Do you really need a business plan, and why?

What’s the fastest, easiest and cheapest way to get one? 

Should you copy one for a company that got funded and edit it? 

Should you do it yourself or hire someone else to do it all for you, and why? 

Can you just start with an executive summary? 

I’ve reviewed many websites, articles, software programs, videos, audio files, and books on the subject of writing business plans for raising capital.  Here’s what most of them say in answer to these questions:

You need a business plan so you can effectively communicate your business to investors, employees, and other stakeholders. 

The fastest, cheapest, and easiest way to get one is to copy and edit one.  However, this is the least effective way to create a business plan.  You get out of the effort what you put into it.  It would be like trying to become a medical doctor by using someone else’s lab work and notes.   May I never visit a doctor thus prepared to practice medicine!

Ditto on copying and editing a plan for a company that got funded. 

Most experts say you should write the business plan yourself.  Sweat it out, gain from the pain, pay your dues, and all of that.  This approach has merit, and you’ll become much more knowledgeable about your business.  But you’ll almost certainly waste a whole lot of time trying to figure things out on your own, learn lots of things that are useful and interesting but not yet critical, and probably have to do quite a few rewrites as you start showing it around.  If you can partner with someone who knows the ropes and is willing to work with you through the process, kind of like a personal trainer or a mentor, you can reduce the time it takes to create a solid business plan and be prepared to present it effectively.  I’m not talking about turning the whole thing over to someone else to create for you, but engaging the support of an expert who works with you to do it right the first time.  

All this stuff is pretty straightforward.  It’s going to take time to create a business plan, and the clock is ticking.  So it’s the final question I primarily want to address. 

Can you just start with an executive summary?

Many entrepreneurs, realizing that a business plan represents a significant investment of time, wonder if they could perhaps create an executive summary and start shopping it around while they work on the full plan …

In theory, it’s a great idea.  But most experts concur that this is not a good approach because you have not thought things through well enough yet, and so you’ll be communicating faulty information. 

Well, I’m not most experts. 

I believe you can and often should go with an executive summary first for a number of reasons.  With one caveat.  First you need to build a comprehensive financial model that tells the story of the business with numbers.  Then you’ll be prepared to start hanging words on the numbers, even in abbreviated form. 

The benefits of this approach include:

• During the process of creating a comprehensive financial model, you’ll think through all aspects of your business, and see how they interrelate with each other.  You’ll have a clear picture of your key success drivers.
• After you’ve done the complete numeric creation, it becomes quite easy to start putting the story into words.
• A solid executive summary supported by a comprehensive financial model can be developed faster and at a lower cost than a complete business plan.
• This speed means you can start circulating the executive summary to generate interest in your business, and even start raising capital, while your business plan is in development.  I have many clients who have successfully followed this path.
• For startup businesses in particular, this is an economical way to test the waters to see how viable your business is and how attractive it will be to investors before you invest heavily in time and other resources.

The viability of this approach all comes down to one thing – how effectively you develop a comprehensive financial model before committing your ideas to words.   And that’s a topic for another time.

1. Customers buy from you and perceive value

The question professional investors often ask is, “Will the dogs eat the dog food?” If you have an existing business where customers pay reasonable prices for your products and services and perceive value in the exchange, you have the foundation for a successful business. The absolute best source of capital for your business is satisfied customers. But if your company has strong proven customer demand and you need expansion capital to meet that demand, you’re in a highly attractive position to investors. For start-ups, the question is more difficult to answer until customer traction is achieved, and we’ll address this issue in a future post.

2. Your business generates strong earnings

Many start-ups launch with strategies to attract customers with free or low-priced goods and services. Of course, the company eventually has to generate profits to be successful, so prices usually escalate and more revenue streams are established. Most start-ups lose money for a while, and even well established companies lose money occasionally. If your business is not currently profitable, you need to demonstrate a clear and credible path to profitability. Investors are looking for proof of your company’s ability to maximize earnings while keeping the customer value equation in balance.

3. Your business is scalable

How much realistic growth potential does your business have? Is there a way to double or triple your revenues within a year or two? What will it take to make it happen? If you can demonstrate the scalability of your company, you’ll find more investors willing to talk to you. However, if you have a $1 million business today and can grow it to $5 million within the next 3 years, your deal won’t appeal to venture capitalists or angel investors, but it may be attractive to informal investors or commercial lenders. The type of investor will depend on how much your company can reasonably scale. Proof of scalability enhances your strength in the eyes of investors, even if it is on a limited or trial basis.

Start-up companies generally don’t have much evidence of these issues, but are often able to achieve it after a period of bootstrapping with a focus on generating the necessary proofs. Both investors and lenders respond well to business owners who have taken this approach.

