which information belongs-ond which doesn't-may surprise you.

How fo Write a Great

by William A. Sahlman

Few areas of business attract as much attentionas new ventures, and few aspects of new-venturecreation attract as much attention as the businessplan. Countless books and articles in the popularpress dissect the topic. A growing number of annualbusiness-plan contests are springing up across theUnited States and, increasingly, in other countries.Both graduate and undergraduate schools devoteentire courses to the subject. Indeed, judging by allthe hoopla surrounding business plans, you wouldthink that the only things standing between awould-be entrepreneur and spectacular success areglossy five-color charts, a bundle of meticulous-looking spreadsheets, and a decade of month-by-month financial projections.

Nothing could be further from the truth. In myexperience with hundreds of entrepreneurial start-ups, business plans rank no higher than 2 - on ascale from 1 to 10-as a predictor of a new venture'ssuccess. And sometimes, in fact, the more elabo-rately crafted the document, the more likely theventure is to, well, flop, for lack of a more eu-phemistic word.

What's wrong with most business plans? Tbe an-swer is relatively straightforward: Most waste too-ftiuch ink on numbers and devote too little to theinformation that really matters to intelligent in-vestors. As every seasoned investor knows, finan-cial projections for a new company-especially de-tailed, month-by-month projections that stretchout for more than a year-are an act of imagination.

William A. Sahlman is Dimitri V. d'Arbeloff Professorof Business Administration at the Harvard BusinessSchool in Boston, Massachusetts. He has been closelyconnected with more than 50 entrepreneurial venturesas an adviser, investor, or director. He teaches a second-year course at the Harvard Business School called "En-trepreneurial Finance," for which he has developed morethan 100 cases and notes.

THE BUSINESS PLAN FORYOUR 5T/\RT-UP 15IDIOTIC BUT r/A GOINGTO PROVIDE THEVEISTURE CAPITALFUNDING ANYCOAY.

An entrepreneurial venture faces far too manyunknowns to predict revenues, let alone profits.Moreover, few if any entrepreneurs correctly antici-pate bow much capital and time will be requiredto accomplisb their objectives. Typically, they arewildly optimistic, padding their projections. In-vestors know about the padding effect and thereforediscount the figures in business plans. These ma-neuvers create a vicious circle of inaccuracy thatbenefits no one.

Don't misunderstand me: business plans shouldinclude some numbers. But those numbers shouldappear mainly in the form of a business model thatshows the entrepreneurial team has thoughtthrough the key drivers of the venture's success orfailure. In manufacturing, such a driver might bethe yield on a production process; in magazine pub-lishing, the anticipated renewal rate; or in software.

98 HARVARD BUSINESS REVIEW July-August 1997

Business Plan

WE'LL GENERATE LOTS OF^ E D I A HYPE , GO PUBLICAND ^\^KE AMLLIONSBY SHAFTING GRELDYAND IGNORANTINVESTORS.

the impact of using various distribution channels.The model should also address tbe break-evenissue: At wbat level of sales does the business beginto make a profit? And even more important. Whendoes cash flow turn positive? Without a doubt,these questions deserve a few pages in any businessplan. Near the back.

What goes at tbe front? What information does agood business plan contain?

If you want to speak the language of investors -and also make sure you bave asked yourself theright questions before setting out on the mostdaunting journey of a businessperson's career-I rec-ommend basing your business plan on the frame-work that follows. It does not provide the kind of"winning" formula touted by some current how-tobooks and software programs for entrepreneurs.Nor is it a guide to brain surgery. Rather, the frame-

THE LATIN COORD FOR"CLOSt YOUR EYES ANDOPEN YOUR ^^OUTH"I S "PROSPECTUS."

THIS ISEXACTLY WHYrN\ AFRAIDOF DOGS.

DILBERT reprinted by permission of United Feature Syndicate, Inc.

work systematically assesses tbe four interdepen-dent factors critical to every new venture:

The People. The men and women starting andrunning tbe venture, as well as tbe outside partiesproviding key services or important resources for it,such as its lawyers, accountants, and suppliers.

The Opportunity. A profile of the business itself-what it will sell and to whom, whether tbe businesscan grow and how fast, what its economics are, whoand what stand in the way of success.

The Context. The big picture - the regulatoryenvironment, interest rates, demographic trends,inflation, and the like - basically, factors that in-evitably change but cannot be controlled by theentrepreneur.

