Tag Venture capital

What investors are looking for in a business plan?

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Focus on why venture may fail. When investors consider a business venture they focus on why this particular new business venture may fail. This is in comparison to the perspective of the entrepreneur who focuses mainly on why this particular venture will succeed.

Main concerns of investors: It is important to clearly address areas that investors are looking for first and foremost. This includes whether the product or service will be accepted by the market as well as potential demand for the product or service. The calibre of the management team and critical risks are also of vital importance to prospective investors. Investors also look for honesty and transparency in the way information is presented to them.

Short, simple and to the point: Investors receive a lot of business plans. Therefore, generally, investors will spend only five minutes briefly looking through the business plan to determine whether this particular plan deserves more time investment for exploration.

Investors usually briefly consider new business opportunity by the reading executive summary or by listening to in-person presentations by entrepreneurs. If within five minutes the opportunity does not seem to be promising, investors will likely to move on to another opportunity.

Therefore, it is vital to be well prepared. An executive summary must highlight all important details why this opportunity is promising. Presentations by the entrepreneur should be concise, to the point and first focus on what investor is most interested.

Value credibility: When an opportunity is presented to an investor in person or via a business plan, the fact whether the investor feels he or she can believe entrepreneur or not will play an important role.

Perceived credibility of an entrepreneur influences the interest of the investor. If the investor will not believe an entrepreneur’s claims and will see entrepreneur as not being trustworthy, the investor most likely will not do business with such an entrepreneur even if the opportunity is promising. Therefore, it is imperative to provide factual support for any claims made in the presentation to the investor, verbally or in writing. The plan should include realistic sales projections and profit margins which are aligned with average figures for the industry, with the exception where the opposite can be factually supported.

High level of preparation: Investors want to see the entrepreneur thoroughly researched the opportunity and considered all important areas.

Value passion: Investors look for passionate entrepreneurs. Investors often invest in entrepreneurs and the management team rather than the business opportunity itself.

After investing: After an investor provides funds to help establish a new business venture, it is imperative to act with integrity and follow through the business plan as agreed at the commencement of the relationship between an entrepreneur and investor. Furthermore, an entrepreneur should monitor actual performance against performance standards and milestones to ensure that he or she stays on track. In building relationship with the investor, it is advisable to follow the simple rule of under promising and over delivering instead of the opposite, which is more customary. Also, the entrepreneur can only control what he or she can control. However, as long as the entrepreneur remains true to his or her word and acts with integrity – natural setbacks and troubles should not be a problem with investors as they usually understand that in the turbulent start-up enviornment setbacks and troubles are inevitable.

 

External sources for financing Pearlparadise.com

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Let’s use Portia as an ongoing example. Portia can consider using external financing, which refers to funds invested by outside investors and lenders. External financing is divided into equity and debt financing. Portia can either borrow money with the agreement to repay the borrowed sum plus interest or can obtain funds in exchange for equity, or use a combination of equity and debt financing.

Portia can consider debt as a source of external financing. Debt financing increases her financial risk because debt must be repaid regardless of whether or not the firm makes a profit. If debt is not repaid according to an agreed upon schedule, creditors may even force the enterprise into bankruptcy. Alternatively, equity investors are not entitled to more than what is earned by the enterprise.

When borrowing from the bank, an entrepreneur has number of options. The following types of loans are generally available:

Lines of credit – this is when bank agrees to make money available to the business. Agreement is made for up to a certain amount and is not guaranteed, but only in place if the bank has sufficient funds available. Such agreement is generally made for a period of 1 year.

Revolving credit agreement – this is similar to the lines of credit but the amount is guaranteed by the bank. A commitment fee of less than 1% of the unused balance is generally charged. Therefore, such arrangement is generally more expensive for the borrower.

Term loans – such loans are generally used for the financing of equipment. The loan is generally corresponds to the useful life of the equipment.

Mortgages – such loans are long-term loans and are available for purchase of the property which is used as collateral for the loan.

Portia can also consider equity financing. Private equity investors include venture capital firms and business angels. Venture capital firms raise a fund and then select portfolio of businesses in which to invest. Portfolios generally include start ups and existing businesses.

In exchange for investment, venture capital firms obtain partial ownership of the business. Convertible preferred stock or convertible debt is usually preferred. This is because the venture capital firm would like to have the senior claim on assets in case of liquidation but still wants to have an option to convert it to common stock if the business becomes successful.