I provide for my family by helping entrepreneurs prepare for the capital raising process.  I’ve seen angel investors, venture capitalists, and trade associations strongly recommend that you should not hire people to help with your financial projections and business plans.  Obviously, I disagree with this recommendation, but I believe there are several basic principles that apply to entrepreneurs trying to raise money that we should all be able agree on, leading to mutually beneficial coexistence.   

• Business owners must have a thorough understanding of their financial projections and business plans.
• Many new business owners have limited experience with creating detailed financial projections, developing effective business plans, and raising money.
• For business owners, time equates to money.

The Issues

If you hire someone to do everything for you, you won’t get the benefit of learning your finances and business model inside and out.

If you don’t have much experience with financial modeling, spreadsheets, business planning, writing, and experience in raising capital, it can take a tremendous amount of time and effort to get it right. 

A lengthy learning curve can be very costly to you, as you spend less time in activities that can generate revenue and profit, and more time developing expertise in the capitalization process.  In my experience, even those who have done it multiple times often rely on help from others.

If your business has the potential to get funded by angel groups or venture capitalists, you preparations better be right on the mark, or your deal will probably not pass the screening process.  This is very difficult to do, especially if you’ve never done it before.  It’s like trying to hit a home run in your first at bat in the major leagues.

A collaborative effort between entrepreneurs and experts in the capital raising process can overcome all these challenges.  This approach has been proven to work effectively time and time again.

Elements of Effective Collaboration

In an effective collaboration:

• An expert walks through all the “nitty-gritty” details of a business with the entrepreneur, discussing ideas, strategies, tactics, plans, opportunities, weaknesses, and many other issues. 
• The expert coaches the entrepreneur, and helps identify solutions to challenges and pitfalls to that specific business, which result in better projections and stronger business plans. 
• The expert provides qualitative feedback on the information provided by the entrepreneur, something that does not come from publications or software. 
• The expert works “side by side” with the entrepreneur to develop a comprehensive financial model and business plan, which are highly customized to each business. 
• At the end of the collaborative process, the entrepreneur has been intensively schooled and tooled in preparation to raise capital. 

If any of these elements is missing at the end, then the collaboration has not been fully effective.  If the expert does all the work, then the collaboration has not been effective, and the end result is an unprepared entrepreneur.  Intelligent investors will be quick to recognize the lack of preparation, and won’t invest. 

Entrepreneurs:

• You do have to pay the price to get correctly prepared. 
• You don’t have to do it alone, you just have to do it right. 
• An effective collaboration is a proven, viable way to do it right. 
• An effective collaboration can save you a tremendous amount of time and money.

A smart man learns from his own mistakes.
A wise man learns from the mistakes of others. 
A fool learns from neither.

How would you respond? 

• Smart money, of course!
• Dumb money, that’s why I’m talking to you.
• Which kind can I get from you?

The question is ridiculous, yet the issue comes up a lot.  Money is inanimate, and is neither smart nor dumb in and of itself.  The way entrepreneurs or investors manage and invest money can be smart or dumb, and this gets more to the heart of the matter.  But before delving into this issue and its implications for entrepreneurs, let’s take a quick look at some definitions. 

The term “smart money” is often used to describe investment capital from sources that also provide valuable expertise and contacts that will enable businesses to become more successful.  This sounds like a smart idea, and I believe the principle is a good one.  But the term is also used in other less useful ways, and not always explicitly.  For example, a venture capitalist or angel investor may deem their investment as smart money, and infer that others who invested in your business at an earlier stage on an informal basis provided dumb money.  

There are many elitists in the capital markets.  But ultimately this doesn’t matter, and I’ll tell you why.  I’ll also tell you what’s far more important as an entrepreneur looking for capital. 

First, many of the “smartest” financial people in the world helped create the current global economic meltdown.  And even today, whenever they talk about the future, the only truth is “we don’t really know . . .” 

Second, $18 billion (the same amount angel investors and venture capitalists each invested in 2009) was entrusted to Bernie Madoff by thousands of smart people. 

Third, let’s compare the failure rates of companies that received angel investment, those that received venture capital, and the whole gamut of U.S. start-ups that survive at least 5 years. 

 
While different studies report varying failure rates, these numbers reflect a reasonable average.  

What does the data indicate about the value of so-called smart money? 

Taken on the whole, it doesn’t seem to make much of a difference. 

So what does matter for you, the entrepreneur? 

YOU being smart. 

Here are some tips to help guide you along.  

Smart entrepreneurs surround themselves with advisors, strategic partners, board members, employees, subcontractors, customers, vendors, etc. who bring expertise and contacts to the business.  When you look at the big picture, you can get vastly more support from these resources than you are likely to get from your investors, though good participating investors can be very helpful members of your team.

