Revenue Forecasts: How To Sniff Out Overexuberance

Revenue forecasts and models are an essential part of articulating the financial goals within a startup. They are tools used to guide the organization, as well as communicate the financial path and valuation to the board of directors, investors, and all other stakeholders.

Lessons from the Inside

We (AgD2) have collectively been involved with dozens of startups and can safely say that most of them are overly optimistic regarding their revenue forecast assumptions, to the point that it has a significant impact on the valuation of the company.

Optimistic forecasting is to be expected, as there needs to be excitement of an upside for an investor. A conservative (more realistic) revenue forecast isn’t as exciting to an investor. As such, a CEO has to find the right balance between a “credible” and a “stretch” or “exciting” forecast. In most cases, the forecast is not credible, and most investors miss the red flags.  An investor needs to understand the critical assumptions which are being made, and to request that the founders transparently explain each assumption and its impact on the model. Founders can use different types of forecasting, depending on the nature of the business.

Forecasting - Bottom Up

This method involves calculating the potential revenue for a specific period by multiplying the number of likely sales for each product or product category in key geographies, the average value of sales, and when they are likely to occur. This is easier to do with a more established company and a sales history. Investors should look carefully at assumptions on market share, customer segments, and geographical markets in relation to regulatory constraints.

Forecasting - Top Down

This method involves starting at a macro level to find market size and potential market growth, and then estimating your own revenue as a function of your assumed market, specific crops, and the respective adoption rates. Investors should challenge assumptions on switching costs, market share growth, and true differentiation relative to existing products.

Learning How to Break the Mold

Transparent management and planning should be expected, and not feared. Startups have to be willing to put forward honest, credible, and well-researched assumptions when generating financial projections and valuation models. Many times, this is not the case, and potential investors and other partners will need to seek additional domain experts to thoroughly assess these assumptions and financial models.