Updated: May 17, 2021
Writing a business plan is one of the most daunting assignments that you as an entrepreneur or as a business executive could face. This is not only because it is challenging to create an all-encompassing roadmap (which it certainly is) and deciding on what to include and what not to. The biggest challenge to overcome is our mental conditioning which always makes us resist planning of any sorts. Afterall, freewheeling opportunism and day to day fire-fighting is way more exciting than trying to find our way to success through a carefully developed roadmap.
A comprehensive, carefully thought-out business plan is essential to the success of entrepreneurs and corporate managers. Whether you are starting up a new business, seeking additional capital for existing product lines, or proposing a new activity in a corporate division, you will never face a more challenging writing assignment than the preparation of a business plan.
At the early stages of my career, as a young finance executive, like many others, I did not have much respect for the value which such work adds to a business. I considered formally written business plans to be fancy documents full of fluff and nice honest things (which often no one had any intention to follow) that served only PR purposes. I thought that all providers of finance make their investment or lending decisions independently of what you tell them. i.e. based on their own judgement of the risk which the venture exposes them to and the return which they desire to earn at that risk level. That view was further supported by banker’s attitude who always looked at your balance sheet to find collaterals, no matter how brilliant was the project or new venture idea you were trying to present them to for funding.
Developments in the business management approaches
Whilst the broad connection between a funding decision and risk-return profile is fundamentally correct, the belief in the futility of an effective presentation and its effects on a funding decision is not true. In fact, it is far from being true. To understand it further, we have to take a quick look at the developments in business management approaches in the past two decades.
Rewind 23 years, back to 1996/97. The years when I was still training with the audit firm. Times were turbulent and we were witnessing one mega financial fraud (or mismanagement) case after another, sending shockwaves through the international financial systems. Accounting & auditing processions as a whole were forced to take a fresh look at the objectives & approaches that were till then adopted and taken. We started hearing about the need for accountants to add value to the business rather than being ‘bean-counters’. Till then, there was very little in our training which could equip us to look at a business strategically and scan through for non-financial signs of a corporate failure. Similarly, we rarely heard of the need for an alignment between all business functions and its correlation with success. The focus was always on control, which we as young auditors construed to be the systems of financial controls.
In the past two decades, we have certainly come a million miles in the development of new management philosophies which are based on the realization that strategic alignment is by far the most important factor for continued success. You hear more and more people talking about the importance of an alignment between a business’s mission, its environment, its pursued strategies, different elements of its value chain and its performance measurement systems (though I believe not many still fully understand it). Businesses tend to devise their performance measurement systems which could give an indication of the likelihood of future success rather than historic results. Strategy has become more or less a buzz word and planning activities seem to be getting more management focus alongside control.
With this background in our minds, let us take a fresh look at the real purposes of formally written business plans.
The purposes of writing-up business plans
Written business plans are formal documents which always have some sort of presentation purpose. In case of a startup, this could be a presentation to potential inventors or loan providers or in case of an established business this could be presentation to a board securing funding for a new project or a proposed new vertical. Or it could be a transformation plan which aims to demonstrate a turnaround roadmap of a struggling business/SBU, again with the objective of securing funding or continued investment commitment.
The presentation document is the final tangible output. It is however, by no means the most important outcome of the process through which you produce that final document.
The most important outcome of the process is the inevitable simulation of the likely performance which you achieve through the plan development process. The linkages (or lack of) between your goals, your environment, your competencies, your resources and the strategies you aim to deploy to pursue your objectives, start to become clearer. This is by far the most valuable outcome. Afterall, how are you supposed to convince others about the viability of a venture if you in the first place are not convinced yourself?
When a business plan has been developed through right methodology with objectivity & honesty (i.e. where the objective is not to willingly deceive) it exudes that alignment between all stages and elements of its implementation. It almost feels like a proven path to success. Through the process, you should be able to discard the idea (or amend your plans) if it does not stand the tests which the process subjects your idea to.
Have you ever thought why case studies often make so much sense? Well the primary reason is that case studies are written backwards with the luxury of hindsight i.e. where a known outcome is traced back to its origins. To develop a winning business plan, you have to use the same methodology.
Your overriding objective with the venture should be established first. Assuming that you intend to achieve that objective in a certain amount of time, you should try to work backwards to established what in your best judgement it is going to take to achieve that. Break it down into milestones and reach a startup point. Establish resources and competencies which would be needed at that startup and which you would need to develop along the way. Decide if these needs are in line with what you could realistically mobilize and develop. Assess the risk and uncertainty inherent and contingent in the environment and assess your capabilities to effectively respond to these. Once your business/venture idea has stood this extensive testing, you have done the most important bit of business plan development. Rest is all fairly simple.
When you look at Google map directions for a destination where all the road names, turns, distances, likely traffic and expected arrival time are clearly marked, you do not feel much risk following these directions. Same is the case with all the people who are going to make a funding decision based on your plan. If you plan is as clear and as reliable as the Google map, their risk perception will inevitably go down. There is nothing more reassuring for investors and lenders then the feeling that they are dealing with someone who knows what he/she is talking about. Not only you will increase your chances of securing funding, but will stand a good chance of reducing their desired rate of return as well.
