Is this a bad time to be entrepreneurial?
Both a good economy and a weak economy present challenges for entrepreneurs starting new businesses.
Morrissey: I’ve never found that there is much correlation between the economy and the way you roll out a start-up. If you wait, you may be giving up a competitive opportunity this is also the time to find good talent the wait could be two or three years, and what are you waiting for? The competition for money then will be just as tough as it is now. There are also more small businesses for sale that an entrepreneur might look at as an alternative to launching their own firm.
Cox: It’s obviously a bad time to go into banking, but other than that, people always need things, and bad times present different kinds of opportunities. It’s kind of like a forest burning down: sometimes the forest fire is a good thing because it burns out all of the dead wood and makes space for new trees, or, in this case, businesses. When that happens, there are opportunities for other people to step in and provide services in a different or a better way. The guy who created Monopoly started in the middle of a depression he was trying to entertain people so he invented this game about people getting rich and owning real estate. He made lots of money coming out of the Depression. Most of the time entrepreneurs don’t think about the economy; they focus on the problem that they’re solving and their own technology, and whether they’re doing a good job.
Villalobos: Bad economies are terrific times to start a business and some of the high-profile successes have been started during down times (Best Buy, Cisco, Amazon). Entrepreneurs are forced to be capital efficient and get things going on a shoestring but that usually means they keep more of their venture.
How important is a business plan?
A business plan is the road map that shows investors the path the entrepreneur plans to take to success. An incomplete map will not give the investor a full picture of where the entrepreneur is going or the plan to get there and will probably cost him or her access to funding.
Cox: There’s just no way anybody is going to lend you any money, no way anybody is going to put equity into your company unless it’s a friend or a family member unless you have a business plan.
Villalobos: A plan is not always seen by (or shown to) investors. But it is essential to gaming out exactly what you are going to do which is a foundation for creating the PowerPoint and exec summary that you show investors; and the plan is also what you need in then operating your business.
What are the essentials of a good business plan?
The business plan is a 25- to 30-page document, which should be written from the funder‘s point of view and explains the details of: 1) how this idea will solve a problem, the way the solution works, and its affordability for the target market; 2) how the product or service will be marketed; 3) who will manage the business, their experience, and that they can actually execute the business plan; 4) what the financial plan is; and 5) how much money the business needs, when the investors will be repaid and what they can expect for a return on their investment.
Villalolobos: There are lots of entrepreneurs who come up with a technology or a software product that they are looking to market, but that usually doesn’t fly very well. So, the first part is to explain who has what problem and how this business will solve it.
The second part is the solution: What’s the product? What’s its core benefit? Is the solution something that’s unique and protectable? Protection can be in the form of patents, it can be in the form of lead time to market in that it takes two or three years to develop this technology and nobody else is close to development, it could be that they have secured a deal with a major player in the industry such as a distribution deal, or it could be in the form of companies that are built around what are called vanity numbers like 1-800-FLOWERS, or one we funded 1-800-WEDDING.
How will the product or service be sold? What’s their marketing channel? Too often entrepreneurs tell us that they are going to sell it every which way through the internet, through distribution, through this, through that. The marketing section should be direct and focused.
Next is a summary of the financials. Often at this level we like to see maybe five or six lines: revenues; cost of goods; what will be spent on the three key areas, R&D (research and development), marketing, G&A (general and administrative expenses); and what is projected for profits and cash flow.
Finally, the valuation of the business, what they expect the company to be worth, what they need in terms of pre-money and post-money and what the investor can expect as a return on their investment. Too often entrepreneurs don’t understand valuation. They all plan to grow their company to the magic number of $100 million dollars and give the investor 10 percent. That isn’t how it works. The entrepreneur needs to spend the time learning the investors’ terminology and how to arrive at a realistic valuation of their company, without exaggerating its value and potential worth.
We also expect them to have thought through an exit strategy. In other words who is going to acquire them and why? And by the way, it’s often very attractive to investors when the entrepreneur says, “This is the major company in this market, here is where they have a hole in their offering, and we’re going to fill that hole. We’ll be perfectly based to be acquired by them, and in fact, they are currently one of our customers.” That’s terrific to hear.
Where does an entrepreneur go for help with writing a business plan?
It is not difficult to find help writing a business plan. There are business courses, books, and even software available for this purpose. There are also places such as small business development centers; SCORE, the Service Corp of Retired Executives; and some communities have community development and business development resources where people offer to help write business plans.
How do you determine whether you need funding and what are some of the sources for investor funding?
There are groups of investors, such as venture capitalists (VCs) and angel investors, who are looking for entrepreneurs with strong and innovative ideas. Frequently these groups invest in specific industries. Before approaching an investor group, an entrepreneur should research what industry that group funds, who is in the group, and what businesses the group is already developing. Sometimes the idea requires low start-up costs and instead of funding, the money comes as the business grows.
Cox: It depends on what the entrepreneur is doing, whether it’s manufacturing something or a service organization. Service companies don’t require as much money typically, and may be able to launch with what we call “bootstrapping” living off the proceeds of the sales. But if the business is going to make a product or is doing something that requires any kind of manufacturing, then it will probably need some capital and some additional investment along the way. If you’re looking for a great deal of money in the $3 million to $5 million category and you have a product that is scalable, something that can become really big down the road, then a venture capital firm might be your answer, but it’s a small percentage of businesses that fall in that category. Angel investors usually fund $250,000 to $1 million. Most businesses are funded with the entrepreneur’s own money and that of friends, fools, and family members.
