Determining the Amount Needed

Chapter 4:

Raising Entrepreneurial Capital

The business plan

Every new business, regardless of size or growth aspirations, needs a business plan.

The plan should be the roadmap to success and should provide benchmarks for measuring progress toward the plan’s objectives along the way.

Uses of the plan

Even if you are not currently seeking external financing there will be a demand for your business plan by outsiders.

Potential management candidates will surely want to read the plan,

as will potential business partners. In forming strategic relationships,

other companies will use your plan to assess your viability as a partner.

Importance to outside financing If you are seeking outside financing,

lenders as well as equity investors will use your plan to help them decide whether or not to finance your company.

A well thought out business plan indicates a well thought out business model.

Failure to identify and address the crucial issues in a plan indicates an unprepared entrepreneur.

Who should write the business plan? YOU must write your own plan. No one can know your business

model as well as you and no one should have the passion that you have for making the business succeed.

The entrepreneur needs to write the plan both to convey the message and to make sure that he or she has fully thought through the business proposition.

The Executive Summary

All good plans start with a succinct but powerful Executive Summary, a 2-3 page document that outlines and defines the business in a compelling manner, and calls the investor to action.

The summary should clearly explain the concept and the problem the proposed business will solve, list the key success factors and spell out the financing needed.

It should be the last piece written, after the business plan is otherwise completed.

Getting considered

Because investors receive far more plans than they can possibly read, it is imperative that you state your case in the summary in a way that compels the reader to read on.

Even with a strong Executive Summary and sound business plan behind it, the challenge is often in getting investors to consider the opportunity.

Networking

The best way to get your plan read is through networking.

Develop relationships with the local investment community by attending events related to investment, venturing, and economic development.

Build an advisory board for your venture that includes your accountant, lawyer, and banker, and ask them to suggest additional members who may later provide introductions to the venture community.

Brief financial picture

If you have some operating history, the Executive Summary should include a brief financial picture of your firm, including items such as expenses to date, number of customers, and a valuation of the customer base.

What are your capital requirements? Define the amount of money needed, and the rate of expenditure, for that money.

Vision Statement/ Business Description The Vision Statement is your

opportunity to spell out in more detail your motivation for the start-up.

Clearly explain the perceived problem and describe how your business will be a solution to that problem.

Lay out major milestones for the business. When will a prototype be ready, the first customer signed, the technology in place, etc.?

The Market Analysis

A market analysis is a study of the market area, the current state of the market, and the nature and extent of competition. The purpose is to make it possible to develop more accurate, that is, more fact-based, sales forecasts.

Is your market research sufficient? Develop and sharpen your competitive advantage.

The Market Strategy

Who are your customers? Start with a general description of your market, then the niche of the market you will enter and why. How many customers are there? What is the size of this niche of the market?

How will you attract those customers? By price? Quality of goods? Features of product? Unique product?

The Competition

May be local and well defined, or quite generalized, depending on the nature of the business and of the market.

It is important to consider both existing competition and potential competition. If your business is successful will it attract competition from larger companies not currently operating in your space?

The Competition

Why do customers buy from them?

How good is their sales and support organization?

How well are they funded? What are their weaknesses?

Can they be exploited?

Porter’s Five Forces

Threat of entry by new competitors.

Intensity of rivalry among existing competitors.

Pressure from substitute products.

The bargaining power of buyers.

The bargaining power of suppliers.

Barriers to entry

Institutional, government, technological, or economic restrictions on the entry of firms into a market or industry.

Four primary barriers to entry are:

resource ownership, patents and copyrights, government restrictions, and start-up costs.

Intensity of rivalry

Where firms hold relatively similar market share, rivalry can be fierce.

Commodity type industries with low differentiation can also have uncomfortably low profit margins.

Factors common to older manufacturing industries, such as low-growth, high fixed costs, large increments in capacity, and high cost of exit can produce damagingly strong competition.

Substitute products

Firms do not always compete directly within their own industry. If movie tickets are perceived as too expensive, the consumer may decide to spend their entertainment dollars on theater tickets or music CDs.

It is important to identify products in the market that could be seen as indirect substitutes for a firm’s product.

Bargaining power of buyers Large companies, which often buy

products in large quantities from one or more suppliers, will always be significant forces in the industries from which they buy.

Larger buyers can sometimes use as leverage that they could manufacture the product themselves.

All buyers benefit when the product is a commodity and is somewhat standardized.