Business angels, which are also referred to as informal venture capital, are wealthy private individuals who invest in the firms in their individual capacity. A very small percentage of start ups manage to get such funding. Therefore, entrepreneurs should have other options available as well.

There are also government supported financing options available to Portia which are specific to Portia’s location.

Further, Portia can use personal sources of funds. The “personal” sources could be personal savings, credit cards, borrowing from friends and relatives or any other way of obtaining money such as selling an asset, such as a car or a summer house, to free up funds for investment in the enterprise.

Personal savings are usually the leading source of “personal” funds. Credit cards are often used but needed to be used with extreme caution as interest rates on outstanding amounts can be incredibly high.

Borrowing from friends and family is also very tricky and should be done with extreme care. If Portia’s business fails or does not perform as expected and money is not repaid when agreed than it can destroy or severely damage relationships. When borrowing from friends and family, it is a good guideline to ensure that it is seen as an investment rather than a gift by the lending side of the transaction. An agreed upon deal should be put in writing since memory is not always reliable. Moreover, the amount borrowed should be repaid as soon as possible.

Overall, Portia has a number of the sources of external financing to choose from. Portia needs to evaluate upsides and downsides of each option and consider all options in light of the unique situation of the business to choose the best option or combination of options.

 

Introducing Business Plan

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There are three basic objectives of a business plan:

  • First, and most importantly, the goal of business plan is to recognize and explain the new business opportunity.  It forces you to crystallize your thinking before you share it with others.
  • Second, the objective is to present, in a written format, how an entrepreneur intends to take advantage of the business opportunity. Business plans need to describe which steps the entrepreneur intends to take to make his dream of a new business a reality. It should include various tools that the entrepreneur will be able to use in the management of the business opportunity, such as vision, mission, goals, budgets, financial forecasts and description of target markets. Business plans also must provide descriptions of key success factors where achievement of, or occurrence and non occurrence of, will determine whether the business opportunity will be successful or not. Therefore, part of the second objective of the business plan is to be a managerial tool to be used to ensure successful pursuit of the opportunity.
  • A third objective of business plan is to allow entrepreneurs to obtain funds necessary to establish a venture. Suppliers of funds usually include banks as well as potential investors. The business plan demonstrates to lenders of funds how well the entrepreneur thought about each aspect of the potential new business. Business plans also provide potential lenders with information they require in making a decision about lending or investing funds into the venture.

Another important main objective of the business plan is to identify factors that will determine if the business opportunity has good potential to be successful.

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The business plan is a road map that allows entrepreneurs and other interested parties to see where prospective or current business is today, where it is going and how it is going to get there. In other words, it examines and identifies key areas that needed to be attended to as well as how it will be attended to and the performance standards which an entrepreneur expects to maintain, such as milestones.

If you work for a large corporate you can use business plan approach to get a buy in for a new project or to explain an existing initiative. You will be surprised at how useful it is to write a business plan. It is powerful because it forces you to think through all aspects of the project. Like a true entrepreneur, it makes you accountable for everything.

The content of the business plan should cover five key factors.

  • It should provide a big picture of the opportunity. This refers to the external factors or context of the opportunity such as regulatory environment, which is beyond the entrepreneur’s control
  • It should also address a management team with their qualifications and experiences
  • It should clearly describe the business opportunity
  • It should also present financial structure
  • It should indicate the resources needed for success of the venture

Structures of a business plan will differ from case to case. Generally, business plans can either be very brief, just covering main key areas and projections. Such plan is called dehydrated business plan and focuses on market issues such as pricing, distribution channels and competition. However, when people in business refer to the business plan, they are usually referring to in depth, all inclusive, business plan which are called comprehensive business plans.

Comprehensive business plan may include the sections discussed below.

It should start with the cover page, which should specify:

  • the name of the prospective venture and entrepreneur
  • the address
  • Contact details of the business venture and entrepreneur
  • It should also include the date when the business plan was completed and a disclaimer advising that information in the business plan is confidential and cannot be used without permission
  • Each copy should be numbered to keep track of the copies and for general transparency as it will indicate to investors, lenders and other parties how many copies were already handed out

Cover page is followed by the table of contents. This part of the business plan is created for convenience of the investors, lenders or any other parties that would be reading the business plan. Just as in any book, table of contents in the business plan sequentially lists each section and subsection and provides a page number where this section or subsection can be found. This allows anybody who is reading a business plan to find any section or subsection that they would like to examine in a fast and easy manner.

