Business Planning: Building an Effective Business Model
Andrew J. Sherman, Partner, Dickstein Shapiro Morin and Oshinsky LLP
Effective business planning is critical to an entrepreneurial company's long-term success and its ability to raise capital and grow successfully. As a result, bankers, accountants, consultants and academics have written volumes about business plans. Yet, it seems the more information there is, the more confused people become. There's no one right answer. A properly prepared Business Plan should tell a story, make an argument and conservatively predict the future. All companies have different stories to tell, different arguments to make and different futures to predict, so they must resist the temptation to copy from others or to follow a rigid outline.
Business planning is the process of setting goals, explaining the objectives and then mapping out a document to achieve these goals and objectives. A well-written Business Plan lays out the best growth path and strategy, as well as the rationale for the selection of the strategy over other alternatives. In essence, a Business Plan is the articulation and explanation of why the chosen game plan for building the company makes sense, what resources it will need to implement the vision, who the team will be that will have the skills and leadership to execute the vision, and what path they will follow to get there.
Nobody has a crystal ball to predict what will work and what won't, not even a savvy investor or veteran entrepreneur. The better the analysis, the better the chances that most of the goals set forth in the Business Plan will be achieved. A well-written Business Plan doesn't oversell the good, undersell the bad or ignore the ugly! It is essentially an articulation of the entrepreneurial company's plan for managing the risks and challenges involved in building or expanding the business. As such, it should acknowledge that growth and success are moving targets by anticipating as many future events or circumstances that will affect the company's objectives. Business Plan, Business Model.
As the document that tells the company's story, the Business Plan also helps shape and modify the entrepreneurial company's Business Model, the elements of which will be driven by the answers to the following questions:
- Who are we? (Team)
- What are we trying to do? (Mission)
- What problem do we solve? (Faster/Better/Easier/Cheaper)
- How are we going to get it done? (Operations)
- How do we reach our customers? (Sales/Marketing/Distribution Channel)
- Who else is doing this? How do we obtain our initial customers? Which are the easiest to reach? What are the target customers' decision-making processes? What relationships do they currently have in place that will need to be terminated for them to do business with us? (Competition/Competitive Analysis)
- What market research have we done to be sure that anyone wants to buy this product or service at this price - or at all? (Substantiation)
- Do we truly modify the way business is being done in our industry (as a change agent) or is this more of a fad or a trend? (Market Trends/First Mover Advantage (FMA))
- Are these targeted customer relationships profitable? How do we make money? (Business Model)
- What do we need to accomplish our goals? (Budget/Resources)
- When are we profitable? (Breakeven/Timetable)
Myths and Realities
In developing a Business Plan and a Business Model, entrepreneurs need to be aware that there are myths and misconceptions about the process. Among the most common are the following:
#1 Myth: BUSINESS PLANS ARE ONLY FOR START-UP COMPANIES.
REALITY: Companies at all stages of development need to prepare Business Plans either for the planning and financing of a specific project, general expansion financing, mergers or acquisitions, and the overall improvement of the company's financial and managerial performance. A company operating for 15 years or more will need to draft a Business Plan in order to raise the necessary capital to reach the next stage in its development.
#2 Myth: BUSINESS PLANS SHOULD BE AS DETAILED AND SLICK AS POSSIBLE. THE LONGER THE PLAN, THE BETTER CHANCE THAT THE COMPANY WILL BE FINANCED.
REALITY: Sophisticated investors will not have the time to review hundreds of pages of text. The plan must be concise, well-written and should focus on the lender's or investor's principal areas of concern, and not be cluttered with lots of exhibits or irrelevant market studies. Companies should typically prepare an Executive Summary, a 10-page version and a 30- to 40-page version. Avoid overly technical descriptions of the company's processes or operations. Investors will commit funds based on the quality and clarity of the document, not its thickness. Although a Business Plan ought to be presented professionally, a very expensive binder or overly lavish presentation will often demonstrate inefficient resource management.