Bargaining power of suppliers Suppliers can have significant

bargaining power when their product is critical to the operations of the customer.

This power is strengthened when the supplier can produce this product or component more cheaply than can the buyer.

Other situations of supplier advantage include where the buyer has little flexibility in making a change, such as the absence of acceptable substitutes.

The Core Venture Team

List the key personnel and the overall organizational structure. What skills and experience does the management team bring to the business?

More experienced management teams have a greater probability of raising capital. Investors will choose an “A” team with a “B” idea over a great idea with an inexperienced management team every time.

Other Venture Team Members Try to create a board of

directors that fills gaps in the management team. You need to demonstrate that you will be able to attract talent where it is needed.

Who else is in the deal? Investors like to see who else found this a good idea.

Sales and Marketing

Describe your overall marketing strategy and sales tactics. Will the business require advertising, direct marketing, sales promotions?

The portion of your plan that deals with channel strategies requires a thorough understanding of distribution. Resist the normal temptation to cover all bases by listing every imaginable channel possibility.

Possible legal complications Was your product developed

while you were employed somewhere else?

Are there any potential employment contracts or non-compete conflicts?

Is there any possible patent infringement?

Can you show clear ownership of your product or service?

Risk

What market forces might prevent your plan from being successful in the future?

Consider the possible impact of new technology, legislative issues, changes in consumer demand and a variety of other issues that could negatively impact your business.

The Investor’s Perspective (1) Is there an unmet market need?

Does the entrepreneur seem passionate about meeting that need? Are there already many similar ventures starting up?

Are the terms of the deal favorable? How much of the company is being sold? What is the financing split between debt and equity? How are shares priced? What is the total valuation of the company? What is the exit strategy?

The Investor’s Perspective (2) What is different about this deal? Is

there some unusual feature of the product or service? Is there some particularly innovative approach, market strategy, or production technique?

Does the company have patents, unusual technology or a significant lead over competition?

Is there a distinctive competence or other competitive advantage?

The Investor’s Perspective (3) How will the proceeds of the

investment be used?

Are there barriers to entry by competitors?

Is there a fit with the other companies in the investor’s portfolio? If yes, the chances of funding go up significantly.

Financial Projections

The financial section of the business plan has three main components:

historical data if the company is already in operation,

pro forma financial statements, and

analysis.

Historical section

Include the past three to five years’ income statements, balance sheets and statement of cash flows.

Indicate the level of CPA involvement in preparing those statements. Who is the CPA firm?

Are the statements audited, reviewed or merely compiled?

Pro Forma financial statementsThis section should include:

three to five-year pro forma income statements (projected operating results),

financial position (balance sheets), and

cash flows.

Statements should be prepared monthly for the first year and annually after that.

Detailed assumptions should be listed.

The Income Statement (1) The financial forecast hinges on the

sales forecast --- base on detailed assumptions about market size, pricing policy, cost structure and growth or market penetration.

Sales: Start by estimating the total market by segment. Define market segments and base the dollar value of sales on segments you can influence. Clearly articulate your pricing assumptions, time to market and rate of market penetration.

The Income Statement (2) Expenses: Research industry

averages and other companies to determine benchmark percentages for operating expenses and cost of goods sold.

Net income: High estimates of profit margins will have to be justified. On the other hand, net income should provide a fair return on knowledge assets as well as on tangible assets.

The Balance Sheet

Most items in the balance sheet can be forecast as a percentage of sales.

Current assets and liabilities tend to fluctuate somewhat linearly with sales.

Use industry averages to establish the relationships for your forecast.

Fixed assets are fixed only over a range of sales. Fixed assets must be modeled separately and tied to the capital expenditure budget for accuracy.

Cash Flows

The statement of cash flows converts your accrual accounting statements to a cash basis to track when the cash flows will actually occur.

While the external financing needed to balance the balance sheet is a high level look at funds needed, the statement of cash flows is a detailed analysis of when cash shortfalls and surpluses will occur.

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Analysis

Show a breakeven analysis and a scenario analysis of the pro forma statements.

After the preliminary pro formas are completed, the relationships in the statements should be compared to industry averages for reasonableness.

For example, is your cost of goods sold percentage in line with industry averages? The same can be done for all the line items in the income statement and balance sheet. www.bizminer.com

Scenario Analysis

In preparing the pro forma financial statements there should be three scenarios; best case, worst case and most likely.

The most likely scenario should be that presented in the business plan as your financial model. The other two scenarios bracket the range of possible outcomes.