A detailed look at the business plan write-up process
With the preceding commentary about understanding the real purposes of developing business plan documents, let us now turn our attention to the practical aspects i.e. how we actually write a business plan.
The business plan admits an entrepreneur to the investment process. Same is true for an SBU manager seeking funding from the board for a new venture. Without a plan furnished in advance, most investor groups and the boards of directors won’t even grant an interview. And the plan must be outstanding if it is to win investment funds.
A vast majority of funding seeking entrepreneurs & business executives continue to believe that if they build a better mousetrap, the world will beat a path to their door. As we tried to demonstrate in the opening commentary, a good mousetrap is important, but it’s only part of meeting the challenge. Also important is satisfying the needs of marketers and investors. Marketers want to see evidence of customer interest and a viable market. Investors want to know when they can cash out and how good the financial projections are.
Importance of addressing all relevant perspectives
Only a well-conceived and well-packaged plan can win the necessary investment and support for your idea. It must describe the company or proposed project accurately and attractively. Even though its subject is a moving target, the plan must detail the company’s or the project’s present status, current needs, and expected future. You must present and justify ongoing and changing resource requirements, marketing decisions, financial projections, production demands, and personnel needs in logical and convincing fashion.
Business plan writeup process is tedious and demanding. Because entrepreneurs and managers struggle so hard to assemble, organize, describe, and document so much, it is not surprising that sometimes they overlook and ignore the fundamentals. To keep right focus, and keep your work coherent, it is extremely important that you address in a structured way, the perspectives of three constituencies.
The market, including both existing and prospective clients, customers, and users of the planned product or service.
The investors, whether of financial or other resources.
The venture initiator, whether the entrepreneur or the corporate manager.
A majority of business plans are written only from the viewpoint of the third constituency i.e. the initiator. They describe the underlying technology or creativity of the proposed product or service in glowing terms and at great length. They neglect the constituencies that give the venture its financial viability i.e. the market and the investor.
To understand it better, let us take an example of few construction engineers seeking financing to establish their own engineering consulting firm. In their business plan, they list a lot of specialized engineering services related to construction industry and estimate their annual sales and profit growth which they consider likely only because of their own feeling about the services they will provide. But they do not determine which of the proposed services their potential clients really needed and which would be most profitable. By neglecting to examine these issues closely, they ignore the possibility that the marketplace might want some services not among the ones listed.
Moreover, they fail to indicate the price of new shares or the percentage available to investors. Dealing with the investor’s perspective is extremely important. For a new venture, backers would normally seek a return of 40% to 60% on their capital, compounded annually. The expected sales and profit growth rates projections which are not in line with this return expectation, could not provide the necessary return unless the founders are willing to give up a substantial share of the company.
In this example, the initiators (engineers) have only considered their own perspective, including the new company’s services, organization, and projected results. Because they have not convincingly demonstrated why potential customers would buy the services or how investors would make an adequate return (or when and how they could cash out), their business plan would lack the credibility necessary for raising the investment funds needed.
The need to emphasize the market
More often than not, investors would want to put their money into market-driven rather than technology-driven or service-driven companies. i.e. the potential of the product’s markets, sales, and profit is far more important than its attractiveness or technical features.
One can make a convincing case for the existence of a good market by demonstrating user benefits, identifying marketplace interest, and documenting market claims.
Clear demonstration of user benefits is your goal, not extolling the virtues of the proposed product or service as you see it. To understand it better, let us take an example of an entrepreneur making a presentation to a group of venture capitalists about an instrument designed to control certain aspects of the production process in the textile industry which is likely to result in reduction of the production costs. He spends majority of his time explaining the technical features and speaks with passion about what an innovative product it would be.
The panelists initial reaction could be completely negative about the company’s prospects for obtaining investment funds because they could think that its market was in a depressed industry.
Now, let us assume that one of the panelists asks the presenter, “How long will it take your product to pay for itself in decreased production costs?” The presenter immediately responds, “Six months.” The second panelist could reply, “That’s the most important thing you’ve said tonight.”
The venture capitalist would quickly reverse their original opinion, saying that they would back a company in almost any industry if it could prove such an important user benefit, and emphasize it in its sales approach. After all, if it pays back the customer’s cost in six months, the product would after that time essentially “print money.”
The venture capitalist would know that instruments, machinery, and services that pay for themselves in less than one year are mandatory purchases for many potential customers. If this payback period is less than two years, it is a probable purchase; beyond three years, they probably would not back the product.
In order to succeed, the entrepreneur would need to recast his business plan so that it emphasizes the short payback period and plays down the self-serving discussion about product innovation.
The virtues of finding-out the market’s interest. Calculating & demonstrating the user’s benefit is only the first step. An entrepreneur must also give evidence that customers are intrigued with the user’s benefit claims and that they like the product or service. The business plan must reflect clear positive responses of customer prospects to the question “Having heard our pitch, will you buy?” Without them, an investment usually won’t be made.
A very valid question that you may ask at this time, would be: how can start-up businesses, some of which may have only a prototype product or an idea for a service, appropriately gauge market reaction?
