Why Believing Your Own Projections Is Risky Business

Why Believing Your Own Projections Is Risky Business
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Hank Aaron once said, “Guessing what the pitcher is going to throw is 80 percent of being a successful hitter. The other 20 percent is just execution.”

While this may work for baseball, the trouble is, in business, the whole guessing part is much tougher. Why? Because you’re working with more variables than eight to nine pitch types. And that means, despite your best attempts to calculate the future, predictions are a hell of a lot less likely to be right. In fact, in early-stage businesses -- between one to three years -- they are almost always wrong.  

For you (the entrepreneur), that creates a dilemma in planning, hiring and investing in overall growth that can make or break your business.

Related: 8 Secrets to Credible Startup Financial Projections

All too often, we see business leaders succeed in raising money and become completely absorbed in planning for (and investing in!) growth -- ignoring their business as it stands today and ramping up their burn rate from 0 to 60 in a matter of seconds. They assume they can be successful in expanding into the space they’ve made for themselves. That they’ll grow big enough and fast enough to account for the resources they’ve laid out in preparation. But they do so based on the same lofty projections mentioned above. As a result, most of their investments leave them over-committed and stretched thin without the return to justify it.

We all run a high risk of this. It’s too easy to get caught up in the very same hype we used to raise money and the excitement of new investors cheering you on to "grow fast. Beat the competition. Own the market!" Staying grounded at this stage is difficult to say the least.

The very same erratic variables that investors are willing to accept as part of doing business become your Achilles heel. You’re the one left holding the Board Report, the dilution reality and the leadership struggles. Funded or not, the worst thing you can do is spend money as though your predictions will play out flawlessly -- because you know better than anyone that they’re riddled with risky assumptions.

Unicorns seem to be especially guilty. They experience rapid growth prior to funding and land extremely high valuations as a result. The funding they receive comes with the expectation that they’ll maintain their growth curve -- and everyone in the business buys into this theory. The blinders go on, and the people leading these Unicorns spend based on the reality of the business as projected one to five years out.

The bubble watchers refer to these companies as “paper unicorns,” whose valuations may never be realized. Most paper unicorns turn into “Unicorpses.” And it’s no wonder. They’re burning through cash at a rate that traditionalists would gawk at long before their earnings come close to landing on the same playing field.

Brad Feld said it best: “I’m encountering an increasing number of companies with burn rates in the stratosphere… when I see $2 million per month net burn rates, I vomit. And a $4 million per month net burn rate, even if you have $100 million on your balance sheet, makes me physically ill.”

The very, very few that start low and left and grow up and right on a daily basis may seem to justify modeling the foundations of a business on rapid growth. But they too suffer from aiming too high, as only a fraction of them will maintain their growth. The rest will see growth curves slow, people (investors) get nervous and blame gets thrown around. The media, however, will continue to highlight their story, only this time, to herald the death of the new, new thing.

What happens when you bet the bank on projections -- and miss?

We’ve seen a growing number of tech giants miss targets and re-evaluate projections. As a result, they’re forced to slow hiring or initiate massive layoffs. High valuations don’t protect these guys from the natural instability of business, despite the fact that they have entire teams dedicated to measuring and predicting the future. Two of the biggest challenges you deal with when "going big" are, unfortunately, the hardest to manage as well -- headcount, and (one of my favorite topics) real estate.

Take HotelTonight, for example. In 2013, their office was featured on TC Cribs. Today, it’s partially vacant, as the company laid off 20 percent of its staff.  Did they do something wrong? Probably not. HotelTonight is a great company and service, one that I use often. They simply fell victim to unpredictable growth.

Related: 6 Ways to Make Financial Forecasts More Realistic

And they’re not alone. Just this year...

Take a look at the unicorn list for yourself, and see what’s happening in the marketplace.

The unicorns will soon have no place to roam.

Getting back to one of my favorite topics, one of the biggest challenges here is how to manage for realistic growth expectations when betting long because of the static structure of commercial real estate. The long-term nature of commercial real-estate deals mean you’ve got a fixed overhead, and you’re paying a pretty penny for it.

You don’t have to have deep pockets and an accelerated growth plan to find yourself stuck with $70 per unused square foot in New York City and $23 per excess square feet nationally. All it takes is a business attempting to plan for growth -- yes, even at conservative rates -- in a model that does not account for change, and boom, you’ve committed to a lease that doesn’t change with your business.

Fortunately, what I’ve seen more and more of lately, is the fear of a bubble driving increasingly realistic investment strategies at the board level.

Brokers beware!

So what does that mean for the people who earn their livelihood by matching companies with the best space for them? As a broker, if you’re looking to land the next unicorn, you can expect their team, their board and their investors to keep a much tighter leash on overhead.

Well-funded businesses will start to be more conservative with their spend and expansion rate. They’ll look for flexibility -- the option to expand and contract without penalty. The SaaS (software as a service) model was built out of the same need not so long ago, and office space will need to follow suit.

So where does that leave us moving forward?

My predictions for 2016

  • Agile businesses who’ve proven their ability to grow on a small budget are be most likely to become the next generation of unicorns -- and the brokers who spot them early will be most likely to close them.
  • Brokers who leverage the examples of failed expansions and provide forward-thinking solutions will be successful in gaining the attention of sought-after clients.
  • Brokers who provide clients more flexible solutions will be the top commercial real estate producers in 2016.

As entrepreneurs, we all understand the unpredictability of our businesses. We sweat it out every day, every quarter end. Let’s not get caught in the hype cycle created by those who don’t sit in our chairs every day. Let’s make sure we plan for flexibility and work with brokers and others who understand how businesses actually grow. And let’s go build great businesses.