Many years ago, having seen all too many financial forecasts, I coined the term ‘Phantasmagorical Forecasts’. Every year entrepreneurs across Canada set out to raise capital, capturing their vision and optimism for their ventures in the form of business plans and financial forecasts that are eventually presented to venture capitalists (VCs). Because you don’t get what you don’t ask for, we wanted to see whether these forecast could potentially be contributing to Canada’s challenge at scaling companies.

To do this we examined the financial forecasts of 88 companies that were seeking venture capital, strategic capital, or an opportunity to be acquired, selecting 35 companies whose forecasts were accompanied by fully-developed business plans and sufficient data to determine the company’s expected level of growth, capital consumption, and profitability.

What we found was a series of forecasts that, on average, expected a 160% compound annual growth rate (CAGR), about double what Unicorns actually achieve.

However, there are two critical flaws behind these forecasts. First, these forecasts anticipate 34% earnings before income tax, depreciation and amortization (EBITDA) in the final year of the forecasts, a rate that is significantly above the rate of profits experienced by the top public companies. Second, they also expect that it will only take an average investment of $3.5 million to increase revenue from a current average of $1.4 million to an average of $20.7 million in three years. Anecdotal evidence suggest that it would be more reasonable to expect an investment of $20 to $30 million to secure such revenue levels.

Therefore, it is clear that Canadian entrepreneurs are creating “phantasmagorical” forecasts that they predict growth rates that experienced practitioners know to be beyond the realm of the believable and achievable.

High growth comes at a significant cost in terms of the capital required. If firms consume vast amounts of capital to grow, they should not expect to be profitable while doing so. Entrepreneurs’ forecasts, while not realistic in terms of growth, should at least be realistic in terms of how much that growth will cost.

The scaling challenges that Canadian companies face are often ascribed to lack of capital. However, perhaps part of the problem is that firms are not aware of the amount of capital they will actually need. As a result, they may be raising too little money, expecting it to go farther than it actually can.

Equipping entrepreneurs with better knowledge concerning the levers of growth including the relationship between growth, capital and profitability, we may be able to improve outcomes and the ability of Canadian firms to scale successfully.

In the last ten years, we as a nation have focused on the quantity of startups, propelled largely by the massive and successful efforts by the provincial and federal governments in creating programs that nurture entrepreneurs. Our next opportunity is to focus on the startup quality. It is only through direct improvements in the quality of entrepreneurial efforts will we improve our ability to create world-class companies.

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