Why founders need to know their numbers

Founders, think your finance team is the only one who needs to know your startup’s numbers? Think again. We explain why investors care.

Investors care about a startup’s financials, so founders should care, too.

The best companies are master capital allocators. Their founders know where to invest financial and people resources to create the best shareholder value. For startup founders who want to raise venture capital, it’s essential that they know and understand their numbers, including how to improve them. While both are important, here we are going to focus on helping the founder understand the investor's point of view, at least around financial due diligence during fundraising.

Why do investors care?

Investors make bets on what companies can become huge by diving deep into the numbers: historical performance, unit economics, conditions for generating cash flow in the future, and the size of the market. Before investing, they want to know how a company is doing to evaluate its current business model and growth potential, which requires accurate financial statements and metrics. Having a compelling story, large market, and financials that support that vision gives founders an advantage in gaining investment and negotiating more money for less dilution.

To understand this better, you have to understand a VCs motivation. VCs incentives are driven by the responsibility to their own investors (Limited Partners), who typically evaluate the performance of VC funds based upon multiple on invested capital (MOIC) or internal rate of return (IRR).

Due to the power law dynamics of venture capital—where a few massive hits more than make up for all of the losses—MOIC is determined by investing in “fund returners,” companies that have the potential to be valued at a high amount and return multiples upon multiples of cash back to investors. Investors want to attract founders that are going to build the biggest companies by shareholder value.

How do investors value startups?

Companies are valued mostly on their financial performance. This is based on financial statements and financial metrics, as well as the growth rate of those metrics, especially revenue growth. Revenue growth is typically the proxy for how futures investors will value a company - free cash flows. In the early days before there was much revenue, there is some influence based on the team and market size.

Investors want financial statements prepared on an accrual basis so they can compare companies’ apples to apples. If one company’s financials are prepared on an accrual basis, it provides better insights into a company’s true revenue and performance.

What do investors want to see?

Investors generally want to see financials sent quarterly, sometimes audited to increase investor confidence in their accuracy. They also want to see quarterly metrics or sometimes more often in the form of investor updates so they know how a company is doing over time.

At the end of the day, the person responsible for a knowing startup’s numbers is the founder/CEO. Financials are the language of business, and every founder should know how to speak the language of the business. Without financial literacy, they cannot understand their business nor adjust the levers to improve it.

In fact, if an investor doesn’t ask about numbers, it’s not actually founder-friendly. Letting a young company continue without financial discipline is a disservice to the founder and their startup.  It is the founder's responsibility to demonstrate leadership and commitment to not just having their numbers, but knowing their numbers.