In my last column, I outlined the reasons my investor pitch deck only has these eight slides. But to build a rock-solid case for your business, that's just your opening argument.
No matter how glossy, succinct or compelling your presentation, investors will want to sanity-check you based on three simple stories about your business. And if you fail to tell these high-level narratives quickly, coherently and convincingly, the money folks in the room will hit you with a high-level narrative of their own: they'll immediately cross you off their list. You won't get to a deeper dive. You won't be getting a check. You will be disqualified from consideration.
The three stories every investor needs to know you understand on a fundamental level are these: what you project your operating expenses, revenue, and customer acquisition cost to look like over a five-year period. They are the key storylines that every entrepreneur must be able to tell about their business, and they should look like this:
1. Operating expenses.
These are pretty straightforward: describe how much you plan to spend on your business. This covers the team you need to hire and all the things you need to buy to build your company. As a single narrative, operating expenses should act fairly predictably. They should go up in a linear fashion for the first two or three years as you start to scale, and then begin to level off in years four and five--no matter your sector or business. There should be no surprises or big guesses here. If your cost line makes a jump--or even a steep drop--you're going to scare the fish. Investors want to see a smooth, linear acceleration of the cost structure in your business that settles into a nice, flat landing. So develop a plan to make it so, and describe it in detail. Even break out the markers if you think it will help.
2. Gross revenue.
The next narrative is a logical counter to your expenses: how much you plan to make. In a good gross revenue narrative, the starting gun goes off when you go live with your product, somewhere between year one and two. Revenue should build slowly from there for a while before making a seemingly magical upward spike to form the fabled "hockey stick".
Of course, there's nothing really magical about this phenomenon. It's simply the moment in which the amount of money you're taking in starts to gain serious altitude from your cost structure. And when these two vectors cross--revenue on the way up and expenses leveling out--it creates a sweet spot called operational leverage. This is where profit lives and where yield will magically appear--the result of either greater efficiency or greater pricing power. All this goodness is why the hockey stick is the moment every business is looking for--from a local pizza joint to a big, disruptive company. In your business narrative, it's when everything starts to get very real indeed, and it should be a central plot point in the company story you tell investors.
3. Customer acquisition cost.
As a CEO, customer acquisition cost is your volatile third child. It comes into the world at a high scream and if it's not tamed as your business matures, it can bring down even the most determined company. Customer acquisition cost kicks in when you launch your product, and it's going to be shockingly high to start. Don't worry. It's okay on day one to pay a lot for customers--as long as this number consistently declines over time. In the early days of your business, you might even be spending $100 for every $100 of revenue. That's fine. But by the time you're up to $1 million in revenue, you better not be spending $1 million to land customers. This number should start to plummet around the time the hockey stick starts shooting your revenue up in the other direction. In fact, all three key business vectors--your plateauing operating expenses, your hockey-sticking gross revenue, and your plummeting customer acquisition cost--should ideally intersect around the same time in year three or four.
One more important note on customer acquisition cost: It has a rational and generally observed cap depending on your company type and industry. People who invest in your category know precisely what these caps are, so an entrepreneur should be firmly grounded in what the comparable narratives look like for whatever business they're building and be prepared to talk about them.
Make no mistake, the above three narratives all have to be going in the right direction for your story to be attractive to investors. But there's a fourth, decidedly less sexy narrative I've also found useful in explaining my business projections in a fundraising setting. Consider it the cherry on top of the key narratives above...
3a. Cost of goods.
In simple terms, cost of goods is just a number representing the cost of every unit you produce to be sold. Obviously, the goal is to get this number lower as you scale--primarily through better rates and other efficiencies. This ideally creates a growing separation between your increasing revenue and falling cost of goods, attaching more profit to each unit you sell.
But the REALLY big idea with cost of goods? It can literally de-risk your business. You can accomplish this by pushing as much of your spending into cost of goods as you can so it doesn't end up in another, much more dangerous cost category: high-variable expenses. Cost of goods is tolerable because it's fixed for each unit and is tethered to sales. It's like paying taxes: you only get a bill when you make money. That's far preferable to high-variable costs, which are unpredictable and involve you spending cash without any guarantee of results.
It's this exact type of spending that killed a lot of dot-coms back in the day. They lavished spending on expensive marketing campaigns--often without even knowing what their customer acquisition costs were. The cost-of-goods version of this scenario would be paying a marketing partner for an introduction to their members based on the actual sales it creates. That's cost of goods. And if you can explain to investors your plan for converting variable expenses into this far more preferable cost category, you're going to make a strong impression indeed.
Are all of the grand projections above going to pan out exactly the way you pitch them to investors? Of course not. Anybody considering putting money in your business knows there are going to be pivots, changes and setbacks galore. Every business plan is written to be a game-changer the same way every play in football is designed to be a touchdown. It does happen, but rarely in the way it's initially drawn up. Much more important is showing investors that you have a high-level understanding of the key vectors of your business and communicating a smartly conceived game plan for the challenges ahead.