Cover Story

 

Do You Really Need a Business Plan to Get Funded?

 

By Nick Macey

 

Business plans. Entrepreneurs hate writing them and investors rarely read them. Yet, entrepreneurs continue to write them and investors continue to ask for them. Lately, a lot of people are asking, "Are business plans really necessary any more to get funding?"

 

A business plan is usually a comprehensive examination of a business. It essentially outlines goals for the business and the path to achieving them. Typically, business plans are long and filled with varying degrees of useful information.

Entrepreneurs often feel pressure to "fluff" up their business plan, which usually means adding information without any real thought. For the lazy entrepreneur, one can even purchase software that helps fill in these holes and guides the process. These two paths create business plans that are essentially useless.

So if no one is reading and the writing isn't worthwhile, why are people still doing it?

To find out, Launch gathered a panel of 13 entrepreneurs and investors to discuss the ins and outs of business plans, where they are coming from and where they are headed.

Three general insights about business plans and raising money came out of our panel. First, getting in the door requires different things for different people. Second, when writing the plans, entrepreneurs are focusing on the wrong areas. Finally, the process is more important than the product; the business plan is neither a deal maker nor a deal breaker.

According to our panel, there are two categories of people seeking financing.

Peter Jarman of Fort Washington Capital calls the first group, "Known Quantities."

These include people who have started businesses before and have experience with financers, and who have performed well for them. Jarman notes, "You see the industry investing more and more in repeat entrepreneurs. And so, for a lot of these funds … they've already worked with these individuals before."

This category can encompass someone who has been in the industry for a long time – someone who knows exactly what they are doing in their market and has years of experience to back it up.

Companies being "spun out" of other companies also fit into this category.

These "known quantity" entrepreneurs generally only need an executive summary and a call to the investor who knows them.

The real differentiator between known quantities and new entrepreneurs seems to be experience, either with a previous startup situation or within the market for the new company.

Not being a known quantity, how does an entrepreneur get in the front door?

For those without that experience, it is a hard road. Documentation and a detailed business plan are critical.

Alan Hall, angel investor and founder of Grow Utah Ventures, spoke of his experience with business plans. "We're always looking for enough information to make some kind of intelligent first pass decision. Most entrepreneurs fail to get there because they don't have a very good business plan."

Apart from the business plan, there are two other things first-time entrepreneurs can do to get their inexperience in the door.

First, research your funding sources. Different investors invest in different types of companies. Entrepreneurs are much more likely to have success when they guide their pitch to the right investor. Sending out a business plan to every investor in the area just wastes the entrepreneur's time as well as the investor's.

Tim Hunt, founder of Lingotek, recently raised a second round of financing. He had a commitment from his funding source within seven days of his initial presentation. "Most of it was they understood the space; you have to make sure the money matches." While rare, matching the money to the investor is a good illustration of the importance of knowing what types of companies certain investors decide to invest in.

The second thing an entrepreneur can do is gain a referral to the investor. Traditionally, this is done by networking into the investor – Utah is a close-knit community and, often, it isn't too many connections away from an investor to an entrepreneur.

Entrepreneurs need to be careful with networking into an investor. Ryan Coombs of Plasma Glass suggests leveraging your network with some important caveats. "The only thing that I could go off of when raising money is someone who has seen my work ethic, and possibly has seen my product in action." It is important to have an introduction with substance.

A new option for referral has come to entrepreneurs in the form of services like FundingUniverse. CEO Brock Blake notes, "I can't say enough about the referral from someone to get in the door of the investor — that's what our service does."

FundingUniverse describes itself as a funding catalyst group that cultivates business opportunities by connecting qualified entrepreneurs with active angel investors. Through education and training of entrepreneurs, and rating of business plans, FundingUniverse provides another venue to get that referral to an investor.

However, under no circumstance should a first-time entrepreneur be under the impression that it is impossible to be funded. Mark Campbell of the University Venture Fund points out that many of the hottest companies were founded by first-time entrepreneurs: YouTube, Facebook and even Google, to name a few. Investors recognize that, and in many cases, are making active efforts to reach those entrepreneurs in the garage with a great idea.

The next observation about business plans is that entrepreneurs are producing plans that are too long and focus on the wrong areas. Entrepreneurs should keep it simple and not agonize over the plan, but provide knowledge of their business in and out. For content, they should focus more on marketing and execution rather than the background of the team. The business plan overall should act as a script to guide conversations and e-mail exchanges about the business.

Looking back, the entrepreneurs on our panel seemed to find that they really had produced longer business plans than necessary. Most also stressed the importance of first producing a three- to five-page executive summary.

Doba CEO Jeremy Hanks believes this may actually be a bigger challenge than the typical narrative, longer plan. "For me, it's a lot more difficult to try to put your business into three pages than it is to put your business into 300 pages." For the entrepreneurs who have done their work, slimming a business plan down may be the hardest part.