Risk and Reward. An assessment of everythingthat can go wrong and right, and a discussion ofhow the entrepreneurial team can respond.

HARVARD BUSINESS REVIEW July August 1997 99

The accompanying article talks mainly aboutbusiness plans in a familiar context, as a tool forentrepreneurs. But quite often, start-ups are

launched within estahlished companies. Do thosenew ventures require husiness plans? And if they do,should they he different from the plans entrepreneursput together?

The answer to the first question is an emphatic yes;the answer to the second, an equally emphatic no. Allnew ventures-whether they are funded hy venturecapitalists or, as is the case with intrapreneurial busi-nesses, by shareholders-need to pass the same acidtests. After all, the market-place does not differentiatehetween products or ser-vices hased on who is pour-ing money into them he-hind the scenes.

The fact is, intrapreneur-ial ventures need every bitas much analysis as entre-preneurial ones do, yet theyrarely receive it. Instead,inside hig companies, newhusinesses get proposed inthe form of capital-hudget-ing requests. These facelessdocuments are suhject todetailed financial scrutinyand a consensus-huildingprocess, as the project wends its way through thechain of command, what I call the "neutron homh"model of project governance. However, in the historyof such proposals, a plan never has heen submittedthat did not promise returns in excess of corporatehurdle rates. It is only after the new husiness islaunched that these numhers explode at the organiza-tion's front door.

That prohlem could he avoided in large part ifintrapreneurial ventures followed the guidelines set

BUSINESSPLANS:

FORENTREPRENEURS

ONLY?

out in the accompanying article. For instance, husi-ness plans for sueh a venture should hegin with theresumes of all the people involved. What has theteam done in the past that would suggest it would hesuccessful in the future, and so on? In addition, thenew venture's product or service should he fully ana-lyzed in terms of its opportunity and context. Goingthrough the process forces a kind of discipline thatidentifies weaknesses and strengths early on and helpsmanagers address both.

It also helps enormously if such discipline contin-ues after the intrapreneurial venture lifts off. When

professional venture capi-talists invest in new com-panies, they track per-formance as a matter ofcourse. But in large compa-nies, scrutiny of a new ven-ture is often inconsistent.That shouldn't or needn'tbe the ease. A husiness planhelps managers ask suchquestions as: How is thenew venture doing relativeto projections? What deci-sions has the team made inresponse to new informa-tion? Have changes in thecontext made additionalfunding necessary? How

could the team have predicted those changes? Suchquestions not only keep a new venture runningsmoothly but also help an organization learn from itsmistakes and triumphs.

Many successful companies have been huilt withthe help of venture capitalists. Many of the underlyingopportunities could have heen exploited hy large com-panies. Why weren't they? Perhaps useful lessons canhe learned by studying the world of independent ven-tures, one lesson heing: Write a great business plan.

The assumption behind the framework is thatgreat businesses have attributes that are easy toidentify but hard to assem1")le. They have an experi-enced, energetic managerial team from the top tothe bottom. The team's members have skills andexperiences directly relevant to the opportunitythey are pursuing. Ideally, they will have workedsuccessfully together in tbe past. The opportunityhas an attractive, sustainable business model; it ispossible to create a competitive edge and defend it.Many options exist for expanding the scale andscope of the business, and these options are uniqueto the enterprise and its team. Value can be extract-ed from the business in a number of ways either

through a positive harvest event-a sale-or by scal-ing down or liquidating. The context is favorablewith respect to both the regulatory and the macro-economic environments. Risk is understood, andthe team has considered ways to mitigate the im-pact of difficult events. In short, great businesseshave the four parts of the framework completelycovered. If only reality were so neat.

The People

when I receive a business plan, I always read theresume section first. Not because the people part ofthe new venture is the most important, but because

100 HARVARD BUSINESS REVIEW fuly August 1997

BUSINESS PLAN

without the right team, none of the other partsreally matters.

I read the resumes of the venture's team with alist of questions in mind. (See the insert "Who AreThese People, Anyway?") All these questions get atthe same three issues about the venture's teammembers: What do they know? Whom do theyknow? and How well are they known?

What and whom they know are matters of insightand experience. How familiar are the team mem-bers with industry players and dynamics? Inves-tors, not surprisingly, value managers who havebeen around the block a few times. A business planshould candidly describe each team member'sknowledge of the new venture's type of product orservice; its production processes; and the market it-self, from competitors to customers. It also belps toindicate whether the team members have workedtogether before. Not played-as in roomed togetherin college-but worked.

