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How a business plan is read
H o w a Business P l a n is Read A n investor may spend only five minutes reading a business plan. The way it is written, therefore, is important. The author suggests an approach based on how the plan is read and interpreted.
JOSEPH R. MANCUSO
Joseph R. Mancuso is head of the management engineering department and a faculty member at Worcester Polytechnic Institute, Worcester, Massaehussetts.
A d o c u m e n t written to raise money for a growing company is called a business plan. The most popular types are written for entrepreneurial companies seeking a private placement of funds from venture capital sources. Internal venture management teams of larger companies also write business plans. While these newer types of plans seldom circulate to external private placement sources, they do progress upward within the organization for approval by corporate management. The differences certainly exist between the entrepreneurial plan and the internal venture group's business plan, but they are quite small. The major difference rests in the risk and reward structure of the enterprise and not in the reading or writing of the document. The objectives of both types of plans are the same-launching a new busi~aess or expanding a promising small business. The ultimate responsibility for success or failure in one case rests with an entrepreneur/venture capitalist and in the other with a manager/ vice-president. However, the d o c u m e n t used to consummate the financing is called the business plan, no matter what its origin. In
AUGUST, 1974
both cases, the document must be thorough and well done to be successful. The vast majority of business plans are prepared by entrepreneurs seeking venture capital. The new venture groups within large companies are expanding their activities, but they do not approach the number of existing small companies seeking the same goal. In addition, start-up companies, which still appear despite current depressed economic conditions, require a special breed of entrepreneurial business plan. The term "business plan" is the more formal name for the document; however, the financial c o m m u n i t y prefers the nickname "deal." While the latter is crude and a bit harsh, it has shock value which makes it realistic and descriptive. Some financiers carry this realism one step further and describe the fund-raising process as comparable to the television program "Let's Make a Deal."
THE VENTURE CAPITALIST The Five-Minute Reader Business plans are comprehensive documents which often require several months to compile. Although they vary in length and c o r n -
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JOSEPH R. MANCUSO
34
plexity, the process of writing them requires the coordination of external legal, financial, and accounting assistance. In addition, the internal analysis of manufacturing, finance, and marketing must coincide with the external activities; this coordination adds to the length of time required for preparation. Spending $1,000 to $10,000 for outside services to prepare a business plan is typical. The company management intuitively believes their plan's thoroughness and sophistication reflect on the likelihood of success. Consequently, there is a tendency to do it well and sometimes to do it and redo it. Despite all this care, most business plans are not read in detail from cover to cover. While five weeks may have been required to compile it, potential investors will typically invest only five minutes in reading it. A venture capitalist who receives a dozen plans a d a y - h u n d r e d s annually-simply does not have the time to read through each one. In fact, a leading venture capitalist at a large Boston bank claims he never reads a plan. "They all say the same thing and it's never true," he comments, "so I never read them." This should not be interpreted to mean that a business plan is unnecessary; it is essential to raising new m o n e y for internal or external entrepreneurs. The businessman who does not have a plan will be immediately conspicuous b y its absence and will be turned away. This fact of financial life is unlikely to change; even though the plan may never be read, the entrepreneur must write one, if for no other reason than to prove that he can do it. One of the reasons w h y hundreds of deals arrive at a single venture capitalist's office is that multiple exposures are given a single business plan. An entrepreneur in dire need of funds often will mail his plan to a large list of venture capitalists. Such lists are available from several sources. This multiple exposure, often described as "shopping the deal," often seriously weakens rather than improves the chances of raising the needed capital. On the
other hand, not showing the plan to anyone assures failure. A thin line exists between too few and too many potential investors. (Incidentally, the Security Exchange Commission frowns on selling a deal to more than thirtyfive potential investors.) The number of deals reviewed b y a venture capitalist depends upon his reputation, which, in turn, depends upon his past successes. There are now about 500 venture capital firms in the United States. The number of successes contained within a venture capital portfolio seldom exceeds one in ten, or, in baseball language, a batting average of .100. A typical venture portfolio might be invested in ten companies. While only one winner is the average, the typical portfolio would have five businesses that are essentially bankrupt; two or three marginal firms with little real potential; and one or two firms with a chance to become a big winner. This pattern reveals the dangers of the venture business and demonstrates the crucial nature of a single winner.
Writing for a Five-Minute Reader Obviously, the primary problem in writing a business plan is to shape it for the reader for w h o m it is i n t e n d e d - t h e prospective investor with five minutes to read it. The businessman should accept the inevitable-a potential investor will take only five minutes to read a plan; therefore, the plan should be adapted to this process. Most articles concerned with the writing of business plans focus on checklists, blank forms, and sample plans. As guides, they help cat~ch items that might be overlooked because they force a full and balanced consideration of the many intertwined issues. To be helpful, they must be broad in scope, b u t this also decreases their effectiveness for a particular reader. These articles also often contain excerpts of business plans or a table of contents from a typical plan.
BUSINESS HORIZONS
How a Business Plan Is Read
A central message in the how-to-write advice is to tailor the d o c u m e n t to meet the needs and desires of the potential investors. This sound advice does not mean to exaggerate, lie, or inflate the sales projections. It does mean to emphasize items of special interest for a specific potential investor. In some cases, a business plan is written in modular
form; the various modules can be combined for different investors depending upon the characteristics of the firm. A single plan rarely suffices for all possible uses. This article is not intended to provide still another new format or table of contents because changes in form are not needed. What is needed is insight into what happens to a
REFERENCES How to Write a Business Plan
Donald Dible, Up Your Own Organization. The Entrepreneur Press, Mission Station, Drawer 27591, Santa Clara, Calif. 95051. Winfred Brown and Leroy Sinclair, "The Business Plan." Spiral-bound booklet. Technimetrics, Inc., 919 Third Avenue, New York, N.Y. 10022. Joseph R. Mancuso, The Entrepreneur's Handbook. A b o o k of readings. Artech House, 610 Washington Street, Dedham, Mass. 02026. Joseph R. Mancuso and Cliff Baumback, Entrepreneurship a n d Venture Management. A b o o k of readings. Prentice-Hall, Englewood Cliffs, N.J. 07632. Small Business Administration, "Business Plans for Small Manufacturers," Management Aid #218. A 24-page booklet. Small Business Administration, Washington, D.C. 20416. Venture Capital Lists and Other Aids
Bank of America, "The Small Business Reporter." A free monthly brochure. Bank of America, Box 37000, San Francisco, Calif. 94137. Center for Venture Management. Valuable services for entrepreneurs, including a bibliography of articles and a monthly newsletter. J o h n Komives, director, Center for Venture Management, 811 East Wisconsin Avenue, Milwaukee, Wis. 53202. Donald Dible, Up Your Own Organization. A 300-page how-to-do-it book; especially helpful are the appendixes, which offer reviews of many forms of help, bibliographies, and venture capital lists. The Entrepreneur Press, Mission Station Drawer 27591, Santa Clara, Calif. 95051. Dun & Bradstreet. A 50-page booklet identifying many of the best articles and books on small business and especially valuable for specific industries because reports on special opportunities are included. Dun & Bradstreet, 99 Church Street, New York, N.Y. 10007. Lawrence A. Klatt, Managing the Dynamic Small Firm. A group of readings on small businesses. Wadsworth Publishing Co., Belmont, Calif.