#3 Myth: BUSINESS PLANS SHOULD EMPHASIZE IDEAS AND CONCEPTS, NOT PEOPLE.
REALITY: Many entrepreneurs fear that if the success of a company depends too heavily on any specific person, an investor will shy away. Although this is partially true, individual financiers and venture capitalists alike actually would prefer to invest in a company that has great people and only a good concept, rather than one with a great concept and a weak management team. Ultimately, lenders and investors will commit funds based on the strength of the management team.
#4 Myth: ONLY THE FOUNDING ENTREPRENEUR SHOULD PREPARE BUSINESS PLANS.
REALITY: Most entrepreneurs are highly skilled in a particular profession or area of management. As a result, they may not necessarily possess the ability to prepare a Business Plan in a form which prospective lenders or investors are accustomed. Ideally, the Business Plan should be developed by a team of managers within the company and then reviewed by qualified experts, such as accountants, attorneys and the board of directors. Conversely, it should never be prepared solely by outside advisors without the input of internal management. A veteran investor will be quick to recognize a "cooked" plan or one that reflects the views and efforts of professional advisors rather than the company's management team who are responsible for running the company on a day-to-day basis. The entrepreneur or founders must be in a position to defend the assumptions that support the Business Plan in meetings with prospective investors or strategic partners.
#5 Myth: BUSINESS PLANS SHOULD BE DISTRIBUTED AS WIDELY AS POSSIBLE.
REALITY: The Business Plan will inevitably contain information that is proprietary and confidential to the company. Therefore, distribution should be controlled and careful records kept about who has received a copy of the plan. The cover sheet should contain a conspicuously positioned management disclaimer reminding the reader that these are only the plans of the company, the success of which cannot be assured, as well as a notice of proprietary information. All applicable federal and state securities laws must be carefully considered if the Business Plan is intended as a financing proposal; however, the Business Plan should not be used in lieu of a formal private-placement memorandum. Finally, certain institutional investors will consider investments only in certain kinds of companies or industries. Research these criteria before sending a Business Plan in order to save both the time and resources of all concerned parties.
#6 Myth: A BUSINESS PLAN SHOULD FOLLOW A SPECIFIED FORMAT, REGARDLESS OF THE INDUSTRY IN, WHICH THE COMPANY OPERATES.
REALITY: While it may be true that all companies face certain common challenges in the areas of marketing, management, administration and finance, companies at different stages of growth (and thus facing different problems) and those operating in different industries will require that different sets of topics be included in the Business Plan. For example, plans for a start-up manufacturing company may be far more concerned with financing of the plant, equipment, patents, inventory, and production schedules than an already established service-oriented company, which may be more focused on personnel, marketing costs and the protection of trade secrets and goodwill.
#7 Myth: IN PREPARING THE BUSINESS PLAN, OPTIMISM SHOULD PREVAIL OVER REALISM.
REALITY: The Business Plan should demonstrate the enthusiasm of the founders of the company as well as generate excitement in the reader; however, it should be credible and accurate. Investors will want to know all of the company's strengths and its weaknesses. In fact, a realistic discussion of the company's problems, along with a reasonable plan for dealing and mitigating these various risks and challenges, will have a much more positive impact on the prospective investor. As a general rule, investors will feel more comfortable investing in someone who has learned from previous business failures rather than a person who has never managed a company. Finally, any budgets, sales projections, company valuations, or related forecasts should be well substantiated with accompanying footnotes, for both legal and business reasons. Unrealistic or unsubstantiated financial projections and budgets will reveal inexperience or lack of attention to detail, or even lead to litigation by disgruntled investors if there are wide disparities between what was represented and reality.
#8 Myth: A WELL-WRITTEN BUSINESS PLAN SHOULD CONTAIN AN EXECUTIVE SUMMARY, WHICH SHOULD BE WRITTEN BEFORE THE FULL TEXT OF THE DOCUMENT IS PREPARED.
