There are more clichés and misunderstandings surrounding business plans than any other part of the capital raising process. These range from the belief that plans are not needed because my concept is so good that it ‘sells itself’, to the ‘thicker the better’ school of business plans.
The failure of both of these approaches stems from a misunderstanding of the role of the business plan in the venture capital world. Unlike ‘Dragon’s Den’, no venture capital firm or angel (defined as persons who invest their own money in businesses) hears a presentation or reads a plan and then writes a cheque on the spot.
An angel is no different than a capital venture firm in his or her desire to make a prudent investment. They want experienced management, collateral, growth industries and significant returns on their investment for the least amount of risk.
People sometimes think that angel investors suspend all prudent business practices and just throw money at any project presented by entrepreneurs. Nothing can be further from the truth. Generally speaking each venture capital source must present the plan to a committee or advisors to determine the next steps. The business plan is the door opener, if the plan is favourably received the firm or individual will proceed to the next step, if not then the potential investment stops right there.
So, what does the venture capital community want to see in a business plan? The projects that move forward are selected because they have a ‘business comfort level’ that encourages further pursuit. If a project or business is inherently unsound, a skilfully drafted plan does not cure the flaws, nor does a poorly written plan automatically condemn an excellent company’s chances for financing, however it does make it significantly more difficult.
Most proposals fall in between these two options, and this demonstrates just how crucial the business plan is.
Venture Capital sources want to see the following 7 key questions answered in the plan:
1. What is unique about this company or project? Not necessarily a unique product, but one with growth potential that sets it apart from other industry members or from other proposals received
2. What does the company do? They must effectively communicate the company’s product and services and the operations of the company
3. How does or will the company attain profitability? This area entails discussion of the market and competition as well an analysis of areas such as revenue and profit margins
4. What benefit will be derived from a capital infusion? In other words how will the proceeds of the financing be utilised and what results benefiting the investor will be achieved. This should translate into increased revenues and profits and an excellent return on investment
5. Is management capable of implementing the business plan? Many investors consider this the most important element of a business plan. An investor must be comfortable with the experience and abilities of the management team. An outstanding management team may have the ability to overcome other deficiencies in the plan
6. Do the financial projections make sense? Over optimistic projections reflects on management’s judgment. Projections can be aggressive, but must be within the realm of the real business world
7. Is there an exit strategy for the investor? Does this business have the potential to merge, be acquired, go public or buy out the investor? This is important, since one of the most popular venture capital vehicles is the convertible debenture. The investor must be confident that either the debt payments can be sustained or that their stock conversion rights have great potential.
If the business plan effectively answers these seven questions, then it has served its purpose.