AUGUST, 1974
Joseph Mancuso, Fun 'n" Guts. A 20-page guideb o o k to the entrepreneur's philosophy offering honesty, humor, advice, and a bibliography. AddisonWesley Publishing Co., Reading, Mass. 01867. National Council for Small Business Management Development. A quarterly academic journal publishing articles for the small businessman. Lillian B. D r e y e r , Secretary, NCSBMD, 351 California Street, San Francisco, Calif. 94104. Newsletter Small Business. A newsletter offering items especially relevant to small business and the government. Newsletter Small Business, 1225 19th Street, N.W. Washington, D.C. 20036. Ted Nicholas, "How to Form Your Own Corporation Without a Lawyer for Under $50.00." Enterprise Publishing Co.,Wilmington, Del. Stanley M. Rubel, "A Guide to Venture Capital." Also newsletters and other material on venture capital including an SBIC venture capital monthly newsletter. Capital Publishing Company, 10 South LaSalle Street, Chicago, IlL 60603. Leroy W. Sinclair, Venture Capital A hard-cover b o o k offering details on all venture capital firms across the country. Technimetrics, Inc., 919 3rd Avenue, New York, N.Y. 10022. Select Committee on Small Business of the House of Representatives. A list of publications and committee memberships. U.S. Government Printing Office, #87-842 pamphlet, Washington, D.C. 20401 Small Business Administration. The SBA publishes a complete quarterly listing of small business investment companies, listing name, address, and size category. The SBA also offers numerous services and seminars. Inquiries about the Service Case of Retired Executives (SCORE) and the student team of the Small Business Institute (SBI) may be worthwhile. SBA Investments Division, 1441 2nd Street, N.W., Washington, D.C. 20416. Smaller Business Assc;ciation of New England. Seminars and newsletter offered b y a group of New England small businessmen who have formed an organization for their mutual benefit. Lew Shattuck, SBANE, 69 Hickory Drive, Waltham, Mass. 02154.
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JOSEPH R. MANCUSO
plan when it finally reaches the top of the pile. What happens during the five minutes the venture capitalist examines the plan? How is it read? How is it analyzed? An understanding of the reading and interpretation process may help to direct the writing style and the focus of the plan. The next section of the article will describe how business plans are interpreted. On the basis of field research involving several dozen venture capitalists and several hundred entrepreneurs, I have concluded that all knowledgeable investors use the precious five minutes of reading time in about the same way. HOW A BUSINESS PLAN IS READ
36
Since little has been written on how a business plan is analyzed, I conducted indepth interviews over the past three years with two dozen venture capitalists and twice as many others (including bankers, lawyers, accountants, and consultants) in the financial community. In addition, I spent several days in actual observation in several companies, and, as an investor in several entrepreneurial companies, h a v e read hundreds of business plans. Almost everyone, the study revealed, analyzed the plans in the same way; the "five-minute reading is a good average if all the plans that are never read are excluded. The following steps are typical of the reading process (less than a minute is invested in each step): Step i--Determine the characteristics of company and industry. Step 2--Determine the terms of the deal. Step 3--Read the latest balance sheet. Step 4--Determine the caliber of the people in the deal, Step 5--Determine what is different about this
deal. Step 6--Give the plan a once-over-lightly.
Step 1-Determine the characteristics of company and industry. Each venture capi-
talist has preferred areas for investment. Some like high technology and others like low technology; some like computers; others like consumer goods; and still others prefer publishing. A single venture capitalist is seldom at ease in every industry, just as a single entrepreneur cannot manage with equal skill in various industries. The venture capitalist's area of expertise is developed over the years and is based upon past successes; success in a particular industry will cause him to be receptive to deals in the same industry. Consequently, the potential investor may never read a business plan b e y o n d Step 1, regardless of the terms of the deal, if he has little interest in the industry. The potential investor also considers the glamour of the industry. Are there any larger publicly traded companies in the same industry? If so, how high is the stock price earning multiple (P/E ratio) of these firms? Or, better yet, is there a larger company that is extremely successful in this industry? Companies find it easier to raise funds when another company has pioneered successfully. In the computer industry, the Data General Corporation could point to Digital Equipment Corporation; in the consumer goods industry, many small companies have pointed to Avon Products. A company that eventually failed, Lanewood Laboratories, Inc., raised $500,000 in a business plan that pointed to Lestoil. Industry glamour rises and falls m u c h like the length of women's skirts. Ten years ago the glamour field was electronics, followed b y franchising and then computers. Next year it will probabb/ be energy. Despite the obvious problems with fads, we must accept them as a reality. They exist and they make a difference; if one's industry is momentarily considered glamorous, one's chances of securing funds suddenly increase. After the potential investor examines and evaluates the industry, he will quickly categorize the company within the industry. He will determine the following facts about the company: annual sales for the past twelve
BUSINESS HORIZONS
How a Business Plan Is Read
"Unfortunately, many plans do not spell o u t . . , issues plainly. The short time invested in looking over the plan is spent in digging o u t . . , details. If they were clearly stated at the beginning, potential investors could spend more time analyzing the plan's more positive selling features . . . . "
m o n t h s ; profit or loss for last year; n u m b e r of employees; share of market; degree of techn o l o g y ; and geographic location of facilities. D e p e n d i n g u p o n his i n t e r p r e t a t i o n of the facts, the investor will soon be able to d e t e r m i n e w h e t h e r the c o m p a n y matches the venture capitalist's visions of an ideal investment. Is it too large or small? Is it t o o far away? There are n u m e r o u s acceptable reasons for n o t making the investment. Seldom, if ever, is a venture capitalist faulted for the investments he did n o t make. More o f t e n and more intense is the criticism for the investments he actually selected. The sequence in Step 1 is to first check the industry and t h e n check the c o m p a n y . S t e p 2 - - D e t e r m i n e the t e r m s o f the deal. H o w m u c h of a c o m p a n y is being sold and the price asked represent the substance of the terms of the deal. The peripheral issue is the form (debt or equity) of the deal being offered. M a n y venture firms strongly prefer convertible d e b t or d e b t with warrants rather t h a n a straight equity deal. Their profitmaking structure m a y require the venture firm to generate i n c o m e to pay salaries and overhead, in addition to the capital gains expected f r o m the capital portfolio. Naturally, these firms would prefer interest-bearing debt to help cover this overhead, and a few of t h e m will reject deals which do n o t satisfy this basic r e q u i r e m e n t . In these cases, form is n o t a peripheral issue, b u t in the m a j o r i t y of cases the more substantive issue of " h o w m u c h for h o w m u c h " is of more concern. Accordingly, a well-done business plan informs the reader of the following items on the first page:
AUGUST, 1974
Percentage of company being sold (after dilution) The total price for this percentage of the company (per share figures also included) The minimum investment (number of investors sought) The total valuation (after the placement) being placed on the company The terms of the investment: Common stock Preferred stock Convertible debentures Stock with warrants Straight equity. U n f o r t u n a t e l y , m a n y deals do n o t spell o u t these issues plainly. The short time invested in looking over the plan is spent in digging o u t these details. If t h e y were clearly stated at the beginning, potential investors could spend more time analyzing the plan's more positive selling features (such as the p r o d u c t literature). A s u m m a r y sheet saves everyone's time and increases an interested reader's enthusiasm. Finally, after the terms are k n o w n , the follow-up analysis focuses on these related issues: How does the price per share of this placement compare with the founder's price per share? Are the founders reinvesting in this placement? What was the value of the company at the last placement and why has it changed? How will the new funds be used and, more specifically, will they be used to repay old debts or to undertake new activities that, in turn, will increase profitability? Step 3 - R e a d the balance sheet. A current balance sheet is usually located j u s t before the appendix and pro f o r m a cash flow and inc o m e statements. O f t e n the first page of the financial exhibits, it is the o n l y financial page ever glanced at during an initial reading of a business plan.