REALITY: Institutional investors are exposed to hundreds of Business Plans in any given month, and as a result will initially only devote a few minutes to the review of each Business Plan. The Executive Summary (generally one to three pages in length) will be the first and possibly the last impression that the company makes on the investor. Thus, if the reader's attention is not captured in these first few minutes, he or she is not likely to complete the review of the document. The Executive Summary should contain all of the information that will be critical in the investment decision, such as the nature of the company and its founders, the amount of money sought, the allocation of the proceeds, a summary of key financial projections, and an overview of marketing considerations. The mistake often made by entrepreneurs in preparing the plan is writing the Executive Summary first (before the main components have been drafted). It is much more effective to prepare the main body of the plan, then draft the Executive Summary last in order to ensure consistency. The Executive Summary is then truly a preview of the details of the plan.
#9 Myth: BUSINESS PLANS ARE ONLY WRITTEN WHEN A COMPANY NEEDS TO RAISE CAPITAL.
REALITY: Although most Business Plans are written in connection with the search for capital, a well-written Business Plan will serve a variety of beneficial purposes to the company and its management team, among them a management tool to use as a road map for growth, a realistic self-appraisal of progress to date as well as against projected goals and objectives, and a foundation for the development of a more detailed strategic and growth management plan (especially after a proposed financing has been successfully completed).
Sensitivity Analysis, Contingency Planning
In addition to becoming of the company's foundation and defining its Business Model by outlining what needs to be done, when, how and by whom, a Business Plan must also deal with the inevitable contingencies. The company's ability to identify the specific tasks and translate them into a specific schedule will be affected by ever-changing capital markets, customer-demand patterns, the entry of new competitors, and general market conditions. The Business Plan must deal with these "what ifs?" and be reflective of changing business models. For example, if the success of the Business Plan relies upon the company's products being faster, cheaper, more reliable and capable of solving more complicated problems than those offered by their competitors, then how does the strategy change when a competitor introduces a product better, faster and cheaper than theirs? Or what if the customer is slow to adopt or even recognize the benefits of the new product or service? Sensitivity analysis is a tool for looking at a wide range of variables and assumptions in the Business Plan to determine the impact on the company and the viability of the plan if and when these planning assumptions change - which they invariably and inevitably will. Sensitivity analysis raises questions such as the following:
- Will our Business Plan still be viable if 20% of the target customers that we assume will adopt this new product do not? 30%? 40%?
- What will be the impact on our Business Plan if two of the key potential competitors we have identified become actual competitors?
- What will be the impact on our Business Plan if we can't attract new employees or strategic partners that we have identified as critical to implementation?
- What if we can't raise the equity capital we need to implement the Business Model? What if we have to give up more ownership and control than we had anticipated to raise the capital? What if we need to raise more debt capital?
- If we planned to borrow money to implement the Business Model, what impact would higher interest rates have on the economics of the model? If our customers will need to borrow to buy our products and services, what impact will higher rates have on these buying decisions?
- What if the market rejects the pricing structure that underlies the introduction of the new product or service? What if deeper discounts need to be offered to encourage customers to make the switch? What impact will this have on our margins?
The bottom line is that overly optimistic or weakly researched assumptions in a Business Plan can and will come back to haunt the entrepreneur. Assuming conservative assumptions and adequate research, there are still many variables that can and will change that will have an impact on the Business Plan and the company. Sensitivity analysis seeks to anticipate the changes in these variables so that owners are not caught by surprise.
Variables Affecting Implementation
No matter how carefully the Business Plan is prepared, things can and will change. Hundreds of variables will go into the development of the Business Plan, which means that thousands of things could go wrong (or right) that will affect the company's actual-to-plan performance. The actual growth results may vary depending on a wide variety of factors, including:
- Demand for the company's products and services
- Actions taken by the company's innovation team, including new product introductions and enhancements
- Ability to scale the company's network and operations to support large numbers of customers, suppliers and transactions
- Ability to develop, introduce and market new products and enhancements to existing products on a timely basis
- Changes in the company's pricing policies and business model or those of its competitors
- Integration of the company's recent acquisitions and any future acquisitions
- Ability to expand the company's sales and marketing operations, including hiring additional sales personnel
- Size and timing of sales of the company's products and services, including the recognition of a significant portion of its sales at the end of the quarter
- Success in maintaining and enhancing existing relationships and developing new relationships with strategic partners, including systems integrators and other implementation partners
- Compensation policies that compensate sales personnel based on achieving annual quotas
- Ability to control costs
- Technological changes in the company's markets
- Deferrals of customer orders in anticipation of product enhancements or new products
- Customer budget cycles and changes in these budget cycles
- General economic factors, including an economic slowdown or recession.