Executive summary should follow. This is generally the most important part of the business plan. This is because many people who will be reading this business plan will read executive summary first and will only read business plan in-depth if the executive summary generated enough excitement.

The executive summary brings together key points from each section of the business plan. It is an overview of the entire business plan and should be written last and be no longer than two or three pages. It should describe opportunity, explain the business concept, explain which market or markets will be targeted, provide an industry overview as well as the competitive advantage the new venture intends to deploy/create. Economics of the business opportunity should be provided and the management team should be briefly described. Lastly, if external funding from investors is required, main points from the offering section should be included regarding how much of external funding from investors is required as well as how this money will be allocated.

In writing the executive summary two strategies can be used, synopsis and narrative. Synopsis provides conclusion of each section of the business plan. It is very straightforward and dry. It is about getting right to the point regarding each section of the business plan. Synopsis is easier to prepare but it may not create enough excitement in the target audience to entice them to continue explore the business opportunity.

A narrative executive summary creates excitement, generates enthusiasm and sense of urgency. It tells a story about business opportunity and requires certain degree of writing talent. Narrative executive summaries are especially relevant if there is something really special about the new venture, such as if a new market or new innovative product is to be explored. An example can be if the business intends to become the first direct life insurance provider in Ukraine. Alternatively, a narrative is relevant if the business is to be led by a well respected entrepreneur or a businessman, which again makes the new venture more special than an ordinary start up.

An industry, target customer and competitor analysis can be presented next. The main purpose of these sections is to present business opportunity as well as to illustrate that there is a profitable and big enough market to be served.

Industry analyses should describe the industry within which the prospective business will be established. This should include industry size, growth, trends and main players. Then the industry should be broken down into main segments. Lastly you should describe the niche from which the entrepreneur would specifically like to focus on or start from.

Target customers should describe in detail the target customer market or markets. It should illustrate factors that confirm that this target market is being underserved.

It should include customer profiles. Customer profile usually includes demographic characteristics of customers, such as their age and gender. It can also include psychological, behavioural and sociological information. Customer profile also includes information regarding transactions history, responses to marketing stimuli and on contacts with customer.

Based on customer analysis, the competitor analysis should be presented which should include profiles of main competitors. Such profile should include SWOT analysis, which is an analysis of the strengths, weaknesses, opportunities and threats of the competitors. More detailed competitor analyses may also be presented.

Company description section may follow which focuses on the type of business, its objectives, where it will be located and which form of organization will be selected.

Vision and mission statements may follow. The vision statement is a statement of the dream of the organization. What the organization inspires to be and to accomplish. The mission statement describes how the organization plans to accomplish its mission. It is more detailed. The mission statement is written based on the vision statement.

A product or service plan may be presented next. This includes description of such areas as why the product or service which the company intends to provide will be better than that of competitors. If the product or service fills a particular gap in the market – it should be indicated as such. It also should be described if any secondary target markets are available. The prospective venture’s competitive advantage should be indicated as well as if this competitive advantage will be sustainable or is it very easy to copy.

Working model, photos of the product or product prototype as well as drawings may be included. Alternatively it can indicate where such information may be found in the appendices. Investors are interested in products that already were developed and shown in practice that they can work well and is useful and meet particular needs of the target market.

It should also be pointed out if company has any specific advantages, such as patent protection and innovative characteristics of the product or service. Product or service strategy for growth should also be included.

The Marketing plan can follow. This plan points out how the new business intends to promote its product or service. This refers to how customers will be persuaded and informed about the existence as well as benefits of the product or service.

The plan should include the pricing strategy and descriptions of which distribution channels will be used. It should be indicated what would be credit and pricing policies, which selling approach or approaches are intended. The plan must describe any types of sales promotions, advertising and how customers will be found and enticed to buy the product.

The marketing plan should include sales forecasts, which are developed based on other information provided in the marketing plan. The plan should describe if there are any warranties that will be provided. If business intends to have product updates than this also should be indicated.