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JOSEPH R. MANCUSO
Much preferred to any pro forma analysis is a one-minute process for interpreting the balance sheet (and income statement). (Merrill, Lynch, Pierce, Fenner & Smith publishes a free twenty-four page brochure, " H o w to Read a Financial Report," which contains greater detail on the same subject). The following four-step process that can be used to read a balance sheet from the top down offers all the financial information needed to make a quick evaluation of the deal: Step A--Determine liquidity Step B--Determine debt/equity structure Step C--Examine net worth Step D--Examine assets and liabilities. Step A - D e t e r m i n e
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liquidity. Check working capital or current ratio, each of which measures about the same thing. Working capital is equal to current assets minus current liabilities, while the current ratio is current assets divided b y Current liabilities. Below is a typical balance sheet illustrating these relationships: Cash
Accounts receivable Inventories Total current assets Accounts payable
Notes payable (one year) Accrued expenses payable Federal income tax payable To tal current liabilities Working capital = $50,000 Current ratio = 1.1
$ 50,000 200,000 250,000 $500,000 $250,000 75,000 100,000 25,000 $450,000
A firm's working capital should be positive while the current ratio should be greater than 1 (these two statements say the same thing in different words). A current ratio closer to 2 indicates a more average company. A company with a positive $100,000 of working capital is liquid b u t may be tight on cash. Step B--Determine d e b t / e q u i t y structure. It is important to remember that the debt/ equity ratio is equal to total debt divided b y
total equity. This ratio reveals how much credit a debt source (bank) has already extended to the company. In addition, it offers insight into the remaining borrowing power of the company. A 50 percent debt/ equity ratio, where a lender advances fifty cents for every equity dollar, is a ballpark upper limit for this ratio. Seldom will debt sources advance one debt dollar for every equity dollar. Consequently, a d e b t / e q u i t y ratio of 1 is rare, while a ratio of 10 percent indicates the c o m p a n y has borrowing power remaining. Step C - E x a m i n e net worth. The potential investor will extract from the balance sheet the amount of m o n e y initially invested in the firm, which is the initial capitalization provided b y the founders. The cumulative profits (or losses) that are contained within retained earnings offer another benchmark of t h e company's success to date. Below is a typical balance sheet: Long-term debt (current portion due this year shown under current liabilities) Capital stock (initial capitalization)
Retained earnings (profit or loss to date) Owner's equity (combines capitalization and retained earnings) Debt Equity
100,000 150,000
$100,000 250,000 (100,000) $150,000
--- .75
A prospective investor interprets this information, noting that the founders began the company with $250,000 and have lost $100,000 since its inception. The c o m p a n y has a long-term interest bearing note which was probably awarded to the company because of the initial capital of $250,000. However, due to the losses to date, the company has little remaining borrowing power. The investor will make a quick check to determine if any or all assets (receivable, inventory, and fixed assets) are pledged to secure any of the debt. Free and unencumbered assets would indicate more borrowing power.
BUSINESS HORIZONS
How a Business Plan Is Read
As a rule of thumb, a debt source will allow the following debt to be secured against assets:
Asset
Cash or marketable securities Accounts receivable Inventory Fixed assets
Percentage of Balance Sheet Value Which Can Be Borrowed Against
100 75-85 20-30 (Percentage will depend on market value, not on book value.)
D - E x a m i n e assets and liabilities. First, the investors quickly check to be sure all assets are real (tangible) and then check liabilities to verify that any debt is owed to outsiders, not to insiders (such as notes to stockholders). By examining t h e asset categories, investors check to be sure soft assets such as good will, patents, or capitalized research and development are not large or unreasonable. For some unexplained reason, small companies often choose to capitalize R&D or organizational expenses rather than write off these expenses during the period in which they occur. This practice is frowned upon b y all potential investors because it distorts the balance sheet, impairs future earnings, and is a sure sign of danger. If this asset is large, it can dampen an investor's interest. Furthermore, entrepreneurs and friends and relatives of entrepreneurs often choose to make their initial investment in a small c o m p a n y as debt rather than equity. It makes these founders feel more secure because it offers some protection in the event of bankruptcy. So, in a quick check, a potential investor discovers the company's creditors and the amount of of debt. This four-step process (A through D) usually takes less than one minute of reading time from beginning to end. In the initial reading of the business plan, potential investors are not necessarily probing the balance sheet in depth b u t are searching for red flags. Step
AUGUST, 1974
Before an investment is consummated, the balance sheet, income statement, and pro formas will be analyzed in considerable detail. However, during the first glance, the above analysis and a quick look to determine the magnitude of last year's sales from the profitand-loss statement are the extent of the financial investigation. The balance sheet, along with a magnitude of sales, provides sufficient data to judge whether or not a more detailed financial investigation is warranted. Step 4 - D e t e r r n i n e the caliber o f the p e o p l e in the d e a l This step is focused on the
single most important aspect of the business plan. A potential investor begins b y examining the founders, board of directors, current investors, outside professional services (accountants, lawyers, bankers; consultants) in hopes of uncovering a familiar name. The reputation and "quality" of the team are the issues in this measure. Unfortunately, this is a subjective area and, as such, is open to a wide range of individual interpretations; what is good to some is not so good to others. Because it is subjective, opinions and assessments fluctuate dramatically. Investors usually k n o w someone associated witl~ the company (at least they will know someone who knows someone), and this person will set the tone for the whole deal, regardless of his affiliations with the company. Even if he is only a small investor, the c o m p a n y loses its identity and the business plan becomes known as " J o h n Smith's deal" around the office. These known insiders b e c o m e the links for further information sought b y the potential investors. Consequently, the reputation of all the individuals surrounding the business is of serious concern in securing additional funds. For start-up deals or for situations where the company is u n k n o w n to the potential investors, a number of questions should be asked in analyzing management's abilities. (This format is about the same for b o t h internal and external businesses. However,
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JOSEPH R. MANCUSO
internal venture teams are greatly assisted when the project directors are highly regarded b y top management. Many times this "golden b o y " syndrome becomes the crucial variable in approving new corporate funds.) What is the track record of founders and managers, including where they worked and how well they performed in the past? Without a doubt, this is the single most significant ingredient when assessing management's abilities. How much balance and experience does the inner management team possess? How long have the members worked together, and what is the degree of balance among marketing, finance, and manufacturing represented by the operating managers? Who is the financial man (or bank or accountant), and what are his credentials? Potential investors much prefer a deal with one strong full-time financial type. He speaks their language and is more at home with money than products. Potential investors like to envision this financial type as a caretaker for the newly arrived funds,
Step 5-Determine what is different about this deal. This difference is the eventual 40
pivotal issue on whether or not a specific venture capital firm chooses to invest. The same holds true for internal venture management teams in larger companies. Is there an unusual feature in the product? Does the company have a patent, an unusual technology, or a significant lead over competition? Is this a c o m p a n y whose critical skill rests in marketing, manufacturing, or finance? Does the company's strength match the skills needed to succeed in this industry? Or is there an imbalance? What is different about this company, and how much better is its product? The answers are the investor's chief concerns. Does this c o m p a n y have the potential to open up a whole new industry like Polaroid, Xerox, IBM, Digital Equipment Corporation, McDonald's, or Hewlett-Packard? Or is this a modest idea with limited future growth? A venture capitalist needs a return of greater than ten times on his investment just to stay even (one in ten succeed), and he is seldom intrigued with companies which hold a marginal advantage over competing firms or prod-
ucts, In essence, this is what Rosser Reaves has called the Unique Selling Proposition. G o o d ideas or products which are b o t h better and unique attract capital. Marginal improvements do not possess enough potential to offset the risks inherent in a new business venture.
