NEW VENTURE CREATION: FROM FEASIBILITY CONCEPT TO BUSINESS PLAN
Simply stated, feasibility is about the business idea and testing the business concept. The business plan is about the execution strategy that will bring that idea to market. The business plan serves three purposes: (1) it serves as a reality check for the entrepreneur, who will need to think very carefully about all aspects of the business; (2) it is a living guide to the business, a complete and comprehensive picture; and (3) it is a statement of intent for interested third parties such as investors, bankers, and strategic partners. Each of these potential stakeholders in a new venture will view the business plan from a different perspective.
Anyone investing in a new venture has four principal concerns: rate of growth, return on investment, degree of risk, and protection. Investors are generally betting that the value of their ownership interest in the business will increase over time at a rate greater than that of another type of investment or of a bank account. They want to know how fast the business is projected to grow, when that growth will take place, and what will ensure that the growth actually occurs as projected. For this reason, they tend to look for market-driven companies rather than product – or technology-driven companies, because they are interested in such things as short payback periods for customers. They expect that predictions will be based on solid evidence in the marketplace and on thorough knowledge of the target market.
Investors are naturally concerned about when and how the principal portion of their investment will be repaid and how much gain on that investment will accrue over the time they are invested in the company. The answers to these questions are largely a function of the structure of the investment deal: whether it involves a limited or general partnership, or preferred or common stock, and so forth.
Investors want to understand thoroughly the risks they face when investing in a new venture; principally, they want to know how their original equity will be protected. They expect the entrepreneur to present the potential dangers facing the new venture, along with a plan for mitigating or dealing with them to protect the investor against loss. Finally, investors want to know how their equity will be protected if the business fails and how the business will protect its assets from seizure by creditors.
Although the business plan is vital to investment decision making, it is not the only piece of information considered. In one survey of 42 venture capitalists, 43 percent claimed to having invested in a venture in the previous three years without the benefit of a business plan. Only 36 percent reported that the business plan was “very important” in their evaluation. And perhaps the most revealing statistics of all was that 96 percent preferred to learn about a potential investment through a referral from someone they trusted. Furthermore, investors found that the primary flaws in most business plans were overly optimistic financial projections, too much hype, poor explanation of the business model, and no demonstration of customer demand.
Bankers /lenders are primarily interested in the company’s margin and cash flow projections, because they are concerned about how their loans and credit lines to the business will be repaid. The margins indicate how much room there is for error between the cost to produce the product (or deliver the service) and the selling price. If margins are tight and the business has to lower prices to compete, the firm might not be able to pay off its loans as consistently and quickly as the bank would like. Similarly, bankers look at cash flow projections to see whether the business can pay all its expenses and still have money left over at the end of each month. Bankers also look at the qualifications and track record of the management team and may require personal guarantees of the principals. Like investors, bankers and lenders want to know they are going to get their money back. When considering a business plan and an entrepreneur for a loan, lenders have several concerns:
- The amount of money the entrepreneur needs: Lenders are looking for a specific amount that can be justified with accurate calculations and data.
- The kind of positive impact the loan will have on their business: Lenders would like to know how the money they are lending is not going to be used to pay off old debt or to pay salaries, but rather will improve the business’s financial position, particularly with regard to cash flow.
- The kinds of assists the business has for collateral: Not all assets are created equal. Some assets have no value outside the business, because they are custom-made or specific to that business and therefore cannot be sold on the open market. Lenders prefer to see industry-standard equipment and facilities that can easily be converted to another use.
- How the business will repay the loan: Lenders are interested in the earnings potential of the business over the life of the loan, but even more important; they want to know that the business generates sufficient cash flow to service the debt. Fixed expenses are fairly easy to predict, but variable expenses – those related to the production of the product or service – present a more difficult problem. In an attempt to avoid any long-term issues, lenders pay close attention to the market research section of the business plan, which highlights the demand for the product or service. They also focus on the marketing plan which tells them how the entrepreneur intends to reach the customer.
- How the bank will be protected if the business doesn’t meet its projections: Lenders want to know that the entrepreneur has a contingency plan for situations where major assumptions prove to be wrong. They want to ensure that they are paid out of the cash flow, not by liquidating the assets of the business, which generally will only give them a small percentage of the value of the assets.
- The entrepreneur’s stake in the business: Like investors, lenders feel more confident about lending to a business in which the entrepreneur has a substantial monetary investment. Such an investment reduces the likelihood that the entrepreneur will walk away, leaving the lender stranded.
Some entrepreneurs, particularly those who intend to manufacture a product, choose to form a strategic alliance with a larger company so that they don’t have to incur the tremendous costs of purchasing equipment for a manufacturing plant. They may, for example, license another firm to manufacture and assemble the product and supply it to the entrepreneur to market and distribute. Alternatively, an entrepreneur may enter into an agreement with a supplier to provide necessary raw materials in exchange for an equity interest in the start-up venture.
Strategic alliances may take the form of formal partnership agreements with major corporations or may contain simply of an informal agreement such as a large purchase contract. In either case, the larger company that is allying itself with the new venture is usually looking for new products, processes, or technologies that complement its current line of products or services. Accordingly, it will seek a new venture management team that has some previous corporate experience so that the relationship will be smoother.
Larger companies are also interested in strategic issues such as the marketing and growth strategies of the new venture. Although there are risks associated with partnering with a larger firm, the benefits of broader distribution and access to deeper resources makes the positives outweigh the negatives. Knowing in advance what these third parties are looking for will help the entrepreneur address their specific needs in the business plan, enhancing the partnership’s ability to achieve the goals of the business.