Investors who are also well-known and successful figures in your industry could be very helpful, if they take an active role in supporting you.  There are many anecdotal tales of high profile experts that promised to help for a premium, but never did.  Find out how active such investors will really be for you (check their references) before you take their money.

Don’t take money from investors that are likely to become a problem for you later on.  You can conduct due diligence on them by asking to talk to the owners of other companies they invested in.   

If investors are too “smart” you could end up in a dangerous situation where they can take over your business if you don’t meet certain performances on schedule.  While this a a major concern for entrepreneurs, the reality is that it doesn’t happen very often.  Most angel investors don’t want your business, don’t have time for it, and would rather support it with help from time to time rather than taking it over.  Onerous terms and conditions proposed by an investor should flag you to perform due diligence on the investor, and talk to your trusted business advisors before committing to do a proposed deal.  This is the path of the smart entrepreneur.

Develop a strong financial model of your business built on leading indicators that will help you manage the business from the beginning of the marketing and sales cycle.  Show it to experienced advisors you trust.  Refine it until you completely believe in your ability to achieve these numbers.  Don’t start trying to raise money until after this has been accomplished.

Expect that you’ll have to do a major overhaul of your business model within a few years in order to ultimately succeed. 

Know that a smart entrepreneur can make just as much with so-called “smart money” as can be made with “dumb money.”  So focus on being a smart entrepreneur.  That’s something you have a lot more control of.

Don’t be a smart aleck, that’s not the same thing as being smart.  You’re unlikely to succeed with Tip #1 if you’re a jerk.  I’d like to be able to say that jerks are also more likely to fail, but I haven’t seen any reliable numbers on that issue yet . . .

Data Sources:

SBA Office of Advocacy FAQ updated September 2009; Kauffman Returns to Angel Investors in Groups study 2007; 2005 Sand Hill Econometrics Report by Susan Woodward; http://www.reuters.com/article/idUSTRE58Q2SE20090927; http://knowledge.wharton.upenn.edu/article.cfm?articleid=2397

Here’s what I mean.

High profile angel investors and venture capitalists are focused on high growth businesses, those that can grow to $30-100 million within a few years.  This is not necessarily based on greed, but more often on the realities of the financial world where they live.  They have compelling reasons for this focus.  And so for the most part, they ignore smaller companies. 

There were about 600,000 new businesses with employees that started in 2009 in the U.S.  Angel investors funded some 13,000 start-up deals, and venture capitalists funded 312.  Statistically, angels funded 2 percent of the new companies, and venture capitalists a tiny fraction of 1 percent.  The SBA reports that nearly 70 percent of start-ups survive at least 2 years, and more than half survive for 5 years. One other statistic of interest is that the average person born in the later years of the baby boom era held 10.8 jobs from age 18 to age 42, according to the U.S. Department of Labor.  This equates to changing jobs every 2.2 years on average.

From these numbers, we can conclude that your odds of starting a business that succeeds on some level for at least 5 years are better than staying with the same employer for 5 years.  While many millions of people do stay at their jobs more than 5 years, most don’t. 

So how successful are those businesses that survive?  According to the IRS, 81 percent have net income of less than $1 million per year, 16 percent have income from $1 million to $10 million, and just 3 percent have income of more than $10 million.  By the way, only 0.5% have income greater than $50 million annually.  

One other statistic is useful to consider.  Of all the small business funding provided during 2009 – a year of economic turmoil – just 7 percent came from angel investors and venture capitalists.  All the other small business funding came from somewhere else. 

Most small businesses, whether start-up or well established, will never receive a nickel from sophisticated angel investors or venture capitalists.  Yet there are more than 5 million households in the U.S. that have a net worth of more than $1 million.  Most did not inherit their wealth – they earned it from small businesses that they found some way to start and fund and grow.  Small business owners have a much higher probability of success in this world than in the realm where angel investors and venture capitalists live, all due respect to those at the top of the food chain. 

And so while we aspiring entrepreneurs can learn much from angel investors and venture capitalists about getting funded, we should remember that 93 percent of small business funding comes from somewhere else.  Somewhere that shares key viewpoints of high profile investors, but also takes many other issues into account.  Things that are often more favorable to you.

Learning to successfully navigate in the world of the 93 percent offers your best chance for success in funding your company. 

Data Sources:
SBA Office of Advocacy FAQ updated September 2009; Center for Venture Research – The Angel Investor Market in Q1Q2 2009; National Venture Capital Association and PriceWaterhouseCoopers (January 22, 2010); U.S. Department of Labor News Ref. USDL-0860 dated June 27, 2008; U.S. Internal Revenue Services, Statistics on Income, Corporation Income Tax Returns – 2006; Federal Financial Institutions Examination Council Fact Sheet (August 2009); GEM 2008 National Assessment for the USA; GEM 2009 Executive Report