Step 6-Give the plan a once-over-lightly. After the above analysis, the final minute is usually spent thumbing through the business plan. A casual look at product literature, graphs, unusual exhibits, samples, letters of recommendation, and letters of intent is the purpose of this last double check. Seldom, if ever, are new opinions formed during this final minute. However, the fact that everyone engages in this leafing-through process supports the argument for unusual enclosures. A product sample pasted on a page, a letter with a meaningful letterhead, or an unusual chart or two can be helpful i n maintaining interest. While enclosures will not make the big difference in the final analysis, they will extend the readership of a business plan. After this final step, the analysis is over and the investors decide whether to obtain more information or to return the plan. Ninety-nine times out of a hundred the deal is turned down. A few investors make phone calls at this stage and then reject the deal after a detail or two is confirmed. But these deals are actually turned down during the first reading even though the act of formal rejection is postponed a few additional days.
THE PLAN PACKAGE Most entrepreneurs assume a positive-relationship between time invested in reading the plan and the likelihood of obtaining capital. "If they would only read m y plan," mumbles the unsuccessful entrepreneur, " t h e y would be chasing me instead of vice versa." With this goal in mind and assuming that the product is
BUSINESS HORIZONS
H o w a Business Plan Is R e a d
"The same person should both presell and eventually deliver the plan. With the company name and location spelled out on the cover page, it should be hand-carried by a mutual friend to a select group of venture capitalists,"
only as good as the package, business plans are often dressed in their Sunday-best, leatherbound jackets sometimes costing over ten dollars. In research with several dozen venture capitalists, I conducted some small tests to determine the method used to select a single business plan from a group of five to ten. Several deals were placed on a table and the investors were asked to examine only the covers of the business plans before selecting which of the half-dozen plans they would read first. The plans that received the most initial attention were not the ones with pretty covers; instead, the c o m p a n y name was more crucial. Next in importance was the geographical location of the company. The third element was the thickness of the plan; the shorter plans received more attention. In these tests nothing else was revealed about any of the business plans other than what appeared on the cover. The position of the deals on the tables was random, and I observed each venture capitalist as he glanced over the deals. To conclude, I have ranked the variables in descending order of importance: c o m p a n y name, its geographic location, length of business plan, and quality of cover. The next question I explored was, " H o w can an entrepreneur increase the likelihood that a venture capitalist will read a business plan once he is past the cover?" Should he send it along in installments with the final chapter arriving first? Or should he send the first chapter first, and should he send along a summary? In my research, I concluded that summaries and "miniplans" are not effective documents. A teaser summary only delays the eventual readership of a plan, and is often vague or incomplete.
AUGUST, 1974
Two additional variables were uncovered that help to determine a plan's eventual readership, and, to a lesser extent, the likelihood that a venture capitalist will make an investment. The first is the method of dispatching the plan. Months may be spent preparing the plan, but only a few minutes spent deciding how to deliver it. The naive entrepreneur follows the suicidal path of a blind mass mailing. Armed with a directory and helped b y a secretary, he mails his plan with a form letter to a sampling from the directory. This wastes everyone's time and his money, because this procedure never works. Another bad approach is for the entrepreneur to make a personal visit with the business plan tucked under his arm. This humble, straightforward approach is like going to a doctor as an unreferred patient. Everyone asks, "Who sent y o u ? " The key man is often away from the office or unable to see the visitor, who then begins to feel like an intruder. The best method of delivering a business plan is through a third party. Unless the entrepreneur is already established and successful, a third-party referral adds credence to the plan and, as a result, increases the likelihood that it will be read. A n y one from the following groups is acceptable as long as his reputation and liaison with the venture capitalist are positive (it need not be the same person for each potential investor): consultants, bankers, lawyers, accountants, or other entrepreneurs. The second level of improvement, a good j o b on "preselling" is invaluable. If the potential investors are told about the exciting company six months before the plan arrives and then once a m o n t h for the next six
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JOSEPH R. MANCUSO
42 ¸
months about current developments, they will be more receptive to reading the plan. After all, the best time to raise m o n e y is when it isn't needed. The same holds for arousing potential investor interest. A well-managed company planning to expand will invest time in such preselling often and early. The same person should b o t h presell and eventually deliver the plan. With the c o m p a n y name and location clearly spelled out on the cover page, it should be hand-carried b y a mutual friend to a select group of venture capitalists. During the process one should remember that the two most successful venture capital deals in the Northeast were turned down a number of times before receiving a '"yes." In 1958, Digital Equipment Corporation (DEC) finally convinced American Research & Development to invest $70,000. DEC is rumored today to be worth about $250 million. In 1968, Fred Adler made a modest investment in a struggling new c o m p a n y known as Data General Corporation. It is rumored that the four principals each made in excess of $10
million within four years of launching venture. The rewards are high for those play and win. Unfortunately, those who lose most of the time, and plans of this significantly o u t n u m b e r the winners.
this who play type
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This article has explained an approach to writing a good business plan, an approach based on the process that will inevitably be used to read and interpret the plan. Whether the writer is an internal or external entrepreneur, it is his responsibility to put the company's best foot forward once the business is underway. The definition of a "'good" business plan is one that raises money; a ""bad" plan does not attract investors. It is that simple, b u t the entrepreneur must remember that the terms '"good plan" and ""good business" are not synonymous. A good plan may raise money, but the business may still fail. However, a bad plan almost always means business failure. To succeed in reaching the more crucial objectives of a profitable business, a good plan plus a good business is required.
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"Go around asking a lot of damfool questions and taking chances" was the credo of Clarence Birdseye (1886-1956); "only through curiosity can we discover opportunities, and only by gambling can we take advantage of them." His curiosity about the way the Eskimos kept their food fresh--and a gamble that nearly bankrupted him--gave birth to a multibillion dollar industry that revolutionized the marketing of food in A m e r i c a . . . . The interesting thing here is that Birdseye nearly went bankrupt, and he spent 17 years from the idea stage to the time he himself realized a large capital gain. --Leroy Sinclair
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BUSINESS HORIZONS
JOSEPH R. MANCUSO
Joseph R. Mancuso is head of the management engineering department and a faculty member at Worcester Polytechnic Institute, Worcester, Massaehussetts.