Investors also look favorably on a team that isknown because the real world often prefers not todeal with start-ups. They're too unpredictable.That changes, however, when the new company isrun by people well known to suppliers, customers,and employees. Their enterprise may be brand new,but they aren't. The surprise element of workingwith a start-up is somewhat ameliorated.

Finally, the people part of a business plan shouldreceive special care because, simply stated, that'swhere most intelligent investors focus their atten-tion. A typical professional venture-capital firm re-

Who Are These People/ Anyvs/ay?Fourteen "Personal" Questions Every Business

Plan Should Answer

• Where are the founders from?n where have they been educated?D Where have they worked-and for whom?n What have they accomplished-professionally and

personally-in the past?D What is their reputation within the business community?• What experience do they have that is directly relevant

to theopportunity they are pursuing?D What skills, abilities, and knowledge do they have?n How realistic are they about the venture's chances for

success and the tribulations it will face?n Who else needs to be on the team?D Are they prepared to recruit high-quality people?D How will they respond to adversity?n Do they have the mettle to make the inevitable hard

choices that have to be made?D How committed are they to this venture?n what are their motivations?

ceives approximately 2,000 business plans per year.These plans are filled with tantalizing ideas for newproducts and services that will change the worldand reap billions in the process-or so they say. Butthe fact is, most venture capitalists believe thatideas are a dime a dozen: only execution skillscount. As Arthur Rock, a venture capital legend as-sociated with the formation of such companies asApple, Intel, and Tcledyne, states, "I invest in peo-ple, not ideas." Rock also has said, "If you can findgood people, if they're wrong about the product,they'll make a switch, so what good is it to under-stand the product tbat they're talking about in thefirst place?"

Business plan writers should keep this admoni-tion in mind as tbey craft their proposal. Talk aboutthe people - exhaustively. And if there is nothingsolid about their experience and abilities to herald,then the entrepreneurial team should think againabout launching the venture.

The Opportunitywhen it comes to the opportunity itself, a good

business plan begins by focusing on two questions:Is the total market for the venture's product or ser-vice large, rapidly growing, or both? Is the industrynow, or can it become, structurally attractive? En-trepreneurs and investors look for large or rapidlygrowing markets mainly because it is often easierto obtain a share of a growing market than to fightwith entrenched competitors for a share of a matureor stagnant market. Smart investors, in fact, tryhard to identify high-growth-potential markets ear-ly in their evolution: that's where the big payoffsare. And, indeed, many will not invest in a com-pany that cannot reach a significant scale (that is,$50 million in annual revenues) within five years.

As for attractiveness, investors are obviouslylooking for markets that actually allow businessesto make some money. But tbat's not the no-brainerit seems. In the late 1970s, the computer disk-drivebusiness looked very attractive. The technologywas new and exciting. Dozens of companies jumpedinto the fray, aided by an army of professionalinvestors. Twenty years later, however, the thrillis gone for managers and investors alike. Disk drivecompanies must design products to meet the per-ceived needs of original equipment manufactur-ers (OEMs) and end users. Selling a product toOEMs is complicated. The customers are large rela-tive to most of their suppliers. There are lots ofcompetitors, each witb similar high-quality offer-ings. Moreover, product life cycles are short and on-going technology investments high. The industry is

HARVARD BUSINESS REVIEW July August 1997 101

The Opportunity of a Lifetime -or Is It?

Nine Questions About the Business Every BusinessPlan Should Answer

D Who is the new venture's customer?n How does the customer make decisions about buying

this product or service?D To what degree is the product or service a compelling

purchase for the customer?D How will the product or service be priced?n How will the venture reach all the identified customer

segments?D How much does it cost (in time and resources) to

acquire a customer?D How much does it cost to produce and deliver the

product or service?D How much does it cost to support a customer?D How easy is it to retain a customer?

subject to major shifts in technology and customerneeds. Intense rivalry leads to lower prices and,hence, lower margins. In short, the disk drive in-dustry is simply not set up to make people a lot ofmoney; it's a structural disaster area.

