‫Projecting financial statements.
‫We're still in years five to six and we'll be going public
‫soon, maybe next year or the year after.
‫It's coming up soon, you'll enjoy the process.
‫Goldman Sachs is gonna take us public.
‫Okay, so, when creating forecasts, we usually
‫project at least three to five years,
‫and again, we always start with sales projections.
‫Remember we talked about budgeting?
‫We talked about sales as the most important
‫thing you can forecast, it's the same thing
‫with companies forecasting for financial models.
‫And so you create projections, which people
‫on Wall Street call pro forma financial statements.
‫I don't know why, it's just a projection.
‫So what is the most important thing to assess
‫for a potential investment in a start-up?
‫What is it?
‫Well, we talked about it before.
‫It's the management team, and there's no point
‫in creating a financial model if you don't
‫have an incredible management team.
‫So when I do my due diligence on potential
‫venture capital investments, I don't even bother
‫making a spreadsheet or forecasting financials
‫if we don't have the best management team in place.
‫Remember, the jockey is always
‫more important than the horse.
‫And I love this quote from Michael Dell,
‫I'm gonna say it again, and it's,
‫"Ideas are commodities, execution is not."
‫Okay, so, is the TAM big enough?
‫I always ask myself that as well
‫before investing in a company.
‫Is the total adjustable market big enough?
‫And we talked about this on the first day of class
‫as well, and so, this company that we're going
‫to invest in now, it's got a TAM of $50 billion.
‫Now, bear with me for a while.
‫We're gonna do a model, and we're gonna assess what
‫the TAM is first in order to be able to forecast revenue.
‫So we're gonna build a model, a long term model.
‫We're gonna invest in this company
‫because we just found out that the management team
‫is amazing, and this management team
‫has had multiple past exits before in the technology sector
‫and the size of the market is $50 billion.
‫So we're really excited about this hypothetical investment.
‫And the founder of this hypothetical company
‫that we're gonna model believes that his firm
‫can capture 10% of the total adjustable market in 10 years.
‫So the TAM is $50 billion, and this guy thinks
‫that he can be 10% of that market in 10 years,
‫So that's, what is that, $5 billion in revenue.
‫Okay, okay, let's look into this.
‫So, whenever you're creating models for private companies,
‫and today's session is all about private companies,
‫and later we'll actually do a model on a public company,
‫which is a lot easier 'cause
‫you have a lot more information.
‫So when you're modeling a private company,
‫you start with a total adjustable market
‫and you figure out what percent of revenue,
‫or what percent of the TAM this company could get.
‫So in this case we know the TAM is $50 billion
‫and the founder thinks that he can capture 10% of that.
‫So this guy is gonna get $5 billion in revenue in 10 years.
‫So we'll create revenue, we'll model out a long time,
‫10 years maybe, whatever, and then we'll list assumptions.
‫And remember, everything's just a percent of revenue.
‫Now I'm gonna show this to you in action.
‫So we start the model building with sales.
‫I'm using Microsoft Excel, you use whatever
‫spreadsheet software you want.
‫I like Excel because I've used it forever now, and it's
‫actually pretty cheap if you use Microsoft Office Online.
‫I think it's less than $10 a month if you're a student,
‫and you get serious discounts too if you're in university.
‫So, I digress, here we go.
‫So the TAM is $50 billion, the market share in year 10
‫is $5 billion, and let's just say the average selling price,
‫the product that this company is making,
‫the average selling price of the ASP is $100,000.
‫And so if we take $5 billiion in revenue
‫divided by $100,000 per unit, or the average price,
‫then that gets you to 50,000 units sold in year 10.
‫Remember, what we're doing now
‫is we're figuring out revenue.
‫So, okay, fine.
‫So in year three, this person told us that he can get
‫to $500 million in revenue, and most people
‫I would call BS on it, but this guy is so awesome
‫in the last company he founded that he actually
‫got his last firm to $350 million in revenue by
‫the third year of existence, which is amazing, and again,
‫most companies go public, that are successful,
‫in year seven or eight or nine, whatever it is.
‫Okay, so let's keep modeling this.
‫So I'm playing around with the numbers here.
‫And usually this whole process of trying to figure out
‫revenue takes me at least a day, and I make a lot
‫of assumptions and then I finish what I believe
‫to be the perfect revenue forecast for the next
‫five or 10 years, and then I go to bed,
‫and then I get up the next morning and I look at it
‫again with a fresh mind, and quite often
‫I make minor tweaks here and there,
‫and then I'm done with revenue
‫and I model the rest of the company.
‫So you're gonna see a truncated or smaller version
‫of this whole revenue process for me
‫when it comes to forecasting, so as you can see,
‫I'm forecasting the year over year growth in the number
‫of units, and so by year 10 you see that they're expecting
‫50,000 units, and I'll just kind of walk through it
‫until I get the right numbers set up,
‫and I'll always list everything I'm thinking about
‫as I go through this process, so when I revisit my model
‫I can understand the logic that was in my head at that time.