To understand possible solutions to this problem, let us look at another hypothetical example. An executive of a small company puts together a prototype of a device that enables small payments made just by waving a mobile phone in front of the device. He needs to demonstrate that customers would buy the product, but the company has exhausted its cash resources and is thus unable to build and sell the item in quantity.
The executive wonders, how to get around this problem. There could be two possible responses (among others off-course). First, the founders could allow a few customers to use the prototype and obtain written evaluations of the product and the extent of their interest when it becomes available.
Second, the founders could offer the product to a few potential customers at a substantial price discount if they paid part of the cost (say one-third) up front so that the company could build it. The company could not only find out whether potential buyers exist but also demonstrate the product to potential investors in real-life installations.
In the same way, an entrepreneur might offer a proposed new service at a discount to initial customers as a prototype if the customers agreed to serve as references in marketing the service to others.
For a new product, nothing succeeds as well as letters of support and appreciation from some significant potential customers, along with “reference installations.” You can use such third-party statements (from would-be customers to whom you have demonstrated the product, initial users, sales representatives, or distributors) to show that you have indeed discovered a sound market that needs your product or service.
You can obtain letters from users even if the product is only in prototype form. You can install it experimentally with a potential user to whom you will sell it at or below cost in return for information on its benefits and an agreement to talk to sales prospects or investors. In an appendix to the business plan or in a separate volume, you can include letters attesting to the value of the product from experimental customers.
The importance of documenting the claims. Having established a market interest, you must use carefully analyzed data to support your assertions about the market and the growth rate of sales and profits. Too often, entrepreneurs & executives think along the lines, “If we’re smart, we’ll be able to get about 10% of the market” and “Even if we only get 1% of such a huge market, we’ll be in good shape.”
Investors know that there’s no guarantee a new company will get any business, regardless of market size. Even if the company makes such claims based on fact (as borne out, for example, by evidence of customer interest) they can quickly crumble if the company does not carefully gather and analyze supporting data.
To understand this better, let us look at another hypothetical example. An entrepreneur wants to sell a service to small businesses. Whilst making a presentation to a panel of potential investors, he reasons that he could have 200,000 customers if he penetrated even 1% of the market of 20 million small enterprises in the country (hypothetical). The panel points out that anywhere from 14 million to 17 million of such so-called small businesses were really sole proprietorships or part-time businesses. The total number of full-time small businesses with employees was actually between 3 million and 6 million and represented a real potential market far beneath the company’s original projections and prospects.
Similarly, in a business plan relating to the sale of certain equipment to citrus growers, one must have the relevant department of agriculture statistics to discover the number of growers who could use the equipment. If your equipment is useful only to growers with 40 acres or more, then you need to determine how many growers have farms of that size. i.e. how many are minor producers with only an acre or two of citrus trees.
A realistic business plan needs to specify the number of potential customers, the size of their businesses, and which size is most appropriate to the offered products or services. Sometimes bigger is not better. For example, a saving of $10,000 per year in production cost may be significant to a modest company but unimportant to a nationwide industry leader.
Such marketing research should also show the nature of the industry. Few industries are more conservative than banking and public utilities. The number of potential customers is relatively small, and industry acceptance of new products or services is painfully slow, no matter how good the products and services have proven to be. Even so, most of the customers are well known and while they may act slowly, they have the buying power that makes the wait worthwhile.
At the other end of the industrial spectrum are extremely fast-growing and fast-changing operations such as mobile telecom and ecommerce companies. Here the problem is reversed. While some companies have achieved multi-million-dollar sales in just a few years, they are vulnerable to declines of similar proportions from competitors. These companies must innovate constantly so that potential competitors will be discouraged from entering the marketplace.
You must convincingly project the rate of acceptance for the product or service and the rate at which it is likely to be sold. From this marketing research data, you can begin assembling a credible sales plan and projecting your plant and staff needs.
How to address investor’s needs?
The marketing issues are tied to the satisfaction of investors. Once presenters make a convincing case for their market penetration, they can make the financial projections that help determine whether investors will be interested in evaluating the venture and how much they will commit and at what price.
Before considering investors’ concerns in evaluating business plans, you will find it worth your while to gauge who your potential investors might be.
Most of us know that for new and growing private companies, investors may be professional venture capitalists and wealthy individuals. For corporate ventures, they are the corporation itself. When a company offers shares to the public, individuals of all means become investors along with various institutions.
But one part of the investor constituency is often overlooked in the planning process i.e. the founders of new and growing enterprises. By deciding to start and manage a business, they are committed to years of hard work and personal sacrifice. They must try to stand back and evaluate their own businesses in order to decide whether the opportunity for reward some years down the road truly justifies the risk early on.
When an entrepreneur looks at an idea objectively rather than through rose-colored glasses, the decision whether to invest may change. To understand it better, let us take a hypothetical example of an entrepreneur who believes in the promise of his scientific-instruments company. The entrepreneur is facing difficulty in marketing because the product is highly specialized and could only have, at best, few customers. Because of the entrepreneur’s heavy debt, the venture’s chance of eventual success and financial return are quite slim.