During the past 20 years, I've read several thousand business plans and executive summaries for angel, venture capital or business buyout investments. Unfortunately entrepreneurs make it too easy for investors who have the biggest check writing capabilities to discard their business plans.
What did these well-meaning entrepreneurs do wrong?
On the first read of any business plan, investors are looking for fast reasons not to invest, rather than reasons to invest. They evaluate risk then reward — in that order.
Yet, entrepreneurs tend to overstate the upside of a business opportunity in their written presentations. Their dream world, every-thing-goes-to-plan presentations lack balance making it too difficult for investors to believe anything in the document. Even worse, the entrepreneur is regarded by plan readers as "unrealistic", which is the venture community equivalent of striking out at your first time to bat.
Here are my top 10 tips for preparing business plans that will be read by prospective investors.
- Prepare multiple plans. Most entrepreneurs ask if they should prepare a best case and worst case plan for investors. My advice is always the same — save time and just develop one plan.
However, you should prepare a separate plan for equity investors and a separate, more conservative business plan for lenders. Lenders care about different measures of business success than investors. Whereas investors get their money back when a company is sold many years down the road, bankers get their money back from a company's monthly cash flow.
As such, business plans and projections prepared for lenders should emphasize risk-adverse attributes that support consistent revenue and cash flow generation. Business plans prepared for investors should emphasize revenue and business valuation growth.
- Say it fast. The first page of your executive summary should be the most concise and well-written page of your business plan; otherwise investors may not bother reading page two. State your entrepreneurial purpose clearly. The point is to get to the point. Avoid hyperbole, exclamation points and statistics that run on for pages and pages.
- Think like an investor. What matters to investors is more important than what matters to you. Emphasize in your executive summary those factors that will lead to successful investment outcomes: industry-leading gross profit margins, intellectual property rights, brand extension capabilities, customer contracts, recurring revenue potential, partnerships with larger companies, etc. If you dedicate more business plan space to describing cool product features and social networking plans than standard "investment fundamentals," then your plan probably won't get a second look. Experienced investors invest in businesses, not hip products that can become obsolete in fast changing markets.
- Know your market. Investors prefer to invest in companies that operate in markets that are growing rather than shrinking. Declining customer demand for products and services only means that competitors will discount prices, which can quickly wipe out company profitability. Any market research you cite in your business plan should match where you intend to sell your products or services too. Check out industry associations, business periodicals, and government reports for up-to-date statistics.
- Profit margin leadership. First-time fundraisers often assume that all they have to do is show a big net profit on their projected income statement to attract investors. Actually, profit margin calculations (measured in percentages) can reveal more about a company's investment value than the net profit dollar figure.
Compare your projected margins to industry averages. Are you at the high end or the low end of your industry in terms of financial performance? If your software company projections predict a gross profit margin of 25% and the industry average is over 60%, guess what? Your business plan is dead on arrival. No smart investor will ever invest in the industry loser.
- Think about the unthinkable. Every business plan should describe competitive and operating risks. Candid risk disclosure doesn't discourage investors but actually helps investors assess management's level of "realism." Investors always have more confidence in entrepreneurs who acknowledge the competition, rather than underestimate them in an idealistic way. To boost the competitive fire power of your plan, consider developing a separate business plan section called, "Management's Assessment of Key Operating Risks." Write down at least five risks that could potentially decimate your business, and then describe how you would mitigate these potential problems.
- Speed product development. The longer it takes to commercialize an idea on a finite amount of cash from personal savings or investment capital, the greater chance of business failure. If you want to avoid joining the one-third of new businesses that fail within the first two years of operations, then consider strategic partnerships to minimize the amount of cash and time required to achieve cash flow breakeven. Strategic partnership candidates may be a source of investment capital too.
- Explain your projections. I hate it when I receive extensive Excel files without any explanation of the entrepreneur's assumptions about costs, speed of customer acquisition, personnel requirements, and other important projection variables. If projections are too cumbersome to understand, investors may give up on your projections, your plan and you. Make it easy for investors and they will continue to read.
Projections should be accurate too. I always test if a company's balance sheet, income statement and working capital statement all flow together in a logical way. What's the most common mistake I find in projections? The income statement shows a profit but the cash flow statement shows a deficit which usually means that the entrepreneur needs to recalculate the amount of capital required to succeed! Check all work and don't point fingers at your accounting staff for stupid mistakes. If you can't own your company's mistakes, then investors don't want to own any part of your company.
- Know your funding purpose. Better business plans include a "use of proceeds" table that summarizes how, when and possibly where investor funds will be spent. How much of the requested funds will be allocated to product development, intellectual property filings, equipment acquisitions, debt repayment, marketing, etc? Make sure your use of proceeds numbers match your projections too. Sloppy presentations indicate that entrepreneurs don't pay attention to details.
- Define performance milestones. Investors are attracted to entrepreneurs who set disciplined yet manageable performance milestones. What must be accomplished and by when to be successful? Be specific, especially about management's milestone objectives during the first 12 months post funding. Concrete milestones give investors added confidence that management is "focused" and won't get easily side-tracked by new ideas.
In my coaching sessions with first-time entrepreneurs, I encourage them to focus on their strategies rather than wordsmithing to make the task of business plan writing more satisfying. What business plan issue are you worried about? Write to me and let me know.
Susan Schreter is a 20-year veteran of the venture finance community, MBA-level educator and policy advocate for small business owners. Her work is dedicated to improving startup operating performance with reduced personal risk to entrepreneurs. She is the founder of www.takecommand.org, which offers the largest centralized database of regional and national small business funding sources in the U.S., including angel clubs, micro-finance lenders, venture capital funds and more. Follow Susan on Twitter @TakeCommand