No, I am not encouraging you to have a drink right now (but feel free if it’s past Happy Hour in your time zone!)

I wanted to briefly point out the difference between a bottom-up and a top-down valuation approach for companies. We run into this topic frequently with company founders who too often rely on the top-down approach.

The top-down approach uses a percentage of the overall market size to forecast revenues. For example, if the total market size for your product is $10 billion annually and we forecast to have 2% of that market next year, our revenues would be $200 million.

The bottom-up approach is a little more complicated as it translates how we are going to generate revenues into formulas and assumptions. For example, one bottom-up approach is to give every sales person in the company a sales target (not in dollars, in products sold). The more sales people we hire, the more product we sell (and generate revenues), but we are also adding to costs. There is also a limit as to how many sales people can be hired, and there is typically a ramp-up phase once a new sales person is hired during which they do not reach their full target. Another bottom-up approach is to forecast the effectiveness of telemarketing efforts and how that translates into sales. For example, let’s assume a telemarketer can make 20 calls in an hour, and has a 5% success rate. That would give us one sale per hour.

Investors want to know how you are going to achieve your revenue forecasts. They want to see that you thought about which sales and marketing channels you are going to use, and how effective you think they are going to be. No one is going to hold you to these numbers. But investors want to know that you thought of your execution strategy, and how that translates into revenues. The worst thing to say in a pitch meeting is this: “if I only have 1% of the market in year 5, we are going to be a $100 million business!”. Fail.

So the next time you do your forecasts, think of having a drink. Bottom-up is the way to go. If you have any valuation related questions, or any other questions surrounding start ups, fundraising, or strategy, do not hesitate to contact me directly.

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