Advice and insights from Anthony Rose, CEO and Founder, SeedLegals
Everyone wants to know: are we in another tech bubble?
Whether we are or not, it’s apparent that investors are going back to basics in their investments, picking businesses with strong fundamentals over more speculative ventures. When the bank paid 0% interest, the bar wasn’t high for speculative investments, any return was better than you’d get from the bank. But with the cost of capital increasing, an investment in your company is competing with the investor earning interest from the bank, or if it’s an angel investor, from paying off their mortgage.
So, how can you tune your pitch to take advantage of the changing investor focus? And that’s where we think the 5 year business plan comes in.
Now, everyone knows that founders just make up that 5 year plan. After all, you haven’t launched a product yet (you may not even have built it!). You have no idea of the Customer Acquisition Cost (“CAC”) or Lifetime Value (“LTV”) that will determine the way you’re able to pay for advertising and pay-per-click ads to gain customers. You have no idea what your competitors are spending, and how to compete with them.
Any astute investor knows that your business plan is just a bunch of made-up numbers… but they still value it, and it’s even more important than before to get right, here’s why.
It shows your ambition
Although investors can’t use your plan to gauge the future profitability of your business, they can gauge your ambition. The ambition, vision and drive that’s shown in your business plan is a cue for the canny investor to see how bold you are as a founder. If your business plan shows your business making £100M revenue in year 5, that’s awesome… but statistically unlikely. You’d be growing faster than Twitter, you’d be a FTSE500 company. It’s brilliant if it works out, but it’s statistically unlikely, and an astute investor’s starting point is that you’re lacking numeracy skills, and they won’t believe any other numbers either.
On the other hand, if by year 5 you’re showing £2M a year in revenue, that’s awesome - the founders and a small team have a real business, brilliant. But it’s not an investible business, because the return on investment for an investor is just too low. To see how, imagine you’re raising £250K at a £2M valuation. In 5 years, if you’re doing £2M a year in revenue, your valuation might be £10M. The investor got roughly 10% equity, so their investment is now worth £1M, less dilution from any additional funding rounds. A roughly 3X return in 5 years is just not enough to justify a high-risk investment in an early-stage startup. Investors call this a ‘hobby business’ - a term that many founders deem offensive, but it’s just saying, that’s a great business you have, go borrow some money from the bank to fund it, it’s not an attractive investment for us.
Measure the market opportunity
A five-year plan might not provide an accurate picture of your business’s future revenue, but it does present a decent picture of your potential market. This will show investors who your company plans to sell your product or service to, and how you’ll do it.
If your plan suggests your company has only a limited potential to scale into a much bigger operation, investors will decide their return would be less so they’ll move on to the next opportunity. Your plan must show room for expansion and continued growth. For example, can you show that as well as the one-off services you’re selling now, you’re working on a subscription model so that you’ll have a continuous income stream from loyal customers?
If you can show that you’re thinking ahead to how you’ll generate more revenue in diverse ways, investors are more likely to see a strong potential for growth.
Calculate future revenue - or at least estimate it properly
In school, the kids who show their ‘working out’ in maths class get better marks than those who don’t. Teachers want to know that their pupils can calculate the right answer, but they also want to see that they use the right method.
Forecasting future business revenue and other calculations in a business pitch works in the same way. Any successful entrepreneur is methodical and numerate. At least one of your founding team needs to know how to do the numbers and your five-year plan is a perfect place to demonstrate your abilities.
No one will expect your forecasts to be perfect predictions. But they need to show that your team can make these calculations, with clear ‘working out’ and rational explanations.
Get SEIS/EIS ready
Many startups make the most of tax relief schemes like the UK’s SEIS and EIS. These schemes make investing in innovative startups more attractive for angel investors because they allow the investor to deduct part of the investment from their income tax, and they pay no capital gains tax if they sell the shares after 3 years. Investors will usually ask the company to get SEIS or EIS Advance Assurance. HMRC expect to get a five-year plan as part of your Advance Assurance application, it’s their way of making sure companies offering SEIS or EIS tax breaks are genuine growth companies. So regardless of whether investors are looking for a 5 year business plan, you’ll need one for your SEIS or EIS Advance Assurance application.
Creating a five-year plan is yet another task on a founders’ to-do list. Because it can feel like you’re writing fiction, you might be tempted to drop your plan from your pitch deck. Don’t. Your plan gives investors plenty of useful information about your company, your attitude and your skills. A good five-year plan could make the difference between ‘no thanks’ and ‘yes, I’m in’.
Create and share your pitch with investors in one click with SeedLegals Pitch.