The information services industry, by contrast, isparadise. Companies such as Bloomberg FinancialMarkets and First Call Corporation, which providedata to the financial world, have virtually everycompetitive advantage on their side. First, they canassemble or create proprietary content - contentthat, by the way, is like life's blood to thousandsof money managers and stock analysts aroundthe world. And although it is often expensive to de-velop the service and to acquire initial customers,once up and running, these companies can dehver

The market is as fickle as it isunpredictable. Who would haveguessed that plug-in roomdeodorizers would sell?

content to customers very cheaply. Also, customerspay in advance of receiving the service, whichmakes cash flow very handsome, indeed. In short,the structure of the information services industryis beyond attractive: it's gorgeous. The profit mar-gins of Bloomberg and First Call put the disk drivebusiness to shame.

Thus, the first step for entrepreneurs is to makesure they are entering an industry that is largeand/or growing, and one that's structurally attrac-tive. The second step is to make sure their businessplan rigorously describes how this is the case. Andif it isn't the case, their business plan needs to spec-ify how the venture will still manage to makeenough of a profit that investors (or potential em-ployees or suppliers, for that matter) will want toparticipate.

Once it examines the new venture's industry, abusiness plan must describe in detail how the com-pany will build and launch its product or serviceinto the marketplace. Again, a series of questionsshould guide the discussion. (See the insert "TheOpportunity of a Lifetime-or Is It?")

Often the answers to these questions reveal afatal flaw in the business. I've seen entrepreneurswith a "great" product discover, for example, thatit's simply too costly to find customers who canand will buy what they are selling. Economicallyviable access to customers is the key to business,yet many entrepreneurs take the Field of Dreamsapproach to this notion: build it, and they willcome. That strategy works in the movies but is notvery sensible in the real world.

It is not always easy to answer questions abouttbe likely consumer response to new products orservices. The market is as fickle as it is unpre-dictable. (Who would have guessed that plug-inroom deodorizers would sell?) One entrepreneurI know proposed to introduce an electronic news-clipping service. He made his pitch to a prospectiveventure-capital investor who rejected the plan, stat-ing, "I just don't think the dogs will eat the dogfood." Later, when the entrepreneur's companywent public, he sent the venture capitalist an anony-

mous package containing an emptycan of dog food and a copy of hisprospectus. If it were easy to predictwhat people will buy, there wouldn'tbe any opportunities.

Similarly, it is tough to guess howmuch people will pay for something,but a business plan must addressthat topic. Sometimes, the dogs willeat the dog food, but only at a priceless than cost. Investors always look

for opportunities for value pricing-that is, marketsin which the costs to produce the product are low,but consumers will still pay a lot for it. No one isdying to invest in a company when margins areskinny. Still, there is money to be made in inexpen-sive products and services-even in commodities. Abusiness plan must demonstrate that careful con-

102 HARVARD BUSINESS REVIEW July August 1997

BUSINESS PLAN

sideration has been given to the new venture's pric-ing scheme.

The Ust of questions ahout the new venture's op-portunity focuses on the direct revenues and thecosts of producing and marketing a product. That'sfine, as far as it goes. A sensible proposal, however,also involves assessing the husiness model from aperspective that takes into account the investmentrequired-that is, the halance sheet side of the equa-tion. The following questions should also be ad-dressed so that investors can understand the cashflaw implications of pursuing an opportunity:D When does the husiness have to buy resources,such as supplies, raw materials, and people?D When does the business have to pay for them?D How long does it take to acquire a customer?DHow long hefore the customersends the business a check?DHow much capital equipment isrequired to support a dollar of sales?

Investors, of course, are lookingfor businesses in wbich managementcan buy low, sell high, collect early,and pay late. The business planneeds to spell out how close to thatideal the new venture is expected to come. Even ifthe answer is "not very"-and it usually is-at leastthe truth is out there to discuss.

The opportunity section of a business plan mustalso bring a few other issues to the surface. First, itmust demonstrate and analyze how an opportunitycan grow-in other words, how the new venture canexpand its range of products or services, customerbase, or geographic scope. Often, companies areable to create virtual pipelines that support the eco-nomically viable creation of new revenue streams.In the publishing husiness, for example. Inc. maga-zine has expanded its product line to include semi-nars, books, and videos about entrepreneurship.Similarly, building on the success of its personal-finance software program Quicken, Intuit now sellssoftware for electronic banking, small-business ac-counting, and tax preparation, as well as personal-printing supplies and on-line information services-to name just a few of its highly profitahle ancillaryspin-offs.

