By Rob Meissner, TCV Growth Partner.
Several times a year I volunteer to review grant applications. The grants support very early stage companies, often spin-outs from universities who have promising technologies. In a typical cycle, each review panel studies three applications, and only one is likely to get funded. My role as a reviewer is to assess the company’s business potential. In reviewing the applications I look to answer the following questions: Is there clear evidence that the proposed product or service addresses a significant customer need? Is there a large addressable market? Is there a sustainable competitive advantage? Is there a clear go to market plan? Is there a strong management team? Given the very early stage nature of these companies, I generally give great leeway in looking at the company’s pro-forma financial statements. However, in each cycle I see errors in the financial statements that raise serious red flags about the business skills of the management team and which can doom their application. The three killer mistakes that I repeatedly see are:
Balance sheets that don’t balance – As basic as that seems, it’s surprising how many grant applications don’t have balance sheets that balance. I’m not referring to a balance sheets where there is an error in an Excel formula. I am referring to balance sheets that show only assets, or balance sheets with a high value for assets yet very little offsetting value for liabilities and owner’s equity.
Made up Values for Intellectual Property – One of the reasons balance sheets don’t balance is that the intellectual property is often listed on the balance sheet with some arbitrary value. I’ve seen everything from $50,000 to millions of dollars. If listing IP as an asset reflects a decision to capitalize patent or research costs (not typical for University licensed IP), then there should be a balancing entry to reflect the use of cash or the liability that was created. Yet often it isn’t there. Understandably a company’s founder takes great pride in their invention and surely it’s worth something. But, just because you believe your IP has a certain value doesn’t mean that you don’t have to account for it properly.
Projections that Make no Sense - Other red flags in the financials come in all sorts of shapes and sizes. On the revenue side red flags include projections that are too low ($100,000 in year five), too high (zero to $100 million in two years without and support for such a jump) or are not internally consistent (the projected revenue doesn’t come close to matching the projected units sold times the anticipated price). Having zero cost of goods sold is another red flag. Even in a software business, there is going to be some cost such as distributing the software or hosting it on a platform such as AWS. Other red flags include very little sales and marking expenses, no ongoing R&D costs, or other items that don’t fit the go to market plan described in the application
No one expects the founder of a company to be an expert on everything. If putting together financial projections is not in your wheelhouse, get help. Add someone with a strong business background to the management team, even if on a part time basis. If you need help, talk to one of the partners at TCV.
Rob Meissner, TCV Partner