Starting the Process with a Presentation
Spending hours and days writing a business plan may not be as valuable as understanding the business and conveying that understanding in a compelling way. Given the new investor environment, a more constructive first step is to prepare an extended version of the “elevator pitch” The elevator pitch is a brief but convincing statement of the business concept: the ever-important issues of why you, why now, how you will change the world. The exercise of putting together a presentation (typically in PowerPoint) forces the founding team to focus on the critical success factors for the business. In other words, what must be in place for the business to succeed?
With a much focused presentation in hand, it will be easier to develop the full business plan without deviating from the essentials. Several fundamental questions must be answered before the presentation.
What need is being served?
In other words, is there really an opportunity here? Support for the answer to this question will come from the market research with potential customers and should demonstrate a real market for the opportunity. The answer should also convey that the company is customer-driven, in that it is solving a real need that customers have. In addition, a detailed profile of the most likely customer should be included.
Can the founding team serve that need?
Why is the founding team the best team to execute this concept? Can it be demonstrated that the founding team has the experience and skills required by the various areas of the business? Do the founders have their own money invested in this concept? It is easy to spend other people’s money or to consider “sweat” equity as equivalent to cash – but it isn’t equivalent in the eyes of the investors, who figure that the founding team won’t give up easily if they have invested their own money in the deal. Does the team have passion and the drive to make this business a success? Passion and drive are difficult to measure but are reflected in the level of work that was put into the market research. How many people did the team talk to – industry experts, customers, and so forth?
Why is now the right time to launch this venture?
What makes this concept so valuable right now? If this business is the only one of its kind, why is that so? Has anyone tried this before and failed? If so, why? What makes the current environment right for this venture? Timing is critical in the launch of any new venture, so it is important to explain why now is the right time.
What is the venture’s competitive advantage?
No venture can succeed in the long-term without a sustainable competitive advantage – not a single competitive advantage, but a bundle of them in every aspect of the business. The presentation needs to address what advantages will enable this venture to create a unique un-served niche and to enter the market and secure customers with little or no competition in the beginning.
Can this venture make money?
Most business plans do not adequately address the business model. How will the business make money over the long term? How will value be created at various points in the business’s life? In general, value is created when the business is adequately capitalized and has highly regarded investors, an experienced management team, a unique technology or service, the ability to continually innovate, and a rapidly expanding market. Once the new venture has passed the start-up stage, additional value is created by its position in the market, significant customers, effective operating systems, a strong gross margin, positive cash flow, and a high return on equity.
Because business plans are most often used to raise capital, the questions they answer are frequently of great interest to an investor or lender. Here are some of the questions that the business plan should answer: How much money is needed to address this opportunity? How will capital be allocated (i.e. to increase sales, to boost profits, or to enhance the value of the company)? How will the business provide a superior return on investment (ROI)? Which exit strategies are possible?
Starting the Process with a Website
Today when people hear about a new business or a new product or service, the first place they go to for more information is the Internet. This makes sense, because the Internet is the perfect place to communicate a new venture’s message. However, many new businesses make the mistake of simply slapping up a single page marked “under construction” or “coming soon”, until they finish their business plan and start the business.
On the Internet, a new business can look as successful and established as any large company for relatively few dollar or pounds invested in development of the site.` A quick online demonstration can communicate to the visitor what the business does, who its customers are, and what its value proposition is. The site should discuss the founding team, state the company’s goals or mission, and tell potential investors, customers, and other interested parties how to contact the business.
One word of caution about the website: proprietary information that is not protected by patents or trademarks should not be put on the site, because companies regularly peruse the Internet for information on their competitors. In fact, entrepreneurs should definitely study the websites of their competitors for important clues about what features they should build into their own sites and how they might improve on what their competitors are doing. As with every promotional or informational piece about the business, differentiation is critical. The following are a few important points to consider when developing a website:
- The site should speak to potential customers: They are the most important visitors, and investors appreciate that entrepreneur recognize that fact.
- Identify the pain for the customer, and then show how it can be cured: Identifying the pain or problem that customers are experiencing is an effective way to get their attention. Immediately following up with a solution assures them that they have come to the right place.
- Clearly describe the business model: Customers should understand what they are paying for, how much, and in what manner. Free items should be clearly distinguished from those that carry a price. If customers are not certain what they are getting for their money, they will resist purchasing.
- Make sure that customers take something of value from the site: That something of value could be free information, an article, or a coupon. If the visit to the site was worthwhile, customers will return again and again.
It is not within the scope of this article to discuss website development. Information on building an effective website is ubiquitous on the Web and in every bookstore.
The Business Plan
Writing a business plan is a huge undertaking that should be planned in terms of tasks and timeline. If a new venture has already been launched – via presentation, a website, or an actual start-up based on a successful feasibility analysis – the writing of the business plan must now be sandwiched in among all the day-to-day activities associated with the operating business. Even if a new business has not yet been launched, an action plan for completing a business plan in a relatively short period of time will help accelerate the process. The following tasks are a guide to preparing to write the business plan.
- Identify who is responsible for what: A lot of updated information must be gathered about industry, market, customer, and costs. Even though all of these data were gathered when the feasibility study was conducted, some time may have elapsed before the writing of the business plan, so it is important to make sure that all information is current. Make a list of everything that must be collected and how it needs to be collected (secondary research, talking to customers, etc.) Decide who will do what and by when it must be accomplished.
- Develop a timeline based on tasks identified: It is important to be realistic about how much time it will take to complete all the tasks associated with the business plan. The timeline is very likely to be too long, especially if the work is being done on evenings and weekends, so the next job will be to determine whether all of the tasks are critical to the business plan and to prune any that are not.
- Hold the team to the timeline and work diligently to get the plan done: Once the business plan is complete, it is a good idea to get a trusted third party to review the plan to catch anything the team may have missed.
If you find this article useful, please share and subscribe to our newsletter