Now, lots of business plans runneth over on thesubject of the new venture's potential for growthand expansion. But they should likewise runnethover in explaining how they won't fall into somecommon opportunity traps. One of those has al-ready heen mentioned: industries that are at theircore structurally unattractive. But there are others.The world of invention, for example, is fraughtwith danger. Over the past 15 years, I have seen

scores of individuals who have devised a bettermousetrap - newfangled creations from inflatablepillows for use on airplanes to automated car-park-ing systems. Few of these idea-driven companieshave really taken off, however. I'm not entirely surewhy. Sometimes, the inventor refuses to spend themoney required hy or share the rewards sufficientlywith the business side of the company. Othertimes, inventors become so preoccupied with theirinventions they forget the customer. Whatever thereason, hetter-mousetrap businesses have an un-canny way of malfunctioning.

Another opportunity trap that business plans -and entrepreneurs in general-need to pay attentionto is the tricky business of arbitrage. Basically, arbi-trage ventures are created to take advantage of

Whatever the reason, better-mousetrap businesses have an

uncanny way of malfunctioning.

some pricing disparity in the marketplace. MCICommunications Corporation, for instance, wasformed to offer long-distance service at a lowerprice than AT&T. Some of the industry consolida-tions going on today reflect a different kind of arbi-trage - the ahility to buy small businesses at awholesale price, roll them up together into a largerpackage, and take them public at a retail price, allwithout necessarily adding value in the process.

Taking advantage of arbitrage opportunities isa viable and potentially profitable way to enter abusiness. In the final analysis, however, all arbi-trage opportunities evaporate. It is not a question ofwhether, only when. The trick in these businessesis to use the arbitrage profits to build a more endur-ing business model, and business plans must ex-plain how and when that will occur.

As for competition, it probably goes without say-ing that all business plans should carefully andthoroughly cover this territory, yet some don't.That is a glaring omission. For starters, every husi-ness plan should answer the following questionsabout the competition:n Who are the new venture's current competitors?DWhat resources do they control? What are theirstrengths and weaknesses?n How will they respond to the new venture's deci-sion to enter the business?D How can the new venture respond to its competi-tors' response?

HARVARD BUSINESS REVIEW July-August 1997 103

Visualizing Risk and Revs ardwhen it comes to the matter of risk and reward in

a new venture, a husiness plan henefits enormouslyfrom the inclusion of two graphs. Perhaps graphs is thewrong word; these are really just schematie picturesthat illustrate the most likely relationship betweenrisk and reward, that is, the relationship hetween theopportunity and its economics. High finance they arenot, hut I have found both of these pictures say moreto investors than a hundred pages of charts and prose.

The first picture depicts the amount of money need-ed to launch the new venture, time to positive cashflow, and the expected magnitude of the payoff.

money

depthof hole

lime to positive cash flow• time

This image helps the investor understand the depthand duration of negative cash flow, as well as the rela-tionship between the investment and the possible re-turn. The ideal, needless to say, is to have cash flowearly and often. But most investors are intrigued hythe picture even when the cash outflow is high andlong-as long as the cash inflow is more so.

Of course, since the world of new ventures is popu-lated hy wild-eyed optimists, you might expect thepicture to display a shallower hole and a steeper re-ward slope than it should. It usually does. But to hehonest, even that kind of picture belongs in the husi-ness plan hecause it is a fair warning to investors thatthe new venture's team is completely out of touchwith reality and should he avoided at all costs.

The second picture complements the first. It showsinvestors the range of possihle returns and the like-

lihood of achieving them. The following exampleshows investors that there is a 15% chance theywould have heen hetter off using their money as wall-paper. The flat section reveals that there is a negligihlechance of losing only a small amount of money; com-panies either fail hig or create enough value to achievea positive return. The hump in the middle suggeststhat there is a significant chance of earning hetween15% and 45% in the same time period. And finally,there is a small chance that the initial outlay of cashwill spawn a 200% internal rate of return, whichmight have occurred if you had happened to invest inMicrosoft when it was a private company.

15%

flatsection

-100%(total loss)

15% 45% 200%(big hit)

rate of return per year

Basically, this picture helps investors determinewhat class of investment the husiness plan is pre-senting. Is the new venture drilling for North Sea oil-highly risky with potentially hig payoffs - or is itdigging development wells in Texas, which happensto he less of a geological gamhle and prohahly lesslucrative, too? This image answers that kind of ques-tion. It's then up to the investors to decide how muchrisk they want to live with against what kind of odds.