A d o c u m e n t written to raise money for a growing company is called a business plan. The most popular types are written for entrepreneurial companies seeking a private placement of funds from venture capital sources. Internal venture management teams of larger companies also write business plans. While these newer types of plans seldom circulate to external private placement sources, they do progress upward within the organization for approval by corporate management. The differences certainly exist between the entrepreneurial plan and the internal venture group's business plan, but they are quite small. The major difference rests in the risk and reward structure of the enterprise and not in the reading or writing of the document. The objectives of both types of plans are the same-launching a new busi~aess or expanding a promising small business. The ultimate responsibility for success or failure in one case rests with an entrepreneur/venture capitalist and in the other with a manager/ vice-president. However, the d o c u m e n t used to consummate the financing is called the business plan, no matter what its origin. In
AUGUST, 1974
both cases, the document must be thorough and well done to be successful. The vast majority of business plans are prepared by entrepreneurs seeking venture capital. The new venture groups within large companies are expanding their activities, but they do not approach the number of existing small companies seeking the same goal. In addition, start-up companies, which still appear despite current depressed economic conditions, require a special breed of entrepreneurial business plan. The term "business plan" is the more formal name for the document; however, the financial c o m m u n i t y prefers the nickname "deal." While the latter is crude and a bit harsh, it has shock value which makes it realistic and descriptive. Some financiers carry this realism one step further and describe the fund-raising process as comparable to the television program "Let's Make a Deal."
THE VENTURE CAPITALIST The Five-Minute Reader Business plans are comprehensive documents which often require several months to compile. Although they vary in length and c o r n -
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JOSEPH R. MANCUSO
34
plexity, the process of writing them requires the coordination of external legal, financial, and accounting assistance. In addition, the internal analysis of manufacturing, finance, and marketing must coincide with the external activities; this coordination adds to the length of time required for preparation. Spending $1,000 to $10,000 for outside services to prepare a business plan is typical. The company management intuitively believes their plan's thoroughness and sophistication reflect on the likelihood of success. Consequently, there is a tendency to do it well and sometimes to do it and redo it. Despite all this care, most business plans are not read in detail from cover to cover. While five weeks may have been required to compile it, potential investors will typically invest only five minutes in reading it. A venture capitalist who receives a dozen plans a d a y - h u n d r e d s annually-simply does not have the time to read through each one. In fact, a leading venture capitalist at a large Boston bank claims he never reads a plan. "They all say the same thing and it's never true," he comments, "so I never read them." This should not be interpreted to mean that a business plan is unnecessary; it is essential to raising new m o n e y for internal or external entrepreneurs. The businessman who does not have a plan will be immediately conspicuous b y its absence and will be turned away. This fact of financial life is unlikely to change; even though the plan may never be read, the entrepreneur must write one, if for no other reason than to prove that he can do it. One of the reasons w h y hundreds of deals arrive at a single venture capitalist's office is that multiple exposures are given a single business plan. An entrepreneur in dire need of funds often will mail his plan to a large list of venture capitalists. Such lists are available from several sources. This multiple exposure, often described as "shopping the deal," often seriously weakens rather than improves the chances of raising the needed capital. On the
other hand, not showing the plan to anyone assures failure. A thin line exists between too few and too many potential investors. (Incidentally, the Security Exchange Commission frowns on selling a deal to more than thirtyfive potential investors.) The number of deals reviewed b y a venture capitalist depends upon his reputation, which, in turn, depends upon his past successes. There are now about 500 venture capital firms in the United States. The number of successes contained within a venture capital portfolio seldom exceeds one in ten, or, in baseball language, a batting average of .100. A typical venture portfolio might be invested in ten companies. While only one winner is the average, the typical portfolio would have five businesses that are essentially bankrupt; two or three marginal firms with little real potential; and one or two firms with a chance to become a big winner. This pattern reveals the dangers of the venture business and demonstrates the crucial nature of a single winner.
Writing for a Five-Minute Reader Obviously, the primary problem in writing a business plan is to shape it for the reader for w h o m it is i n t e n d e d - t h e prospective investor with five minutes to read it. The businessman should accept the inevitable-a potential investor will take only five minutes to read a plan; therefore, the plan should be adapted to this process. Most articles concerned with the writing of business plans focus on checklists, blank forms, and sample plans. As guides, they help cat~ch items that might be overlooked because they force a full and balanced consideration of the many intertwined issues. To be helpful, they must be broad in scope, b u t this also decreases their effectiveness for a particular reader. These articles also often contain excerpts of business plans or a table of contents from a typical plan.
BUSINESS HORIZONS
How a Business Plan Is Read
A central message in the how-to-write advice is to tailor the d o c u m e n t to meet the needs and desires of the potential investors. This sound advice does not mean to exaggerate, lie, or inflate the sales projections. It does mean to emphasize items of special interest for a specific potential investor. In some cases, a business plan is written in modular
form; the various modules can be combined for different investors depending upon the characteristics of the firm. A single plan rarely suffices for all possible uses. This article is not intended to provide still another new format or table of contents because changes in form are not needed. What is needed is insight into what happens to a
REFERENCES How to Write a Business Plan
Donald Dible, Up Your Own Organization. The Entrepreneur Press, Mission Station, Drawer 27591, Santa Clara, Calif. 95051. Winfred Brown and Leroy Sinclair, "The Business Plan." Spiral-bound booklet. Technimetrics, Inc., 919 Third Avenue, New York, N.Y. 10022. Joseph R. Mancuso, The Entrepreneur's Handbook. A b o o k of readings. Artech House, 610 Washington Street, Dedham, Mass. 02026. Joseph R. Mancuso and Cliff Baumback, Entrepreneurship a n d Venture Management. A b o o k of readings. Prentice-Hall, Englewood Cliffs, N.J. 07632. Small Business Administration, "Business Plans for Small Manufacturers," Management Aid #218. A 24-page booklet. Small Business Administration, Washington, D.C. 20416. Venture Capital Lists and Other Aids
Bank of America, "The Small Business Reporter." A free monthly brochure. Bank of America, Box 37000, San Francisco, Calif. 94137. Center for Venture Management. Valuable services for entrepreneurs, including a bibliography of articles and a monthly newsletter. J o h n Komives, director, Center for Venture Management, 811 East Wisconsin Avenue, Milwaukee, Wis. 53202. Donald Dible, Up Your Own Organization. A 300-page how-to-do-it book; especially helpful are the appendixes, which offer reviews of many forms of help, bibliographies, and venture capital lists. The Entrepreneur Press, Mission Station Drawer 27591, Santa Clara, Calif. 95051. Dun & Bradstreet. A 50-page booklet identifying many of the best articles and books on small business and especially valuable for specific industries because reports on special opportunities are included. Dun & Bradstreet, 99 Church Street, New York, N.Y. 10007. Lawrence A. Klatt, Managing the Dynamic Small Firm. A group of readings on small businesses. Wadsworth Publishing Co., Belmont, Calif.