Morrissey: For many years I made a presentation at the Orange County Venture Conference called “The Investor May Be Right Down the Hall.” Although employees are sometimes apprehensive that taking their idea to someone in the management of their employer may come across as stealing secrets or as not being happy with the firm, it’s just the opposite. There’s a maturity now in corporate America that “we better start listening to some of these new ideas” and that if they are spun out, “they may be more successful than if we try to keep them under our wing.” Obviously, whether an employee takes their idea to someone at their employer has a lot to do with the culture of the company and the experiences of previous “intrapreneurs” in the firm.
Villalobos: Try to get as far as you can without external funding (keep your day job initially, recruit like-minded partners who aren’t expecting to get paid a salary initially, do things entrepreneurially). Only when you can make a good case that external capital will advance the venture, should you consider it. Ideally, [try]to expand sales for a proven product, e.g. one for which you have shown traction in a regional market or some small scale market test.
What do you tell an entrepreneur who brings you a great idea for a start-up and is looking for investors?
It is imperative to start with an idea for a service or a product that solves a problem. Next, develop that idea into an “elevator pitch“ three or four sentences that convey the heart and the excitement of the idea. Prepare an executive summary of four or five pages, and have a PowerPoint presentation ready that includes most of what is in the business plan. If these three steps are not developed, the entrepreneur may not get the opportunity to present their business plan to an investor.
Morrissey: Students sometimes think that printing 200 business plans and sending them to all the venture capitalists in the world will produce a couple of positive responses. Doesn’t work. Networking continues to be the best path. Many times meetings are serendipitous and somebody might say, “Charlie, what do you do?” and you’ll say, “Matter of fact, I’m starting a new venture…” and this is the opportunity Bang! that’s all the time you get. You don’t have time to say, “By the way, here’s my business plan, will you please read it?” You really have to get yourself to the point where you can create excitement in two or three sentences, and that’s the biggest struggle everyone has.
What are some of the mistakes entrepreneurs make in developing their business plans and talking to investors?
Although investors and entrepreneurs have the same end goal in mind offering a profitable product or service clearly they approach a new business opportunity from different perspectives. Too often entrepreneurs forget to look at the investor‘s side when developing their idea or approaching investors.
Morrissey: One of the things students learn in entering business plan competitions or getting in front of a prospective investor is that a single founder has a lot of flexibility. Committing to the roll out plan and the prospective management team overcomes the issues of the roles of the partners and their commitment.
Cox: People tend to get enamored with their product and think, “If I build a better mouse trap, the world will beat a path to my door.” Typically, that doesn’t happen. You may have a product that’s an innovation, but that doesn’t necessarily mean that there’s going to be a market for it. Something like only 1 percent of all the patents that are filed actually get commercialized, so, there are a lot of ideas out there that don’t end up being businesses. The entrepreneur needs to be solving a real problem.
In his experience, Luis Villalobos has identified several major mistakes entrepreneurs make. Below are some of the most common mistakes and how to avoid them:
- Answer questions directly. When dealing with investors, you can always backfill if you think that’s useful, but it’s very, very bad to dance around the topic and come across as evasive or obfuscating the topic.
- Avoid hyping and exaggeration. It doesn’t come across well. Don’t use off-the-wall statements such as “We have no competition,” or claim to take 90 to 95 percent of the revenues to pre-tax profits in the out years. Investors see right through these.
- Use specifics versus generalities. “We have the highest miles per gallon of any vehicle on the highway,” doesn’t tell me much. If you tell me, “Our car yields 200 miles per gallon on the highway and 180 on city streets,” now I know something
- Maintain your integrity. A mistake that is absolutely lethal is demonstrating any sense of a lack of integrity in anything. Good investors know that if you don’t have integrity in one situation, then you probably aren’t going to have integrity with them. That doesn’t mean that you can’t have made mistakes, but, at the appropriate time, a prior bankruptcy or drug rehab or stint in prison should be discussed.
- Keep investors in the loop. Investors hate surprises, both pre-funding and post-funding. Always let the investor know where things stand.
- Target your market. Find a niche that your product can be successful in.
- Understand the value of marketing. Do not forget to include an appropriate expenditure for marketing.
- Plan your expenses accordingly. Study the expense numbers of companies in your industry. Unrealistic expense allocations show investors you haven’t done your research.
- Have a CEO succession plan. Investors are also concerned about whether the founder is willing to step down as CEO if the company outgrows him or her.
- Use NDAs with caution. Sometimes the entrepreneur wants the investor to sign an NDA (non-disclosure agreement) before they talk to you. Know that investors, VCs or angels, will rarely ever sign an NDA, and when they do it’s pretty far into due diligence and it’s going to be very narrow with angels it will be for one or two angels as opposed to the whole group, or, for example, it will be specifically about the technology.
For additional information on writing business plans, take a look at the GBR Blog “Ideas vs. Opportunities” by Tim Berry, GBR Editorial Review Board member and President of Palo Alto Software.