Again, the people who write husiness plans mighthe inclined to skew the picture to make it look as if theprohahility of a significant return is downright hugeand the possihility of loss is negligihle. And, again, Iwould say therein lies the picture's heauty. What itclaims, checked against the investor's sense of realityand experience, should serve as a simple pictorialcaveat emptor.

D Who else might he able to observe and exploit thesame opportunity?D Are there ways to co-opt potential or actual com-petitors by forming alliances-

Business is like chess: to be successful, you mustanticipate several moves in advance. A businessplan that describes an insuperahle lead or a propri-etary market position is by definition written bynaive people. That goes not just for the competitionsection of the business plan but for the entire dis-cussion of the opportunity. All opportunities havepromise; all have vulnerabilities. A good business

plan doesn't whitewash the latter. Rather, it provesthat the entrepreneurial team knows the good, thebad, and the ugly that the venture faces ahead.

The Context

Opportunities exist in a context. At one level isthe macroeconomie environment, including thelevel of economic activity, inflation, exchangerates, and interest rates. At another level are thewide range of government rules and regulationsthat affect the opportunity and how resources are

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BUSINESS PLAN

marshaled to exploit it. Examples extend from taxpolicy to the rules about raising capital for a privateor public company. And at yet another level are fac-tors like technology that define the limits of whata business or its competitors can accomplish.

Context often has a tremendous impact on everyaspect of the entrepreneurial process, from identifi-cation of opportunity to harvest. In some cases,changes in some contextual factor create opportu-nity. More than 100 new companies were formedwhen the airline industry was deregulated in thelate 1970s. The context for financing was also fa-vorable, enabling new entrants like People Expressto go to the public market for capital even beforestarting operations.

Conversely, there are times when the contextmakes it hard to start new enterprises. The reces-sion of the early 1990s combined with a difficult fi-nancing environment for new companies: venturecapital disbursements were low, as was the amountof capital raised in the public markets. (Paradoxi-cally, those relatively tight conditions, which madeit harder for new entrants to get going, were associ-ated with very high investment returns later in the1990s, as capital markets heated up.)

Sometimes, a shift in context turns an unattrac-tive business into an attractive one, and vice versa.Consider the case of a packaging company someyears ago that was performing so poorly it wasabout to be put on the block. Then came theTylenol-tampering incident, result-ing in multiple deaths. The packag-ing company happened to have anefficient mechanism for installingtamper-proof seals, and in a matterof weeks its financial performancecould have been called spectacular.Conversely, U.S. tax reforms enactedin 1986 created havoc for companiesin the real estate business, eliminat-ing almost every positive incentiveto invest. Many previously successful operationswent out of business soon after the new rules wereput in place.

Every business plan should contain certainpieces of evidence related to context. First, the en-trepreneurs should show a heightened awareness ofthe new venture's context and how it helps or hin-ders their specific proposal. Second, and more im-portant, they should demonstrate that they knowthe venture's context will inevitably change and de-scrihe how those changes might affect the business.Further, the business plan should spell out whatmanagement can (and will) do in the event the con-text grows unfavorahle. Finally, the business plan

should explain the ways (if any) in which manage-ment can affect context in a positive way. For ex-ample, management might be able to have an im-pact on regulations or on industry standardsthrough lobbying efforts.

Risk and RewardThe concept that context is fluid leads directly to

the fourth leg of the framework I propose: a discus-sion of risk and how to manage it. I've come tothink of a good business plan as a snapshot of anevent in the future. That's quite a feat to beginwith-taking a picture of the unknown. But the bestbusiness plans go beyond that; they are like moviesof the future. They show the people, the opportu-nity, and the context from multiple angles. Theyoffer a plausihle, coherent story of what lies ahead.They unfold possibilities of action and reaction.

Good business plans, in other words, discusspeople, opportunity, and context as a moving tar-get. All three factors (and the relationship amongthem) are likely to change over time as a companyevolves from start-up to ongoing enterprise. There-fore, any business plan worth the time it takes towrite or read needs to focus attention on the dy-namic aspects of the entrepreneurial process.