- Effective business planning is not an easy process. Entrepreneurs and executives are likely to make classic mistakes. Having worked with hundreds of companies of all sizes and in many different industries over the years in reviewing Business Plans and developing growth strategies, I have pulled together below some tips, thoughts and observations that should govern the planning process, as well as the review and support of that process.
- Have the right mix of talent to develop and maintain the Business Plan. The wrong planning team will yield the wrong planning decisions, leading the company down a path of disaster.
- Think long-term but act short-term. Be ready to modify the plan based on changes in market conditions but without taking your eye off the long-term goals.
- Effective business planning is a continuing process, not a stand-alone task.
- Don't buy into the mantra that planning is a thing of the past. There are some who believe that market conditions are too dynamic and uncertain to make long-term business growth-oriented strategic planning possible - SIMPLY NOT TRUE! In fact, fast-moving business conditions make the need for strategic planning that much more critical, provided that the plan does not sit on a shelf but rather is monitored and modified as conditions may warrant.
- Invest in systems that will gather competitive intelligence. Information rules! If the company does not have reliable data on the trends affecting its competitors and customers, then they are dead in the water. The data gathered becomes a key component of the Business Plan and becomes the trigger point for changes to the plan or strategy selected.
- Protect key assets. An entrepreneur can develop Business Plans until blue in the face, but if the success of the company's business model depends on the ability to keep and leverage key intangible assets - then owners must take the time to protect intellectual property and to reward and motivate employees.
- Be sure to connect the dots. A well-drafted Business Plan understands and anticipates how all of the market forces and players fit together, taking into account social, environmental, political and economic influences and figuring at how these factors come together to afford your growth plans. One common mistake is when the strategic assumptions underlying financial projections do not fit squarely with the written text of the plan. The ability to view things at 40,000 feet, 20,000 feet as well as at ground level, and the ability to see the dynamics of your markets at all of these levels is key to effective growth planning. And because these market conditions are never static and the relationships that connect the dots constantly change, you need to keep climbing the mountain to look down on the valley.
- Build an organization that has a deeply rooted commitment to growth. The commitment must begin with the leader or founder of the company, whose mission and passion become contagious, and everyone in the company focuses their efforts on meeting business growth objectives. To achieve this, the company's leadership must clearly communicate and reinforce the growth plans, objectives and strategies, reward those who contribute to the achievement of these goals and monitor the company's progress, changing its course and direction as may be necessary. If the course does need to change, these shifts in direction must be regularly shared with the company's employees, together with an explanation for the need for the change. Employees at all levels will resent a change in direction without knowing it or understanding it and if they are not told how or why their positions and tasks must change to meet these new challenges.
- Don't be afraid to measure and monitor performance. It is critical to develop an objective set of metrics for each key area of the Business Plan that can be continuously monitored and periodically measured against key goals. The metrics may include sales, profitability, the number of new customer relationships added, the growth market partners, the number of new employees, customer satisfaction, the level of employee turnover, inventory cycles, the number of new offices opened, warranty returns or even the number of new rounds of capital raised at favorable valuation rates. Regardless of the specific metrics selected, the growing company must build systems to track and measure these performance indicators and have the expertise in place to understand, analyze and properly react to this data once it has been reported.
- Develop high quality products and services. As veteran entrepreneurs and professional advisors will always say, a Business Plan will be completely ineffective if the "dogs will not eat the dog food." At the end of the day, all Business Plans must revolve around a set of high-quality products and services that customers genuinely want and need.