You’re either taking investment to launch and grow your legal tech startup, or you’re bootstrapping it. And, really, it’s probably a little bit of a mix of both. Even if you’re relying on investment to fund the product build, you’re probably covering your own marketing and travel costs. It can be a slog, and it can feel like a constant scramble for money when you’re getting started. That’s one of the reasons you build a financial model, although there is another, more important, reason for doing so.
Financial modeling for startups is, more than anything, educated guesswork. You’re conjecturing about what your market entry and growth will look like. You can look at all the comparisons you want, but it’s impossible to predict your numbers. Even so, a financial model for your new business will get you closer to what your actual numbers will be than no financial model at all. And, it can help you to reach your financial goals. If you create a moderate financial case for your business, you can set your goals higher. If you set an aggressive financial case for your business, be prepared to work like a dog (more like a dog?) to meet it. If nothing else, financial modeling for an early-stage startup, especially if you haven’t started a business before, gives you a window into what things will look like further down the road. It’s easy to get discouraged when you’re building a business. One of the ways to ward off that frustration is imagining a world in which your company is generating revenue. It provides a sense of hope and some interim goals you can strive for, in the midst of what might otherwise feel like hacking away for nothing.
Of course, the chief reason for designing a financial model is that it and your pitch deck are going to be the main inputs that a savvy investor will want to see from a startup. If a potential investor asks you for a financial model, and you don’t have one, you better be able to play it off, or run (don’t walk) to create one in short order. A financial model is also going to offer an investor a peak into your expectations about the kind of money your company can make, and whether that vision is reasonable, based on the factors included in your model. In essence, a financial model reveals (often better than a pitch deck) whether you know what you’re doing. So, know what you’re doing.
And, at this juncture you may be asking yourself, what am I doing? Good question. A standard financial model is going to be a spreadsheet, and you should brand it with your logo and colors, for consistency’s sake, and also to continue to build out your brand awareness. It helps to have an overview sheet, a growth hypothesis, a cost hypothesis, and then a full-scale financial model, showing month over month revenue and costs (overhead). Your overview sheet will show your total revenue for 2-3 years, and will show your costs (including costs of goods sold). Essentially this is your revenue minus overhead projection on a year over year basis. If you’re using a subscription model for your product, the acronym ARR (annual recurring revenue) stands in for the term “annual revenue.” In your overview, you should also acknowledge (if it’s the case) that your company will not immediately turn a profit (which is why you’re asking for funding in the first place) — so, include the amount of cash you need to cover your costs until you’re profitable. Your growth hypothesis sheet should show a quarter by quarter analysis for your revenue based on your average price point, customer growth percentage and churn rate. (Your churn rate is the percentage of existing customers you lose each quarter. And, this number should go down as your product stabilizes.) Your cost hypothesis is essentially a rundown of your overhead. Since the most significant cost for any company is its people, start with salaries. Founder salaries can (and probably should, at the early stages) be lower than employee salaries. Then address your product development costs and your marketing costs. And, if you’re establishing a legal technology startup, those are going to be your three major expenses: hiring good people, building a good product, and engaging an effective marketing campaign. There are other miscellaneous costs (legal services, office supplies, etc.) that should be included here as well. If you don’t know what your costs will be, research them, to establish a realistic scenario — and understand that you’re likely to blow by your projections. In your full-scale financial model, you will offer a granular look into how your company will grow over time. Whereas ARR is annual recurring revenue for a subscription-based software company, MRR is monthly recurring revenue, and you should follow that format, if the pricing model applies, in arraying your full-blown financial model. Incorporate everything that came before (costs, growth percentage, churn rate, etc.) into the most complete representation of your financial picture — and run it out 2-3 years.
Of course, things change all the time in startups until footing is found, so you’re probably going to rework your financial mode (and your pitch deck) about a hundred times. That’s okay. Running a startup is about standing as upright as possible on shifting sands, but things will stabilize over time – and your financial model is the document that best highlights what comes next.
Jared D. Correia, Esq. is the CEO of Red Cave Law Firm Consulting, which offers subscription-based law firm business management consulting services for law firms, bar associations and corporations. Red Cave also works with legal vendor to develop programming and content. Jared is also the COO of Gideon Software, Inc., which offers intelligent messaging and predictive analytics software built exclusively for law firms. A former practicing attorney, Jared has been providing services to lawyers and law firms for over a decade. He is a regular presenter at local, regional and national events, including ABA TECHSHOW. He regularly contributes to legal publications, including his column, ‘Managing,’ for Attorney at Work, his ‘Law Practice Confidential’ advice column for Lawyerist and his column for Above the Law focused on the legal technology startup community. Jared is is the host of the Legal Toolkit podcast on Legal Talk Network. Jared also teaches for Concord Law School, Suffolk University Law School, Solo Practice University and Becker College. He loves James Taylor, but respects Ron Swanson; and, he tries to sneak Rolos when no one is looking.
