At Edison, one of my main responsibilities is leading financial diligence for our investment opportunities. Before jumping into diligence, we ask the company to present to our partnership and to provide a pitch deck in advance, which generally includes 3-5 slides of financials. So, if you’re coming to Princeton to present next Monday, you might be wondering, ‘what are the big things Edison looks for when reviewing your financial statements?’
- What was the Cash Burn over the last twelve months?
We've found capital efficiency to be a key indicator of a company’s sustainability and seek this charcteristic in investment candidates. If the company has been irresponsible with prior investments, why should we believe anything will be different with this upcoming investment? We generally like to see 18-24 months of runway from the time of our initial investment. Of course, we are willing to accept heavy burn if the company’s growing.
- What is the company’s Equity Turnover Ratio?
The Magic Number is a SaaS favorite, but there are plenty of great businesses for which it doesn’t apply. Equity Turnover is a metric that quickly compares capital raised to revenue, another strong indicator of a company’s capital efficiency. If you can stay at or above a 1:1 ratio, then you're golden. Or platinum. Or whatever the best metal is.
- What is the Net Working Capital position?
This one is particularly important when Edison is considering an investment. If Current Liabilities are greater than Current Assets, then at least a portion of the incoming equity has already been committed. Anything greater than a 500K negative working capital position may warrant a valuation adjustment.
- What is the departmental allocation of operating expenses?
If you’re an avid reader of Edison’s blog (like Steve Nash is), then you may have caught our piece on how to be a fast grower. My favorite takeaway from the article is that fast growers invest in sales and product. Allocating budget to sales is the most immediate and direct way to drive growth. Investing in product requires more time to yield results, but is imperative to sustaining a long-term position in the market. We generally recommend allocating 20-30% of budget to sales and product, respectively.
- Is the Balance Sheet balanced?
I promise, a lot of talented accountants make this mistake, as I did in my second year of public accounting. You never really forget the first time your manager calls you out for this… It might seem like a small/tactical item, but if neglected, it can undermine the entire set of financials.
- What’s missing?
If I’m the CFO of a company that is performing well, I can’t wait to tell you about it. But if there’s an issue, well, uh… I’m less inclined to disclose certain details. So, what didn’t you include in your financial statements? Outstanding debt? Gross Margin? A comparison to the prior period? What isn’t listed in the company’s financial statements will often lead to more insightful information than what is listed.
You just need to know which questions to ask…