Why bother with a business plan and if you do, what to put in it?
Business planning is done for many reasons. In large organisations it is an ongoing process to give the organisation direction and crucially to plan cash flow. Within large companies business plans are required for "projects", for example to launch a new product. In this case investment appraisal may the focus of the plan. However, most people think of business planning in the context of setting up a new business and raising finance from investors and this is what we focus on in this article.
There seems to be an un-written rule that says that the more money you want, the more you need to write and the longer and more detailed your plan should be - if the structure and requirements of business plan templates of large corporations are anything to go by. So do voluminous business plans stand a greater chance of attracting investment?
Research at the Robert H. Smith School of Business at the University of Maryland, published in 2009 however, suggests that whether you have a business plan or not makes very little difference to your ability to raise finance from the venture capitalist community. It has also been argued that, in industries that face high levels of change and uncertainty, a business plan is often out-of-date before the print has even dried and so the value of a plan is highly questionable. Nearly all entrepreneurs will admit that their initial financial forecasts turned out to be a work of fiction compared to reality. However, while the value of a business plan document may be questionable, the process of developing the plan is of extremely high value. As Dwight Eisenhower, the former US General and President, once wrote "In preparing for battle I have always found that plans are useless, but planning is indispensable."
The most effective business planning processes are those that attempt to understand how the industry will evolve and adapt as a result of the launch of the new venture or product and furthermore how this process of evolution and adaptation affects and shapes the development of the new venture itself.
So what should the formal business planning process look to achieve? Anyone who has ever watched the popular television series "Dragon's Den" in the UK will be familiar with the format where a nervous entrepreneur, seeking funding for their fledgling business, pitches their idea to 5 seasoned investors who then interrogate them about their business and business plan before deciding whether to invest or not. Those who watch the series regularly will have noticed that the Dragons ask the same questions in every episode:
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How much money do you want?
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What are you going to do with it?
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How much am I going to make?
Any business planning process needs to be able to answer these important questions. However before a Dragon, a venture capitalist or a private equity firm even begins to think about these issues there is one, much more fundamental question that must be addressed first. This question can be couched in a number of ways: What is it that is special and unique about the business's product or service that ensures customers are prepared to pay a premium for it and what barriers to entry exist that will make it harder for competitors to imitate it? To use the language of Michael Porter, what is the business's source of sustainable competitive advantage, what is its unique selling proposition or USP? How robust are the underlying economics of the business model?
To some extent, once a potential investor is convinced of the market opportunity and the underlying strength of the business proposition the rest of the business planning process and its outputs, as presented in the business plan, are often superfluous to further negotiations. If the potential backer does not "buy" the underlying idea, the detailed implementation project plan and the extensive market research in the appendix of the business plan are not going to convince him to back an idea which he believes has fundamentally poor economics.
Presenting the core idea in a few words is therefore key. As a rule of thumb, if the fundamental idea cannot be communicated clearly and effectively within the first half page of the executive summary then another 30 pages of business plan are unlikely to secure their investment. A successful US entrepreneur explained that he used to test any new investment idea on his 13 year old daughter, if he could not explain it successfully to her in a few simple sentences then he would not touch it.
The problem with traditional business planning is that it seldom, if ever, delivers this one, unique, simple, game changing business idea. Business planning processes incorporate various analytical phases ? analyse the market, the customers, the competitors and the resources and competencies of the firm and from the results of this analysis the business planner is supposed to tease out an insight or idea which delivers a rock solid economic business model. If creating great businesses were this easy a new Google, Amazon, Dyson, iPod, Microsoft would be invented every day.
Inspirational ideas often occur out of personal frustration with existing products or services or the status quo, at the most unusual and unexpected moments or often, purely by chance. What the business planning process can do is explore the idea, test it and refine it to enhance its chance of commercial success, establish a plan for implementing it and come up with a financial forecast. A business plan is not only a written document - an Excel based business planning model is an integral part of it. An entrepreneur may well have a product with excellent market appeal, but most businesses fail because they become insolvent as a result of poor financial planning. Furthermore, without a valuation, the entrepreneur would not know how much to ask for (the funding requirement) and much equity he should give away.
In order to test, explore and refine an idea a business planning process first needs to examine the idea in the context of customer and market demand. If the customer is not interested there is little point in pursuing the idea further. This may involve market research, focus groups or for business people lacking the funds of large, existing businesses, be based on a "gut feel" about the market. From this analysis the idea will be translated into a proposition which will encompass the 4 Ps so beloved of marketers - price, product, promotion and place.
Once the idea is proven from the customers? perspective the business plan will also test the idea strategically. How strong are the barriers to entry and can competitors react and if they do - how? Although a new product or service might be a great hit with customers if you cannot prevent everyone else from copying your idea you will gain little traction with potential investors.
Lastly, the business should answer the question "how would we actually turn the idea into a reality". An implementation plan and budget are the two key outputs. The operational plan is also required to generate operational Key Performance Indicators (KPIs). These sector specific indicators (footfall, occupancy rates, stock turnover, churn etc.) allow an investor to quickly ascertain whether assumptions are out of line with industry benchmarks.
With the main elements of a potential business in place the business planning process usually turns to the financial aspects and the development of a financial forecast. Any potential investor will usually be much more concerned with how much money they are going to have to invest, when they are going to have to invest and how can they safeguard their investment rather than how much they are going to make. Post credit crunch the providers of debt will seek much greater security and high interest cover and lower leverage than in the era of easy credit. The financial projections will be subject to significant stress testing to ensure that even with the most pessimistic of forecasts key banking covenants will remain intact.
In summary, the business planning process is essential, and this is where the effort lies. The business plan document is almost a by product of the business planning process. When it comes to presenting the business idea the research from the University of Maryland suggests a power point presentation of no more than 15 slides is about all the venture capitalists can tolerate as they attempt to screen efficiently literally hundreds of ideas looking for that one hidden gem.
At the simplest level a good business planning process will test and refine an idea and a business plan can provide a road map for its implementation. However, as Mike Tyson, the infamous US boxer, once said "Everyone has a plan until they get punched in the mouth." For a business to withstand unforeseen blows and prosper in a turbulent world good planning is invaluable and a written, well structured business plan supported by extensive business modelling is the best way to achieve it.
© Graham Friend and Stefan Zehle
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Do voluminous business plans stand a greater chance of attracting investment?
In preparing for battle I have always found that plans are useless, but planning is indispensable.
Dwight Eisenhower, US General and President
If the fundamental idea cannot be communicated clearly and effectively within the first half page of the executive summary then another 30 pages of business plan are unlikely to secure their investment.
Everyone has a plan until they get punched in the mouth.
Mike Tyson, Boxer
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