Last Updated May 16, 2011 12:03 PM EDT
Christopher Mokwa and Soenke Sievers, both from the University of Cologne, have examined records of 176 German startups, backed by 339 different venture capital firms, to try figure out exactly how overly optimistic startup founders really are. They also tried to determine if milestone payments-making the next round of funding conditional on certain accomplishments, such as reaching a certain level of revenue, signing big customers, or reaching a certain phase in project development-would lead to more realistic projections. Here's what they found:
- Entrepreneurs are way too optimistic. Overall, management projections for expenses, revenues and profits are significantly inflated across a one-to-five-year time horizon.
- Revenue projections are the worst. On average, entrepreneurs think their revenues will be 388 percent higher than they turn out to be.
- Entrepreneurs don't need as much money to run a company as they think they do. Entrepreneurs over-estimate their expenses by 211 percent, on average
- Profits are the most accurate projection, but still are way off. On average, profits are overstated by 136 percent.
- The first year goes better than entrepreneurs expect. The one-year profit forecast is the only one that was routinely too low.
- Most companies expect to break even after being in business for three years.
- Milestone payments do make a company's forecasts somewhat more accurate. They bring the errors in revenue forecasts down by 58 percentage points and the error in profits down by 122 percentage points.
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Kimberly Weisul is a freelance writer, editor and consultant. Follow her on twitter at www.twitter.com/weisul.