It turns out that investors are looking for focus more than length. Entrepreneurs are spending too much of their time away from what investors are looking to hear, and that is why investors fail to read through the inch-thick plans they receive. Focusing on the right areas is the key to getting funding.

For now, it seems the thickest sections hold the biggest mistakes. The business plans coming in to local investors from first-time entrepreneurs are focusing too much on unrealistic financial projections and the executive team.

For those who are not known quantities, a few sentences about the key people in the company should suffice. Investors aren't interested in experience in unrelated industries or companies they haven't heard of. Instead, keep it simple and provide relevant experience.

The common joke investors see in business plans is claims of a small part of a huge market. "The market for this product is $3 billion," says the entrepreneur. "All we need to do is get 10 percent of the market, and we'll be at $300 million in three years."

Obviously this logic is flawed, and everyone seems to know it. Build financial projections from the bottom up — start with your product and the pricing, and build from there. If entrepreneurs spend less time justifying a small piece of a huge market and more time building financials from the ground up, everyone wins. Investors get a breath of fresh air about financials, and entrepreneurs don't fail to meet the projections they propose in the initial business plan.

So what then, exactly, are investors looking for in a business plan?

For young companies, it is all about the execution. The focus should be on a well-thought-out, go-to-market plan that takes the investor step by step through the entire rollout process. The plan should answer questions about the product production, sales channels, and process and measurement about that process.

Founder of CFO Solutions, Kent Thomas said it best, "The one thing that we see as the single most common missing link is the marketing analysis. Who is my customer and how do I get to that customer? What's the distribution channel? These are the questions that investors want answered."

Investors want to know what drives your business. Identifying a need, showing the opportunity and providing a solution are three critical components of your execution strategy and should also be a part of the business plan.

A key to getting funding is having a great idea and communicating it well. Whether that be through a good elevator pitch followed by a 30-minute phone call, or a two-page executive summary forwarded from a third party, communication is critical.

Additionally, if you progress with the investor, he or she will want details about how your business will make money. Truthfully, the investor may or may not read the whole document, but, in the end, will require documentation before investing. Being ready by having something written shows that you know what you are doing and have prepared for the process.

Campbell addresses another aspect of the process, saying, "It is such a living, breathing document, the business plan. It's going to change so much within three to six months anyway. We're more concerned about, ‘Will they adjust to market conditions?' than what's down on paper." So, really, the document you create isn't the basis for a decision. It is a plan that evolves with your organization and throughout the funding process.

The process also helps entrepreneurs gain a focused description of their business. Many times, entrepreneurs will find themselves in a situation where they need to explain their business in a short amount of time. This so-called "elevator pitch" is a quick, less than 30-second description of your business. The "elevator pitch" takes its name from the entrepreneur who meets a potential investor in an elevator, and only has time to convince him or her of a second look before the elevator hits his or her floor. Developing of this pitch is critical, whether you end up in an elevator with a VC or not.

It is important to remember to keep your communication at a basic level. Investors may not be completely versed in the jargon of your industry. Blake notes, "You need to be able to communicate what you do in the first 30 seconds. You need to communicate it effectively so that a 12-year-old can understand it." But at the same time, you also need to project that you actually know what you are talking about.

Jarman notes, "You generally can tell within the first minute or two whether this person has an idea of the market sizing." If investors are trying to pick this out quickly, the process of creating a business plan can help you verbalize the answer, and give them the idea that you have done your homework about your own company.

Most investors pride themselves in having the ability to pick talent out of the crowd of proposals they get every year. If you only have one or two minutes to give that first impression and show that you know what you are talking about, then you must be able to answer any question that comes your way. The process of developing a business plan helps you accomplish knowledge that you might not otherwise have, and leaves a better impression on potential investors.

Hanks talks about the business plan as "writing the script for a verbal exchange." Investors will often grant a phone call to businesses of interest. Using the written business plan as a verbal exchange can help guide that conversation and leave a good impression on the investor. Along with that, investors, especially VCs, are known for interrupting and asking questions. If you're planning on getting funding, you better be able to answer those interruptions with ease. This "verbal script" will help immensely in such a situation.

Outside of fundraising, getting to know the market and planning (or revising) the execution strategy for any business can't hurt. If anything, it helps increase knowledge of the organization, enabling everyone to serve customers better and make more money. If you can do that successfully, you might not even need to go through the agony that is raising capital.

The simple truth is that startups need to raise money. It can be a painful process, whether you're a first-time entrepreneur or a veteran. The critical component, however, is being able to communicate your business and marketing strategy in a focused, knowledgeable manner to the right people. If you can project confidence in your company, give an impression of knowledge about the market, show the path it will take to make money, and pitch it to the right audience, the fundraising process might be just a bit easier.

 

Launch - May/June 2007

 

 

For the full "digital magazine" version of May/June 2007, visit: http://www.nxtbook.com/nxtbooks/growutah/launch0507/