The Operations and development plan can be presented next. This part of the business plan explains how the product will be manufactured or service provided. This section should indicate if the operations process will contribute to a competitive advantage. For example, this could be the case if the operation process is expected to be cheaper than that of competitors. The operations and development plan descries operational aspects of the business such as how much space the business will require, if the business will require a special location and which equipment is necessary for the operation of the business. The business plan should indicate what will be bought, built, owned and operated and/or outsourced and why. Lastly, it is important to point out how quality standards will be maintained, how and from whom raw materials are intended to be obtained, if business plasn to use subcontractors and which approach the new venture intends to use to control its inventory.

The management team section of the plan can follow. This is an important section because investors often look at the quality and calibre of the management team before they even look at what the new venture’s product of service will be.  Investors want to see a well balanced management team which consists of members with complementing skills. Investors want to see that all crucial skills and experience are present in the proposed management team. For example, investors and lenders may be looking to make sure that businesses have management with relevant skills, education and experience in areas such as finance, marketing, production and management.

Next, critical risks should be discussed. Investors, lenders and other interested parties understand that any business venture has critical risks. What they want to see is if the entrepreneur is aware of it and if entrepreneur has a plan how to manage, control or eliminate such risks. One example of critical risks includes lack of market acceptance which occurs when customers do not buy product or service as anticipated. Another example of critical risk is that competitors may respond by putting success of the new venture in jeopardy. For example, if the new venture is going to compete with a very large established company that produces the same kind of product, a large competitor may take action to ensure that the emerging new competitor is eliminated. For example, a very large company may temporarily lower its prices. The new venture will not be able to offer such low prices and may go out of business. Yet another example of critical risks can be unexpected government regulation which may have adverse effects on the new venture. New ventures generally have better protection from competitor response risk if they target a niche in which larger businesses are not so interested. Another way for the new venture to protect itself from competitor responses is to have a competitive advantage which is very difficult to imitate.

An offering section can follow. This section is relevant if the entrepreneur requires external financing from investors. This section describes how much money the venture will require from investors and at which times. It is advisable to present investors with sources and uses table which describes where money will come from, such as from equity or debt and for what purposes money will be used.

The Financial plan can be presented next. This is a very important section. It provides financial forecasts of the new venture in the form of pro forma statements. It should include annual pro forma income statements, balance sheets and cash flow statements for a minimum of three and up to five years. This section should also include monthly cash budgets for the first year and quarterly cash budgets for the second and third years. Assumptions based on which the pro forma financial statements have been prepared as well as clarifications of how the pro forma statements were determined should be indicated.

Specific attention should be paid to statements of cash flows. Without cash inflows the business will not be able to survive even if it is profitable according to income statement. It indicates sources of cash and for which main investments, such as equipment or property, it will be used for.

Appendices should conclude business plan. This section contains supporting documents. It can contain details on information that is briefly discussed in the main body of the business plan. For example, in the case of the management team section, brief descriptions of the management team’s skills, education and experience should be supplemented with detailed resumes of each member of the management team which should be presented in the appendices. Appendices also may contain photographs of the product and facilities, copies of signed contracts with important customers and/or research documents, patent filings etc.

 

Sources of financing

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When it comes to sources of financing, firms at any stage of the company’s life cycle have three options from which to choose:

  1. Internal financing – using retained profits.
  2. External financing – using funds invested by outside investors and lenders. Investors include the common stockholders, venture capitalists and entrepreneurs.
  3. Spontaneous financing – such as accounts payable, which increase automatically with increases in sales. Accounts payable, which is also called trade credit, are funds payable to suppliers.

Further, an entrepreneur needs to take into account certain variables when making a decision on optimal sources of financing. Particularly, entrepreneurs need to decide if they are willing to give up part of the voting control which will be inevitable if equity financing is chosen. Entrepreneurs also need to decide if they are willing to take on bigger financial risk which is inevitable when debt financing is selected.

Debt financing increases financial risk because debt must be repaid regardless of whether or not the firm makes a profit. If debt is not repaid according to an agreed upon schedule, creditors may even force the enterprise into bankruptcy. Alternatively, an equity investor is not entitled to more than what is earned by the enterprise.