Of course, the future is hard to predict. Still, it ispossible to give potential investors a sense of thekind and class of risk and reward they are assuming

One of the greatest myths aboutentrepreneurs is that they arerisk seekers. All sane people

want to avoid risk.

with a new venture. All it takes is a pencil and twosimple drawings. (See the insert "Visualizing Riskand Reward.") But even with these drawings, riskis, well, risky. In reality, there are no immutahledistributions of outcomes. It is ultimately the re-sponsibility of management to change the distribu-tion, to increase the likelihood and consequences ofsuccess, and to decrease the likelihood and implica-tions of problems.

One of the great myths about entrepreneurs isthat they are risk seekers. All sane people want toavoid risk. As Harvard Business School professor(and venture capitalist) Howard Stevenson says,true entrepreneurs want to capture all the reward

HARVARD BUSINESS REVIEW July-August 1997 105

A Glossary of Business Plan Terms

what They Say... and What They Really Mean

We conservatively project... We read a book that said we had to be a $50 millioncompany in five years, and we reverse-engineeredthe numbers.

We took our best guess and divided by 2.

We project a 10% margin.

The project is 98% complete.

Our business mode! is proven...

We hove a six-month lead.

We only need a 10% market share.

Customers are clamoring for our product.

We are Hie low-cost producer.

We have no competition.

Our management team has a great deal of experience

A select group of investors is considering the plan.

We seek a value-added investor.

We accidentally divided by 0.5.

We did not modify any of the assumptions in the businessplan template that we downloaded from the Internet.

To complete the remaining 2% will take as long as it tookto create the initial 98% but will cost twice as much.

if you take the evidence from the past week for the bestof our 50 locations and extrapolate it for all the others.

We tried not to find out how many other people have asix-month lead.

So do the other 50 entrants getting funded.

We have not yet asked them to pay for it. Also, all of ourcurrent customers are relatives.

We have not produced anything yet, but we areconfident that we will be able to.

Only IBM, Microsoft, Netscape, and Sun haveannounced plans to enter the business.

consuming the product or service.

We mailed a copy of the plan to everyone inPratt's Guide.

We are looking for a passive, dumb-as-rocks investor.

If you invest on our terms, you will earn a 68% internal If everything that could ever conceivably go right doesrate of return. go right, you might get your money back.

and give all the risk to others. The best business isa post office box to which people send cashier'schecks. Yet risk is unavoidable. So what does thatmean for a business plan?

It means that the plan must unflinchingly con-front the risks ahead-in terms of people, opportu-nity, and context. What happens if one of the newventure's leaders leaves? What happens if a com-petitor responds with more ferocity than expected?What happens if there is a revolution in Namibia,tbe source of a key raw material? What will man-agement actually Jo?

Those are hard questions for an entrepreneur topose, especially when seeking capital. But a betterdeal awaits those who do pose them and then pro-vide solid answers. A new venture, for example,might be highly leveraged and therefore very sensi-tive to interest rates. Its business plan would bene-fit enormously by stating that management intendsto hedge its exposure t:hrough the financial-futuresmarket by purchasing a contract that does wellwben interest rates go up. That is the equivalent ofoffering investors insurance. (It also makes sensefor the business itself.)

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Finally, one important area in the realm of risk/reward management relates to harvesting. Venturecapitalists often ask if a company is "IPOable," bywhich they mean. Can the company be taken pub-lic at some point in the future? Some businessesare inherently difficult to take public because doingso would reveal information that migbt harm itscompetitive position (for example, it would revealprofitability, thereby encouraging entry or anger-ing customers or suppliers). Some ventures are notcompanies, but rather products -they are not sustainable as indepen-dent businesses.

Therefore, tbe business planshould talk candidly about the endof the process. How will the investoreventually get money out of thebusiness, assuming it is successful,even if only marginally so? Whenprofessionals invest, they particularly like com-panies witb a wide range of exit options. They likecompanies that work hard to preserve and enhancethose options along the way, companies that don't,for example, unthinkingly form alliances with bigcorporations that could someday actually buythem. Investors feel a lot better about risk if theventure's endgame is discussed up front. There is anold saying, "If you don't know where you are going,any road will get you there." In crafting sensible en-trepreneurial strategies, just the opposite is true:you had better know where you might end up andhave a map for getting there. A business planshould be the place where that map is drawn, for, asevery traveler knows, a journey is a lot less riskywhen you have directions.

The Deal and BeyondOnce a business plan is written, of course, the

goal is to land a deal. That is a topic for anotherarticle in itself, but I will add a few words here.

