product design, monetization, traction, reach and valuations in 15 minutes.
In 6 minutes and 45 seconds, we walk through 3 ideas and 20 years as a serial founder to identify why the stories we started writing ended the way they did.
Are there are any lessons future founders could take away from that discussion? I have often wondered given the chance to go back if there were things I would do differently in the startups and businesses I had built. Here is a list. Tweaks and hacks that would change how those stories ended.
The sharpest of students often pose this question. What would you change? What did you learn? What is the takeaway? How do we put this to work in our own ideas, startups, and teams?
Note down these lessons from Episode III.
a) Build businesses intimately linked to growth arc of your customers.
b) Pick segments that are growing and will continue to grow.
c) Natural incentives to convert.
d) Segments you reach, access and influence through channels you control.
Building financial models. Mostly Urdu.
Teach a 20 minute session on building financial modeling in Urdu without switching to English in between? Watch me fail miserably. How to build a financial model in 19 minutes.
Mostly Urdu (85%). Some English (15%). Excel model walk through. Some Excel required.
How do you link customer stories to financial models? How do you pitch a business model centered around the life arc of a single customer? (Mostly Urdu — 70%, some English — 30%).
Here is an example of a walk through of a real business that sells exam prep and continued medical education solutions to doctors and physicians in the making.
We start with the customer life arc, map that to LTV and link that to our financial model. How? Start with your customer’s journey, link to LTV, model churn and retention, link that to scale multiples, link that to financial model and build your pitch around that story. Excel model walkthrough included. Some Excel required.
The Zen of building financial models.
A framework for developing financial models the right way.
One. Build it to bin it. Your first model, your first set of answers are going to be wrong. Remember that. So there is a reasonable chance you are going to throw that away. If you are likely to trash version 1.0, don’t spend too much time building it.
Two. Build models from the founder’s perspective, not investors. Investors don’t mind. They like to see us founders think. If your models help them walk through your decision-making process, they would be happier with it.
Three. Create sub-models. Take complex models, difficult models and break them into simpler, shorter models that are easier to work with. Divide and conquer.
Four. Use dynamic assumptions, don’t hard code values. Sensitivity test assumptions & results, evaluate the interaction between assumptions, and use them to make strategic decisions.
Five. Calibrate your model to real-world assumptions and results. Real data, real results. Ask yourself is this how the real world works.
Do you have 4 minutes? Can I teach you something about financial modeling in less than 4 minutes that you can put to work today?
What is a simple financial model and how is it different from a complex one? How do we use simple models as building blocks?
Using Maya’s closet case as the background, we walk through three different types of models. From the simplest to the complex using the simpler ones to build the complex variations.
a) Can we give a real-life example of a simple model?
b) How do we grow and evolve a simple model into a more complex model?
c) How do sub-models fit together on a single tab in a meta-model?