Personal Sources of Financing

It is most likely that entrepreneurs will have to invest some of his or her “personal” money or money from “personal” sources to ensure that others will even consider investing in the enterprise. The “personal” sources of financing could be personal savings, credit cards, borrowing from friends and relatives or any other way of obtaining money such as selling an asset, such as a car or a summer house, to free up funds for investment in the enterprise.

Personal savings are usually the leading source of “personal” funds. Credit cards are often used but needed to be used with extreme caution as interest rates on outstanding amounts can be incredibly high.

Borrowing from friends and family is also very tricky and should be done with extreme care. If the business fails or does not perform as expected and money is not repaid when agreed than it can destroy or severely damage important relationships. When borrowing from friends and family, it is a good guideline to ensure that it is seen as an investment rather than a gift by the lending side of the transaction. Agreed upon deals should be put in writing since memories are not always reliable. Moreover, the amount borrowed should be repaid as soon as possible.

Bootstrapping

Bootstrapping is usually a strategy that entrepreneurs follow to survive at the beginning stages of business establishment and growth.A bootstrapping or bootstrap financing refers to a situation when entrepreneur uses his or her initiative to find capital or use capital more efficiently to survive.

It includes minimization of the company’s investments and refers to such situations as leasing instead of buying, adapting just-in-time inventory system, operating business from home, obtaining free publicity instead of paying for advertising and using other people’s resources as much as possible, while paying as little as possible.

Other examples of bootstrap financing include factoring and trade credit. Factoring refers to the situation when the business sells its accounts receivable to a financial institution at a discount rate. Factor refers to the financial institution which business is to purchase accounts receivable from other companies. Trade credit refers to situations when suppliers provide their products and services on credit. Suppliers usually extend interest free credit for 30 days or less commonly for 60 or 90 days interest free credit.

Borrowing from the Bank

When borrowing from the bank, an entrepreneur has a number of options. The following types of loans are generally available:

Lines of credit – this is when the bank agrees to make money available to the business. Agreement is made for up to a certain amount and is not guaranteed but only in place if the bank has sufficient funds available. Such agreement is generally made for a period of 1 year.

Revolving credit agreement – this is similar to the lines of credit but the amount is guaranteed by the bank. A commitment fee of less than 1% of the unused balance is generally charged. Therefore, such an arrangement is generally more expensive for the borrower.

Term loans – such loans are generally used for financing of equipment. The loan generally corresponds to the useful life of the equipment.

Mortgages – such loans are long-term loans and are available for purchase of the property which is used as collateral for the loan.

When banks consider loaning money, they generally will have to consider certain requirements before they will even consider loaning the funds. Such requirements include the request of a business plan to learn whether or not the entrepreneur have their “own skin in the game”.

Other considerations include the entrepreneur’s own net worth which refers to personal assets less personal liabilities. The projected annual income of the entrepreneur is also considered.

If the company is not a start up, the historical financial statements may be requested. Further, pro forma financial statements may be requested which include pro forma income statements, balance sheets and cash flow statements.

It is advisable for the entrepreneur to cultivate a good relationship with the banker since intuitive judgments also play a role when bankers decide whether or not they should lend money to the particular borrower. However, this is only valuable if all other considerations discussed above are attended to.

Banks use different methods to evaluate the appropriateness of the potential borrower. One of such methods, the five C’s method, is discussed below.

Five Cs of credit:

  1. Capital – businesses position with regards to debt versus equity
  2. Collateral – whether or not the entrepreneur has assets that can be sold to cover debt
  3. Character – borrower’s history of meeting obligations
  4. Capacity – ability to repay the loan. This is judged by such indicators as projected cash flows
  5. Conditions – conditions surrounding this particular lending opportunity such as market conditions and transaction conditions

Venture Capital

In exchange for investment, venture capitalists obtain partial ownership of the business. Convertible preferred stock or convertible debt is usually preferred. This is because venture capital firm would like to have the senior claim on assets in case of liquidation but still have an option to convert it to common stock if the business becomes successful.

Angel Investors

Angel Investors, which are also referred to as informal venture capital, are wealthy private individuals who invest in the firms in their individual capacity. Very small percentage of start ups manage to get such funding. Therefore, entrepreneur should have other options available as well.

Government Programs

There are also government supported financing options available which are specific to an entrepreneur’s location.

Other

Other less feasible options exist. One example is to obtain funding from large corporation which is willing to invest in the enterprise.