[photopress:guy2_0_1.jpg,thumb,alignright]Over on Guy Kawasaki’s Blog “How to Change the World – A Practical Blog for Impractical People”, Glenn Kelman of Redfin posts their Actual Numbers against “The Redfin Model” figures in a post titled “Financial Models for Underachievers – Two Years of the Real Numbers of a Startup”
Seems the model is based on worst case scenario, to increase the odds of repeated rounds of funding. Glenn says: “…we heeded Guy’s advice that ‘the three most powerful words you can utter at a board meeting are, We beat projections’. This convinced us to develop the worst possible financial model that could still be used to raise money.”
Hmmmm. So you set your sights artificially low, so you can say you beat projections when asking for more money. Had the sights not been intentionally low, maybe there wouldn’t be a new round of funding. I guess that’s a strategy. But it sounds a bit deceptive, doesn’t it?
Surely people spending lots of money, aren’t totally awed when someone says “We beat projections!”. One would hope that they would first ascertain if those projections were intentionally placed at worst case scenario, just so they could say “we beat projections!” to get more money. One would think investors on a grand scale are a little smarter than that…or at least we hope they are. But looks like Guy and Glenn know for fact that they are not, and are capitalizing on that fact.
It really is a great article, and Glenn is offering sanitized versions of the model for others to follow. But if people looking for money can read this and use that model, wouldn’t the people handing out venture capital also be reading this? Wouldn’t they in turn learn to scoff when someone says the magic words: “We beat projections!” again and again?
Yup, it’s “A Practical Blog for Impractical People” alright. Sounds like the practical people are the ones asking for money, and the impractical ones are the people giving the money.
Other blog posts commenting on Guy Kawasaki’s post:
Sneak a Peak Inside Redfin by Joel Burslem on FoREM
Nick Bostic on Radiohead and Redfin (not quite related, but cute and noteworthy)
Tim Berry of Up and Running quotes the quote “Plan slow; Run fast”
Not to put words in Glenn’s mouth, but when he talks of putting up worst case scenarios, I think the idea is this: Be pessimistic (ie. high) on your costs. Be pessimistic (ie. low) on your revenues. If your model still shows you making money, then you might just have yourself a viable business model.
He may have been cautioning entrepreneurs to not succumb to the temptation of being optimistic on both your costs and revenues, because if you are, practically any hare-brained scheme out there will seem to make money — on paper!
I completely agree with Kevin. As a software professional I always inform my clients of the ‘worst case scenario’ when I tell them the numbers of developing a piece of software. As anyone who has ever done anything knows the worst case scenario happens more often that statistics would warrant.
By presenting a pessimistic view and not overreacting to how great you think your new company is then you are giving your potential investor a ‘realistic’ view of their returns. I think it would be irresponsible to present anything other than the worst case scenario when talking to investors.
Ardell doesn’t seem to be thinking from the investors point of view. If you are an investor you are ‘agreeing’ to give money to someone based on the projected return. If someone gives you their pessimistic view and you still find it an acceptable return and decide to invest then of course you would be happy if they beat your acceptable return.
Kevin… exactly… given two pitches which would you fund… the pie in the sky guy saying “we’re banking on 10,000,000% growth month after month because we’re all on happy pills” or the guy saying “this is the worst case scenario, we make X%”.
One person thought it out… the other person is just guessing.
There’s a place and a time for hope, faith, enthusiasm, emotional decisions… but if it’s part of your business plan you’re screwed. You might get lucky, you might not, what kind of business plan is that?
I wonder how much they paid Guy for MBA 101 advice?
I totally agree with the “worst case scenario” logic, and ALL of Glenn and Guy’s “tactics”.
But you have to scratch your head when the basis for more money seems to so heavily rely on the fact that they outperformed the worst expectations by a smidge…no?
It’s not Glenn or Guy that I question, it’s the logic of those pouring the money in. Could it really be as simple as being able to set the goals so low that you almost can’t help but outperform them? Are investors really that easily fooled?
In true Dilbert style – some companies try to prevent this by punishing executives who beat the projections by too much. One of my good friends is the VP of a large local software company and recently got in trouble for having an outstanding quarter because they suspected he projected purposefully low on purpose (which wasn’t the case).
If you think about this tactic in the simplest terms it makes sense. If I put money in a savings account that says they’ll give me 5% back and I don’t get 5% back I’ll be pissed. But, if they give me 10% back I’ll be happy. If they give me 10% back 3 quarters in a row I’ll put more money in. Wouldn’t you? If they drop back to 5% – c’est la vie. Do I care that they obviously low balled what they’d give me back? No. The market then corrects for this… if you have 3 banks they need to start upping that % return without failing too often. With competition, abusing this concept is hard to do.
I think Ardell brings up a great point and it’s part of the reason I find most of my finance degree pointless. Investors, be it VC or day traders, base so much of their investments on emotions – typically blindly. I spent a couple of years learning how to value a stock, then when my instructors would have me do a real life example and all my calculations were correct, the price was still off. It’s the emotion-factor.
Same thing with these VC’s. “We beat expectations” sounds great after the original .com bubble burst where money was continuously poured into companies that didn’t even come close to meeting expectations.
As ben points out though, this is pretty much MBA 101 (or even BA101). I learned how to write a business plan and it was always beat into me to set my revenue goals low and my expense budget high. That way I wouldn’t run myself out of business.
Also, thanks for the plug, I wasn’t intending on it being “cute”, but I sure don’t mind.
Related to my field…that’s why I am the “anti-Gary Keller” 🙂 Though can’t say I learned any of that at Wharton back in the early 80s. I learned it from my Mom.
I think Glenn’s post was overly-pessimistic. I was most surprised at his claim that revenues were a “black hole”; he could have forecasted a tad better than that.
His transparency was attractive. He has an innate ability to get you to “root for the underdog”.
I was shocked that he asked for Greg Swann’s contribution in redefining his pricing model. However, both players are true mavericks with an eye for change. Sometimes, strange bedfellows makes beautiful offspring.
Ardell is right: lower projections result in a lower valuation. We can live with that. But at some point we also have to project significant growth, to generate the returns that VC’s expect. We’ve tried our best to steer between the Scylla of low valuation and the Charybdis of unrealistic projections. Nice post, Ardell.
Thanks Glenn.
Brian, you are missing something. The “underdog” that everyone roots for is not Glenn or Redfin, it’s the buyers who are often left with the short end of the stick in the real estate arena. Everyone is “rooting” for the underdog, the buyer, getting a little more control of information and commission negotiations. Redfin spearheads that movement.
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