AUGUST, 1974
Joseph Mancuso, Fun 'n" Guts. A 20-page guideb o o k to the entrepreneur's philosophy offering honesty, humor, advice, and a bibliography. AddisonWesley Publishing Co., Reading, Mass. 01867. National Council for Small Business Management Development. A quarterly academic journal publishing articles for the small businessman. Lillian B. D r e y e r , Secretary, NCSBMD, 351 California Street, San Francisco, Calif. 94104. Newsletter Small Business. A newsletter offering items especially relevant to small business and the government. Newsletter Small Business, 1225 19th Street, N.W. Washington, D.C. 20036. Ted Nicholas, "How to Form Your Own Corporation Without a Lawyer for Under $50.00." Enterprise Publishing Co.,Wilmington, Del. Stanley M. Rubel, "A Guide to Venture Capital." Also newsletters and other material on venture capital including an SBIC venture capital monthly newsletter. Capital Publishing Company, 10 South LaSalle Street, Chicago, IlL 60603. Leroy W. Sinclair, Venture Capital A hard-cover b o o k offering details on all venture capital firms across the country. Technimetrics, Inc., 919 3rd Avenue, New York, N.Y. 10022. Select Committee on Small Business of the House of Representatives. A list of publications and committee memberships. U.S. Government Printing Office, #87-842 pamphlet, Washington, D.C. 20401 Small Business Administration. The SBA publishes a complete quarterly listing of small business investment companies, listing name, address, and size category. The SBA also offers numerous services and seminars. Inquiries about the Service Case of Retired Executives (SCORE) and the student team of the Small Business Institute (SBI) may be worthwhile. SBA Investments Division, 1441 2nd Street, N.W., Washington, D.C. 20416. Smaller Business Assc;ciation of New England. Seminars and newsletter offered b y a group of New England small businessmen who have formed an organization for their mutual benefit. Lew Shattuck, SBANE, 69 Hickory Drive, Waltham, Mass. 02154.
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JOSEPH R. MANCUSO
plan when it finally reaches the top of the pile. What happens during the five minutes the venture capitalist examines the plan? How is it read? How is it analyzed? An understanding of the reading and interpretation process may help to direct the writing style and the focus of the plan. The next section of the article will describe how business plans are interpreted. On the basis of field research involving several dozen venture capitalists and several hundred entrepreneurs, I have concluded that all knowledgeable investors use the precious five minutes of reading time in about the same way. HOW A BUSINESS PLAN IS READ
36
Since little has been written on how a business plan is analyzed, I conducted indepth interviews over the past three years with two dozen venture capitalists and twice as many others (including bankers, lawyers, accountants, and consultants) in the financial community. In addition, I spent several days in actual observation in several companies, and, as an investor in several entrepreneurial companies, h a v e read hundreds of business plans. Almost everyone, the study revealed, analyzed the plans in the same way; the "five-minute reading is a good average if all the plans that are never read are excluded. The following steps are typical of the reading process (less than a minute is invested in each step): Step i--Determine the characteristics of company and industry. Step 2--Determine the terms of the deal. Step 3--Read the latest balance sheet. Step 4--Determine the caliber of the people in the deal, Step 5--Determine what is different about this
deal. Step 6--Give the plan a once-over-lightly.
Step 1-Determine the characteristics of company and industry. Each venture capi-
talist has preferred areas for investment. Some like high technology and others like low technology; some like computers; others like consumer goods; and still others prefer publishing. A single venture capitalist is seldom at ease in every industry, just as a single entrepreneur cannot manage with equal skill in various industries. The venture capitalist's area of expertise is developed over the years and is based upon past successes; success in a particular industry will cause him to be receptive to deals in the same industry. Consequently, the potential investor may never read a business plan b e y o n d Step 1, regardless of the terms of the deal, if he has little interest in the industry. The potential investor also considers the glamour of the industry. Are there any larger publicly traded companies in the same industry? If so, how high is the stock price earning multiple (P/E ratio) of these firms? Or, better yet, is there a larger company that is extremely successful in this industry? Companies find it easier to raise funds when another company has pioneered successfully. In the computer industry, the Data General Corporation could point to Digital Equipment Corporation; in the consumer goods industry, many small companies have pointed to Avon Products. A company that eventually failed, Lanewood Laboratories, Inc., raised $500,000 in a business plan that pointed to Lestoil. Industry glamour rises and falls m u c h like the length of women's skirts. Ten years ago the glamour field was electronics, followed b y franchising and then computers. Next year it will probabb/ be energy. Despite the obvious problems with fads, we must accept them as a reality. They exist and they make a difference; if one's industry is momentarily considered glamorous, one's chances of securing funds suddenly increase. After the potential investor examines and evaluates the industry, he will quickly categorize the company within the industry. He will determine the following facts about the company: annual sales for the past twelve
BUSINESS HORIZONS
How a Business Plan Is Read
"Unfortunately, many plans do not spell o u t . . , issues plainly. The short time invested in looking over the plan is spent in digging o u t . . , details. If they were clearly stated at the beginning, potential investors could spend more time analyzing the plan's more positive selling features . . . . "
m o n t h s ; profit or loss for last year; n u m b e r of employees; share of market; degree of techn o l o g y ; and geographic location of facilities. D e p e n d i n g u p o n his i n t e r p r e t a t i o n of the facts, the investor will soon be able to d e t e r m i n e w h e t h e r the c o m p a n y matches the venture capitalist's visions of an ideal investment. Is it too large or small? Is it t o o far away? There are n u m e r o u s acceptable reasons for n o t making the investment. Seldom, if ever, is a venture capitalist faulted for the investments he did n o t make. More o f t e n and more intense is the criticism for the investments he actually selected. The sequence in Step 1 is to first check the industry and t h e n check the c o m p a n y . S t e p 2 - - D e t e r m i n e the t e r m s o f the deal. H o w m u c h of a c o m p a n y is being sold and the price asked represent the substance of the terms of the deal. The peripheral issue is the form (debt or equity) of the deal being offered. M a n y venture firms strongly prefer convertible d e b t or d e b t with warrants rather t h a n a straight equity deal. Their profitmaking structure m a y require the venture firm to generate i n c o m e to pay salaries and overhead, in addition to the capital gains expected f r o m the capital portfolio. Naturally, these firms would prefer interest-bearing debt to help cover this overhead, and a few of t h e m will reject deals which do n o t satisfy this basic r e q u i r e m e n t . In these cases, form is n o t a peripheral issue, b u t in the m a j o r i t y of cases the more substantive issue of " h o w m u c h for h o w m u c h " is of more concern. Accordingly, a well-done business plan informs the reader of the following items on the first page:
AUGUST, 1974
Percentage of company being sold (after dilution) The total price for this percentage of the company (per share figures also included) The minimum investment (number of investors sought) The total valuation (after the placement) being placed on the company The terms of the investment: Common stock Preferred stock Convertible debentures Stock with warrants Straight equity. U n f o r t u n a t e l y , m a n y deals do n o t spell o u t these issues plainly. The short time invested in looking over the plan is spent in digging o u t these details. If t h e y were clearly stated at the beginning, potential investors could spend more time analyzing the plan's more positive selling features (such as the p r o d u c t literature). A s u m m a r y sheet saves everyone's time and increases an interested reader's enthusiasm. Finally, after the terms are k n o w n , the follow-up analysis focuses on these related issues: How does the price per share of this placement compare with the founder's price per share? Are the founders reinvesting in this placement? What was the value of the company at the last placement and why has it changed? How will the new funds be used and, more specifically, will they be used to repay old debts or to undertake new activities that, in turn, will increase profitability? Step 3 - R e a d the balance sheet. A current balance sheet is usually located j u s t before the appendix and pro f o r m a cash flow and inc o m e statements. O f t e n the first page of the financial exhibits, it is the o n l y financial page ever glanced at during an initial reading of a business plan.
