The answer depends on many factors, but I’d like to focus on what I believe are three critical aspects; 1) how well developed the revenue generation model is, 2) how reasonable the key financial assumptions are, and 3) how the management team views the numbers.

Revenue Model

Projections that are based on capturing “just 1% of the market” are the mark of a novice entrepreneur.  Projections of generating X million dollars of revenue in the first year will be greeted with questions about what the company will do to achieve that revenue volume.  The action plan for generating sales prospects and converting them to orders should be outlined and quantified in a good revenue model.

There are multiple benefits to this approach.  First, you demonstrate an understanding of the marketing and selling processes by which investors can assess your ability to oversee these key aspects of a business.  Second, you create an action plan that will be easier to implement upon funding.  And third, you generate leading indicators which can be used to manage the business.  This enables you to seek resolution to problems that arise before the company starts missing revenue targets several weeks or months later.  I believe the revenue model is the foundation for the entire business.  If done well, it will demonstrate your business expertise to investors, thereby engendering confidence and moving you toward funding success, as well as creating a useful tool that will help you manage the growth of the company after funding.

Reasonable Assumptions

In your financial model, the assumptions used should have a reasonable basis, something that is relatively easy to justify for a company at your stage of development.  For example, if you are a start-up, it would be unwise to use conversion rates or success factors of well-established competitors.  Your numbers should be reasonably lower.  Though it does not always work, I try to use assumptions that investors will acknowledge are reasonable after a brief explanation.

When talking with investors, “reasonable” is not a specific number, but rather a demonstration of your perception of reality.  Are you a pessimist, an optimist, a pragmatist, or a starry eyed dreamer?  As you explain your assumptions, investors get a read on you personally, as well as on the business opportunity.  What will they see?   In my experience, entrepreneurs that are pessimists and dreamers don’t generally get funded, and optimists have limited success.  Most successful investors are pragmatists, and optimistic investors generally have limited success.

Management Team View

Does your management team believe that your projections are cast in stone, are lofty goals, or are performances to manage by?  Clearly the best answer is the last.  Is your management team expecting things to go awry as you start to implement your plan?  The odds are very high that this is what will happen.  A solid management team that is experienced in dealing with such challenges (making lemonade from lemons as it were) can use a good projection tool to manage by.  Assumptions may change.  Revenue streams may be significantly altered or fall by the wayside.  If your financial model enables you to enter actual data in the place of assumptions, you can see what the effect will be on the business, and make appropriate course corrections faster and with better visibility.

Summary

Perhaps you noticed a common theme in this brief discussion about financial projections.  The exercise shows investors how you approach complex challenges, and how you view a good financial model as a flexible navigational aid rather than a definitive road map.  I like to use the analogy of a commercial jet flying from Los Angeles to New York.  Before departure, the pilot files a specific flight path.  During the flight, weather conditions, winds, and other issues arise that cause the plane to deviate from the flight path more than 90% of the time.  However, a good pilot can still arrive at the destination specified on time.  This is similar to the mission of the management team.  The development and presentation of a good financial model helps quantify a business while demonstrating the perspective and capabilities of the management team – a key factor in most investment decisions.

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 books, websites, videos, 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.

• 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.

]]> http://www.readyforinvestors.com/bucking-convention/feed/ 0 http://www.readyforinvestors.com/an-essential-unspoken-truth/ http://www.readyforinvestors.com/an-essential-unspoken-truth/#comments Tue, 30 Mar 2010 21:40:37 +0000 Steve Mortensen http://www.readyforinvestors.com/?p=266 As most everyone over the age of five knows, people don’t always tell the truth.  Untruths come in many flavors, ranging from nonspecific or slightly misleading information to pathological lies.

When raising money for your business, you have control over the truths you tell, and therefore the ability to earn trust from investors by demonstrating integrity.  But there is at least one truth that’s difficult for entrepreneurs and investors to candidly discuss, even though it’s a vital factor in the decision-making process of most investors.

Investors won’t write a check to your company if they don’t like you or find you credible.

Some may tell you to your face (particularly if you live in New England), but most will either simply stop communicating with you, or will offer a less offensive reason for not investing.  In either case, it can be difficult to know what really went wrong.

The best way to address this problem is through preparation, presentation materials that invite discussion, honesty, and humility.  Here are several tips for each of these issues that can help increase your likeability, credibility, and capital raising success.  They’re not meant to be comprehensive, but rather to point you in the right direction.

Preparation Highlights

• Be thoroughly familiar with the way you have developed the financial projections for your business.  Build your revenue model not on capturing some percentage of the market, but rather on specific activities that should result in the revenues you project.  Be conservative in your assumptions – it’s better to underpromise and overdeliver.  Find external data to show that your assumptions are reasonable.  Don’t lead with this data, but keep it handy to show if asked.
• Identify a significant and painful problem your business will solve, be prepared to give a few “real world” examples of how your solution is or will be better than other alternatives available to customers.  You’ll always have competition, and you need to be able to convincingly explain why customers will choose your solution over those offered by competitors.
• Be highly conversant in the “secret sauce” aspects of your business – those things that give you a significant competitive advantage.  While you won’t give the recipe to investors, they will have to get enough of a taste to validate your claims of competitive strength.

Presentation Materials

• Your presentation materials will perform several critical functions, which include demonstrating professionalism, communicating specific information, and providing a framework for dialog.
• Your materials should be professional in appearance and content.  Typographical and grammatical errors, sloppy formatting, and faulty data must be eliminated.
• Investors are not the federal government, so they usually don’t want to be buried under a mountain of research and projections from entrepreneurs.  You need to say the right things in the right way in the right amount at the right time to efficiently and effectively move investors through the decision-making process.
• Lastly, your documents should lead investors to ask you questions about those subjects they are most interested in.  If you are properly prepared, this is one of the most effective ways to demonstrate both your likeability and your credibility.

Honesty

• The tendency for entrepreneurs is to maximize business strengths and opportunities while minimizing weaknesses or problems.  This is both naïve and dangerous when raising capital.  Investors will usually see through the smoke and mirrors, hurting your chances to get funded.  If investors let you slide on these issues and make an investment, you will likely be unable to achieve your projections, opening a whole different can of worms that can put the future of your company in jeopardy.
• A balanced discussion of strengths and weaknesses is a far better approach.  Show that you understand the risks, know where the company is weak, and have appropriate strategies for addressing these issues.
• If you cannot answer a question asked by an investor, don’t bluff.  They’ll know.  It’s better to recognize the validity of the question, promise to get back with an answer, and follow through on your commitment.

Humility

• Investors like smart people, not smart alecks.  So don’t act like you know it all.  Be confident, but be receptive to input.  This does not mean that you have to implement all input, but you should at least express thanks for and appropriately consider it.
• While there are certainly some arrogant business owners, the majority of those I’ve encountered are approachable and open to the ideas and concerns of others.  In my capital raising experience, arrogance on the part of entrepreneurs is a deal breaker.