9 rules of thumb to detect BS on financial projections and assumptions
I’ll spare you the long story of my life and how I’ve got to be above average when detecting BS on projections and assumptions (financial or not). But there are a few rules of thumbs that you can use to quickly validate some assumptions on your own projections or on someone else’s projection in case you are an investor.
Each industry is significantly different from the other as to assumptions not being easily transposed. So, mostly of what I talk here only applies Web-based consumer services. On the same note, unless two companies are on the exact same market, have the exact same positioning and exact same product, it’s hard to say that everything you know about company A applies to company B. So, whatever you do, you have to figure out how to validate assumptions on a case-by-case basis, however, there is the bullshit line. This is line that anything above it (or below it) is guaranteed to be BS.
The most easy BS threshold to detect is the growth of X, where X can be users, page views, widgets, etc. If someone tells they expect a 30% month-over-month growth for the next 2 years, you just detected the BS line. Why? Simple math. A 30% growth M-o-M for 2 years would mean a 41,654% growth in 2 years. That’s like saying you have 100,000 users today and in two years you’ll have 41 million users. Of course, the most used argument of a BS projection is to talk about examples like YouTube or Facebook.
Here are some simple direct numbers (BS lines) that you can use to validate your projections or your portfolio company projections that I use myself (see some exceptions after the list):
- > $10 CPM (at niche): On the context of web advertising, even highly targeted ads are very unlikely to reach above $10 CPM. You’ll hear a lot about how the price of ads will go up, how profiling data on users will help drive up the price of ads, yada, yada. Above $10 CPM is BS to me.
- > $4 CPM (at generic): On generic audiences website, it’s nearly impossible to get more than $2 CPM, and most sites are below $1 CPM. There is a step function in terms of volume and price because you can negotiate better rates (even w/ Google) if your volume gets really big (> 20 MM PV), but still, you won’t be getting $4 CPM for a photo-sharing site or any other kind of generic service.
- > 20% Conversion Rate: Defining conversion rate as the number of people that sign up to your service divided by the number of people that visited the website cannot be above 20% and more likely will be between 5 and 10%. I can give you many reasons why this is true (another blog post), but if you think you’ll be getting more than 20% conversion at a high volume, stop.
- > 5% Conversion to Premium: If you are on a “freemium” model it’s nearly impossible to get past the 5% conversion to premium of sign ups (notice: that’s 5% of the sign ups, not 5% of the visits).
- < 50% Churn of New Users: If you are offering a free service, a free-trial or a freemium (free w/ ads or paid), you should expect a huge churn of new users. People might just be evaluating your service, they even might have been mislead into believing your service is a duck while it’s just a chicken by your hyperbolic marketing material. Either way, if your model projects a churn of new user of less than 50% I call it BS.
- < 3% Churn of Active Users: The biggest problem with projections of churn of active users is not low numbers, it’s that is not even modeled. People think once they get a user, they get a user for life.
- > 10 visits/UU/month: Really? You think you can get each user to visit 10 times per month? On *average*?!! Yikes.
- > 30 PVs/visit: I love web stats and this is one of the most interesting ones. 30 PV/visit is impossible (see exceptions), and even that number is ridiculously high. More likely a site will have 5 PV/visit on average, anything above 10 PV/visit is suspicious, above 30 is BS. And the more your site’s traffic depends on referrals from search engine, the closer it gets to 1 PV/visit.
- $0 Customer Acquisition Cost: Ah, what the heck. Your site is super-duper viral and signing up just 1 user will bring another 100, that will bring another 10,000, that will bring another 1,000,000… Yay!
The list above are the most obvious data points, and probably most used, on Excel spreadsheets all over the word trying to justify a business model. Feel free to complement or disagree with my list on the comments.
Exceptions: Mostly you can apply these rules to any web-based consumer service, except communication services, like email, IM, chat, forums, etc., because they have very high number of return visitors, high number of PV per visit, etc. On the flip-side, the CPMs for those service take a nose dive.