When I talk to young (and old) entrepreneurslooking to finance their ventures, they obsess aboutthe valuation and terms of the deal they will re-ceive. Their explicit goal seems to be to minimizethe dilution they will suffer in raising capital. Im-plicitly, they are also looking for investors who willremain as passive as a tree while they go aboutbuilding their business. On the food chain of in-vestors, it seems, doctors and dentists are best andventure capitalists are worst because of the degreeto which the latter group demands control and alarge share of tbe returns.

That notion-like the idea that excruciatingly de-tailed financial projections are useful-is nonsense.

From whom you raise capital is often more impor-tant than the terms. New ventures are inherentlyrisky, as I've noted; what can go wrong will. Whenthat happens, unsophisticated investors panic, getangry, and often refuse to advance the companymore money. Sophisticated investors, by contrast,roll up their sleeves and help the company solve itsproblems. Often, they've bad lots of experience sav-ing sinking ships. They are typically process liter-ate. They understand how to craft a sensible busi-

The best business is a postoffice box to which people

send cashier's checks.

ness strategy and a strong tactical plan. They knowhow to recruit, compensate, and motivate teammembers. They are also familiar with the Byzan-tine ins and outs of going public-an event most en-trepreneurs face but once in a lifetime. This kind ofknow-how is worth the money needed to buy it.

There is an old expression directly relevant toentrepreneurial finance: "Too clever hy half." Often,deal makers get very creative, crafting all sorts ofpayoff and option schemes. That usually backfires.My experience has proven again and again that sen-sible deals have the following six characteristics:n They are simple,n They are fair.n They emphasize trust rather than legal ties.DThey do not blow apart if actual differs slightlyfrom plan.D They do not provide perverse incentives that willcause one or both parties to behave destructively.DThey are written on a pile of papers no greaterthan one-quarter inch thick.

But even these six simple rules miss an impor-tant point. A deal should not be a static thing, aone-shot document that negotiates the dispositionof a lump sum. Instead, it is incumbent upon entre-preneurs, before they go searching for funding, tothink about capital acquisition as a dynamicprocess - to figure out how much money they willneed and when they will need it.

How is that accomplished? The trick is for theentrepreneurial team to treat the new venture as aseries of experiments. Before launching the wholeshow, launch a little piece of it. Convene a focusgroup to test the product, build a prototype andwatch it perform, conduct a regional or local rolloutof a service. Such an exercise reveals the true eco-

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BUSINESS PLAN

nomics of the business and can help enormously indetermining how much money the new ventureactually requires and in what stages. Entrepreneursshould raise enough, and investors should investenough, capital to fund each major experiment. Ex-periments, of course, can feel expensive and risky.But I've seen them prevent disasters and help createsuccesses. I consider it a prerequisite of putting to-gether a winning deal.

Beware the AlbatrossAmong the many sins committed by business

plan writers is arrogance. In today's economy, fewideas are truly proprietary. Moreover, there hasnever been a time in recorded history when the sup-ply of capital did not outrace the supply of opportu-nity. Tbe true half-life of opportunity is decreasingwith the passage of time.

A business plan must not be an albatross thathangs around the neck of the entrepreneurial team,dragging it into oblivion. Instead, a business planmust be a call for action, one that recognizes man-agement's responsibility to fix what is brokenproactively and in real time. Risk is inevitable.

avoiding risk impossible. Risk management is thekey, always tilting the venture in favor of rewardand away from risk.

A plan must demonstrate mastery of tbe entireentrepreneurial process, from identification of op-portunity to harvest. It is not a way to separate un-suspecting investors from their money hy bidingthe fatal flaw. For in the final analysis, the only onebeing fooled is the entrepreneur.

We live today in the golden age of entrepreneur-ship. Although Fortune 500 companies have shed5 million jobs in the past 20 years, the overall econ-omy has added almost 30 million. Many of thosejobs were created by entrepreneurial ventures, suchas Cisco Systems, Genentecb, and Microsoft. Eachof those companies started with a business plan. Isthat why they succeeded? There is no knowing forsure. But there is little doubt that crafting a busi-ness plan so that it thoroughly and candidly ad-dresses the ingredients of success-people, opportu-nity, context, and the risk/reward picture-is vitallyimportant. In the absence of a crystal ball, in fact,a business plan built of the right information andanalysis can only be called indispensable. ^

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