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JOSEPH R. MANCUSO
Much preferred to any pro forma analysis is a one-minute process for interpreting the balance sheet (and income statement). (Merrill, Lynch, Pierce, Fenner & Smith publishes a free twenty-four page brochure, " H o w to Read a Financial Report," which contains greater detail on the same subject). The following four-step process that can be used to read a balance sheet from the top down offers all the financial information needed to make a quick evaluation of the deal: Step A--Determine liquidity Step B--Determine debt/equity structure Step C--Examine net worth Step D--Examine assets and liabilities. Step A - D e t e r m i n e
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liquidity. Check working capital or current ratio, each of which measures about the same thing. Working capital is equal to current assets minus current liabilities, while the current ratio is current assets divided b y Current liabilities. Below is a typical balance sheet illustrating these relationships: Cash
Accounts receivable Inventories Total current assets Accounts payable
Notes payable (one year) Accrued expenses payable Federal income tax payable To tal current liabilities Working capital = $50,000 Current ratio = 1.1
$ 50,000 200,000 250,000 $500,000 $250,000 75,000 100,000 25,000 $450,000
A firm's working capital should be positive while the current ratio should be greater than 1 (these two statements say the same thing in different words). A current ratio closer to 2 indicates a more average company. A company with a positive $100,000 of working capital is liquid b u t may be tight on cash. Step B--Determine d e b t / e q u i t y structure. It is important to remember that the debt/ equity ratio is equal to total debt divided b y
total equity. This ratio reveals how much credit a debt source (bank) has already extended to the company. In addition, it offers insight into the remaining borrowing power of the company. A 50 percent debt/ equity ratio, where a lender advances fifty cents for every equity dollar, is a ballpark upper limit for this ratio. Seldom will debt sources advance one debt dollar for every equity dollar. Consequently, a d e b t / e q u i t y ratio of 1 is rare, while a ratio of 10 percent indicates the c o m p a n y has borrowing power remaining. Step C - E x a m i n e net worth. The potential investor will extract from the balance sheet the amount of m o n e y initially invested in the firm, which is the initial capitalization provided b y the founders. The cumulative profits (or losses) that are contained within retained earnings offer another benchmark of t h e company's success to date. Below is a typical balance sheet: Long-term debt (current portion due this year shown under current liabilities) Capital stock (initial capitalization)
Retained earnings (profit or loss to date) Owner's equity (combines capitalization and retained earnings) Debt Equity
100,000 150,000
$100,000 250,000 (100,000) $150,000
--- .75
A prospective investor interprets this information, noting that the founders began the company with $250,000 and have lost $100,000 since its inception. The c o m p a n y has a long-term interest bearing note which was probably awarded to the company because of the initial capital of $250,000. However, due to the losses to date, the company has little remaining borrowing power. The investor will make a quick check to determine if any or all assets (receivable, inventory, and fixed assets) are pledged to secure any of the debt. Free and unencumbered assets would indicate more borrowing power.
BUSINESS HORIZONS
How a Business Plan Is Read
As a rule of thumb, a debt source will allow the following debt to be secured against assets:
Asset
Cash or marketable securities Accounts receivable Inventory Fixed assets
Percentage of Balance Sheet Value Which Can Be Borrowed Against
100 75-85 20-30 (Percentage will depend on market value, not on book value.)
D - E x a m i n e assets and liabilities. First, the investors quickly check to be sure all assets are real (tangible) and then check liabilities to verify that any debt is owed to outsiders, not to insiders (such as notes to stockholders). By examining t h e asset categories, investors check to be sure soft assets such as good will, patents, or capitalized research and development are not large or unreasonable. For some unexplained reason, small companies often choose to capitalize R&D or organizational expenses rather than write off these expenses during the period in which they occur. This practice is frowned upon b y all potential investors because it distorts the balance sheet, impairs future earnings, and is a sure sign of danger. If this asset is large, it can dampen an investor's interest. Furthermore, entrepreneurs and friends and relatives of entrepreneurs often choose to make their initial investment in a small c o m p a n y as debt rather than equity. It makes these founders feel more secure because it offers some protection in the event of bankruptcy. So, in a quick check, a potential investor discovers the company's creditors and the amount of of debt. This four-step process (A through D) usually takes less than one minute of reading time from beginning to end. In the initial reading of the business plan, potential investors are not necessarily probing the balance sheet in depth b u t are searching for red flags. Step
AUGUST, 1974
Before an investment is consummated, the balance sheet, income statement, and pro formas will be analyzed in considerable detail. However, during the first glance, the above analysis and a quick look to determine the magnitude of last year's sales from the profitand-loss statement are the extent of the financial investigation. The balance sheet, along with a magnitude of sales, provides sufficient data to judge whether or not a more detailed financial investigation is warranted. Step 4 - D e t e r r n i n e the caliber o f the p e o p l e in the d e a l This step is focused on the
single most important aspect of the business plan. A potential investor begins b y examining the founders, board of directors, current investors, outside professional services (accountants, lawyers, bankers; consultants) in hopes of uncovering a familiar name. The reputation and "quality" of the team are the issues in this measure. Unfortunately, this is a subjective area and, as such, is open to a wide range of individual interpretations; what is good to some is not so good to others. Because it is subjective, opinions and assessments fluctuate dramatically. Investors usually k n o w someone associated witl~ the company (at least they will know someone who knows someone), and this person will set the tone for the whole deal, regardless of his affiliations with the company. Even if he is only a small investor, the c o m p a n y loses its identity and the business plan becomes known as " J o h n Smith's deal" around the office. These known insiders b e c o m e the links for further information sought b y the potential investors. Consequently, the reputation of all the individuals surrounding the business is of serious concern in securing additional funds. For start-up deals or for situations where the company is u n k n o w n to the potential investors, a number of questions should be asked in analyzing management's abilities. (This format is about the same for b o t h internal and external businesses. However,
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JOSEPH R. MANCUSO
internal venture teams are greatly assisted when the project directors are highly regarded b y top management. Many times this "golden b o y " syndrome becomes the crucial variable in approving new corporate funds.) What is the track record of founders and managers, including where they worked and how well they performed in the past? Without a doubt, this is the single most significant ingredient when assessing management's abilities. How much balance and experience does the inner management team possess? How long have the members worked together, and what is the degree of balance among marketing, finance, and manufacturing represented by the operating managers? Who is the financial man (or bank or accountant), and what are his credentials? Potential investors much prefer a deal with one strong full-time financial type. He speaks their language and is more at home with money than products. Potential investors like to envision this financial type as a caretaker for the newly arrived funds,
Step 5-Determine what is different about this deal. This difference is the eventual 40
pivotal issue on whether or not a specific venture capital firm chooses to invest. The same holds true for internal venture management teams in larger companies. Is there an unusual feature in the product? Does the company have a patent, an unusual technology, or a significant lead over competition? Is this a c o m p a n y whose critical skill rests in marketing, manufacturing, or finance? Does the company's strength match the skills needed to succeed in this industry? Or is there an imbalance? What is different about this company, and how much better is its product? The answers are the investor's chief concerns. Does this c o m p a n y have the potential to open up a whole new industry like Polaroid, Xerox, IBM, Digital Equipment Corporation, McDonald's, or Hewlett-Packard? Or is this a modest idea with limited future growth? A venture capitalist needs a return of greater than ten times on his investment just to stay even (one in ten succeed), and he is seldom intrigued with companies which hold a marginal advantage over competing firms or prod-
ucts, In essence, this is what Rosser Reaves has called the Unique Selling Proposition. G o o d ideas or products which are b o t h better and unique attract capital. Marginal improvements do not possess enough potential to offset the risks inherent in a new business venture.
