Identifying lies in financial projections

One of the most dangerous mistakes an entrepreneur can make is to seek confirmation of his actions rather than seeking the truth. They want to do something, so they talk about it with people who work for them. They talk to their families and friends. But they're only looking for confirmation; they're not looking for the truth. They're looking for somebody to tell them they're right. But the truth always comes out, especially in financial projections.

Entrepreneurs usually “lie” to themselves (without knowing it) when preparing the financial projections. This is not “technically” their fault, they are just too excited about the opportunity and they usually end up by setting wrong assumptions when building their numbers. Sometimes is excessive demand, sales, time to market, market share, speed of growth… you name it. Some get mad at me when I point out their inconsistencies (it happened to me again yesterday, and it will happen many more times in the future, I am used to it now).

Financial projections usually tell a great deal both about the start-up and the entrepreneur. One gets very fluent at identifying “lies” in financial projections by seeing a lot of them. Healthcare entrepreneurs should be aware of what an income statement says, and what it hides.

Investors are looking forward to investing in start-ups that offer a very large opportunity (which could become 1st, 2nd or 3rd in the market, could generate long term competitiveness and, let’s say, a 10x return on investment). Every entrepreneur knows that when looking at the numbers, investors will be trying to anticipate how much total financing will the company need, how probable is liquidity and how long to get there, when does profitability occur, and milestones and fundraising events.

But there is much more information hidden in the financials besides that. For example, does the business model “scale” well? Do revenues increase at greater rate than expenses? Are sales projections realistic? Is the total amount of financing needed realistic? Have the costs of growth been factored in?

When analyzing 5-year projections, I usually look only at the first three years to learn about the start-up. Anything longer than that is just science fiction, the entrepreneur just does not know. But years 4 and 5 offer very useful information as well, not necessarily about the start-up but about the entrepreneur himself… Is he ambitious? Is he consistent? How aggressive is he? What is his vision of the company for the future?