‫Okay, so I'm gonna read some of the line items
‫off of my Excel spreadsheet here.
‫So in year three, our guy said he can get to $500 million
‫in revenue, hmm, this seems pretty aggressive.
‫Let's assume it's $400 million.
‫You see what I did there?
‫It's a little bit more of an art than
‫a science when you're modeling.
‫The science is the mathematical calculations,
‫and the percentage of the TAM you think you can get
‫loaned to term, but there's an art side to it as well,
‫and that's why finance is a little bit more
‫of an art and a science type of process
‫or analysis process than accounting is.
‫This growth is pretty high.
‫Let's assume it slows down a lot in future years
‫just due to the law of large numbers.
‫So I get the 50% unit growth in year 10.
‫That still seems high.
‫My numbers are way too big.
‫I'm just reading here.
‫Okay, let's haircut them a lot.
‫Okay, but the increase between year two
‫and year three seems nutty high,
‫I don't think 10% share in 10 years can be done.
‫There will be a recession at some point,
‫and these growth rates seem too high.
‫Okay, fine.
‫Let's assume that this is our uber-optimistic scenario,
‫as companies don't grow at triple digits
‫for that many years in a row.
‫Okay, so here's where I'm at right now.
‫So, 50,000 units in year 10, I'm at 51,000 now.
‫In 2015 there's 20 units coming to launch then,
‫200 the next year, then four grand,
‫then 2018 that got 8,400, and then you can see
‫the year over year growth there, which is high.
‫It's still way too high.
‫Look at that triple digit year over year growth there
‫in year 2020 through 2024, unrealistic, unrealistic.
‫But the reason I'm showing this slide is because
‫I want to show you that the revenue line item
‫is, quite simply, the number of units multiplied
‫by the average selling price of 100 grand.
‫And we're gonna tweak that a bit.
‫But I also want to show you this slide because
‫you can see a yellow box there, and that yellow box
‫I put a comment, and if you're using Windows and Excel
‫you hit Shift F2 which inserts a comment,
‫and then on Mac just right click or whatever
‫and then put in a yellow comment.
‫And the best practice is always to put your name
‫in the comment, and quite often if you're working
‫with big teams of investment bankers or M and A people,
‫whatever it is, or a mutual fund analyst,
‫what you do is you put your name in that comment
‫as well as the date and the time that you
‫put that comment in, and why you put that comment in.
‫It might be based on a conversation you had with
‫somebody that's a C level or an executive or an
‫investor relations professional at that firm.
‫Okay, let's keep going.
‫So I wrote here, again, there must be competition at some
‫point, so we have to haircut the average selling price.
‫So we'll assume competition enters the market
‫in three years, and at that point the price drops
‫from 100 grand down to something else.
‫And so I did it right here, you see that, actually
‫by the end of the third year and into the fourth year,
‫I assume that the pricing point is no longer $100,000.
‫It actually drops to $90,000.
‫That's why I multiply it by 0.9.
‫And so pricing components come down as well,
‫and I think this company, actually,
‫is making a pretty revolutionary appliance.
‫It's a hardware product that has some
‫really cool software in it as well.
‫This is just an exercise, so we're not gonna go into too
‫much detail of the qualitative background on this company.
‫Okay, so we took a haircut pricing wise.
‫And then we comment our code
‫or our spreadsheet, I should say.
‫When I used to be a programmer at Accenture,
‫another tech company back in the 90s,
‫I would program a lot, and I'd always add comments
‫to my code, so when I revisit it in the future,
‫or if a colleague revisited it, I could understand
‫what the heck I was coding about at that time.
‫And the same thing can be said here when it comes to Excel.
‫Add lots of comments, really important.
‫Okay, so I'm expecting a 20% price cut the following year
‫here, you can see that on the spreadsheet.
‫Especially since component costs are always dropping.
‫Okay, I understand what I was saying there.
‫All right, and so I keep playing around with the model,
‫I keep tweaking it, you can pause the presentation
‫any time you want and read my comments there.
‫I'm not gonna go into too much detail on this.
‫And then I assume that by year 10, or 2024,
‫whatever it is, you get a 40% price cut.
‫So prices come down significantly from
‫100 grand today to $40,000 longer term.
‫Okay, great.
‫And then what I do is I copy that revenue column,
‫and I want to take that column and paste Special as a row,
‫so we can make our income statement.
‫Remember, the top of the income statement
‫you've got revenue in that row.
‫And so what you do is you right click,
‫you go Paste Special, you paste the values,
‫and then you transpose.
‫And transpose is just an Excel term for
‫take columns, turn into rows.
‫Okay, great, so we did that, and so I have all my comments
‫here, the company said they think they can do
‫$350 million in three years from now.
‫Based on our revenue analysis and our revenue projections,
‫we think $350 million is more appropriate.
‫And I basically just took a 24 hour, or 18 to 20 hour,
‫whatever, exercise of modeling out revenue
‫and I truncated it into 10 minutes or so.
‫Okay, great.
‫So we're gonna move on to expenses.