Step 6-Give the plan a once-over-lightly. After the above analysis, the final minute is usually spent thumbing through the business plan. A casual look at product literature, graphs, unusual exhibits, samples, letters of recommendation, and letters of intent is the purpose of this last double check. Seldom, if ever, are new opinions formed during this final minute. However, the fact that everyone engages in this leafing-through process supports the argument for unusual enclosures. A product sample pasted on a page, a letter with a meaningful letterhead, or an unusual chart or two can be helpful i n maintaining interest. While enclosures will not make the big difference in the final analysis, they will extend the readership of a business plan. After this final step, the analysis is over and the investors decide whether to obtain more information or to return the plan. Ninety-nine times out of a hundred the deal is turned down. A few investors make phone calls at this stage and then reject the deal after a detail or two is confirmed. But these deals are actually turned down during the first reading even though the act of formal rejection is postponed a few additional days.
THE PLAN PACKAGE Most entrepreneurs assume a positive-relationship between time invested in reading the plan and the likelihood of obtaining capital. "If they would only read m y plan," mumbles the unsuccessful entrepreneur, " t h e y would be chasing me instead of vice versa." With this goal in mind and assuming that the product is
BUSINESS HORIZONS
H o w a Business Plan Is R e a d
"The same person should both presell and eventually deliver the plan. With the company name and location spelled out on the cover page, it should be hand-carried by a mutual friend to a select group of venture capitalists,"
only as good as the package, business plans are often dressed in their Sunday-best, leatherbound jackets sometimes costing over ten dollars. In research with several dozen venture capitalists, I conducted some small tests to determine the method used to select a single business plan from a group of five to ten. Several deals were placed on a table and the investors were asked to examine only the covers of the business plans before selecting which of the half-dozen plans they would read first. The plans that received the most initial attention were not the ones with pretty covers; instead, the c o m p a n y name was more crucial. Next in importance was the geographical location of the company. The third element was the thickness of the plan; the shorter plans received more attention. In these tests nothing else was revealed about any of the business plans other than what appeared on the cover. The position of the deals on the tables was random, and I observed each venture capitalist as he glanced over the deals. To conclude, I have ranked the variables in descending order of importance: c o m p a n y name, its geographic location, length of business plan, and quality of cover. The next question I explored was, " H o w can an entrepreneur increase the likelihood that a venture capitalist will read a business plan once he is past the cover?" Should he send it along in installments with the final chapter arriving first? Or should he send the first chapter first, and should he send along a summary? In my research, I concluded that summaries and "miniplans" are not effective documents. A teaser summary only delays the eventual readership of a plan, and is often vague or incomplete.
AUGUST, 1974
Two additional variables were uncovered that help to determine a plan's eventual readership, and, to a lesser extent, the likelihood that a venture capitalist will make an investment. The first is the method of dispatching the plan. Months may be spent preparing the plan, but only a few minutes spent deciding how to deliver it. The naive entrepreneur follows the suicidal path of a blind mass mailing. Armed with a directory and helped b y a secretary, he mails his plan with a form letter to a sampling from the directory. This wastes everyone's time and his money, because this procedure never works. Another bad approach is for the entrepreneur to make a personal visit with the business plan tucked under his arm. This humble, straightforward approach is like going to a doctor as an unreferred patient. Everyone asks, "Who sent y o u ? " The key man is often away from the office or unable to see the visitor, who then begins to feel like an intruder. The best method of delivering a business plan is through a third party. Unless the entrepreneur is already established and successful, a third-party referral adds credence to the plan and, as a result, increases the likelihood that it will be read. A n y one from the following groups is acceptable as long as his reputation and liaison with the venture capitalist are positive (it need not be the same person for each potential investor): consultants, bankers, lawyers, accountants, or other entrepreneurs. The second level of improvement, a good j o b on "preselling" is invaluable. If the potential investors are told about the exciting company six months before the plan arrives and then once a m o n t h for the next six
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JOSEPH R. MANCUSO
42 ¸
months about current developments, they will be more receptive to reading the plan. After all, the best time to raise m o n e y is when it isn't needed. The same holds for arousing potential investor interest. A well-managed company planning to expand will invest time in such preselling often and early. The same person should b o t h presell and eventually deliver the plan. With the c o m p a n y name and location clearly spelled out on the cover page, it should be hand-carried b y a mutual friend to a select group of venture capitalists. During the process one should remember that the two most successful venture capital deals in the Northeast were turned down a number of times before receiving a '"yes." In 1958, Digital Equipment Corporation (DEC) finally convinced American Research & Development to invest $70,000. DEC is rumored today to be worth about $250 million. In 1968, Fred Adler made a modest investment in a struggling new c o m p a n y known as Data General Corporation. It is rumored that the four principals each made in excess of $10
million within four years of launching venture. The rewards are high for those play and win. Unfortunately, those who lose most of the time, and plans of this significantly o u t n u m b e r the winners.
this who play type
Bldl,II
This article has explained an approach to writing a good business plan, an approach based on the process that will inevitably be used to read and interpret the plan. Whether the writer is an internal or external entrepreneur, it is his responsibility to put the company's best foot forward once the business is underway. The definition of a "'good" business plan is one that raises money; a ""bad" plan does not attract investors. It is that simple, b u t the entrepreneur must remember that the terms '"good plan" and ""good business" are not synonymous. A good plan may raise money, but the business may still fail. However, a bad plan almost always means business failure. To succeed in reaching the more crucial objectives of a profitable business, a good plan plus a good business is required.
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"Go around asking a lot of damfool questions and taking chances" was the credo of Clarence Birdseye (1886-1956); "only through curiosity can we discover opportunities, and only by gambling can we take advantage of them." His curiosity about the way the Eskimos kept their food fresh--and a gamble that nearly bankrupted him--gave birth to a multibillion dollar industry that revolutionized the marketing of food in A m e r i c a . . . . The interesting thing here is that Birdseye nearly went bankrupt, and he spent 17 years from the idea stage to the time he himself realized a large capital gain. --Leroy Sinclair
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BUSINESS HORIZONS