Prospective investors usually require business plans as a first step to assess an investment opportunity. In this way, a business plan serves as a means of communicating a new business venture’s potential to an investor in a logical, accessible, and consistent manner.
A good business plan hence needs to carefully articulate the opportunity, the strategy and resource requirements, outline risks and rewards, and introduce the management team.
Potential investors generally use business plans as initial screening tools to understand the company and to overcome the information asymmetry between the entrepreneur and the investor. Business plans thereby serve as a starting point for due diligence in which the business risks are assessed in detail.
The ‘pure’ submission of a business plan to potential investors is, however, by no means a guarantee for successfully raising investments. Only a minority of business plans will ever reach the negotiation stage.
To get off on the right foot, make sure to cover the following 4 aspects:
- Product/service should be attractive to an investor
Investors become quite risk adverse when there is uncertainty in the market. They tend to back entrepreneurs with compelling ideas that add significant value to customers by solving a significant problem or fulfilling a need. The business plan should, therefore, be stringently customer-focused. Avoid situations in which the product is still at the concept stage and when it is not clear whether and how it can be developed. It is important to state the development cost/timescale and to include key milestones. Also, cover all costs associated with making and marketing the product/service, incorporate the anticipated customer perception of the value of the product/service and furthermore, consider the pricing of the competition. Avoid undercutting the competition at the outset as the established players are likely to be …able to respond and move one out of the market before the venture even takes off.
- Address the target market
Investors need to be convinced that the business is solving a significant customer problem. The business plan should highlight lots of growth and profit potential and the ability to achieve market power. If one has a solution to a problem, the investors will be very attentive. Investors like to see evidence that the market can be developed and penetrated with a matching, well executed, customer-focused marketing strategy. The product/service should have a strong unique selling point and rise above the competition. High costs to gain critical mass and low barriers to entry worry investors and negatively impact the company’s opportunity to gain and sustain critical market share. In the absence of a crystal ball, a business plan relies on in-depth market analysis and the evaluation of the collected data.
- Be clear about the deal
Investors will want a rate of return that matches the risk involved in the venture. In general, the greater the risk, the greater the necessity to offer a higher rate of return. Younger firms are regarded as being more risky and, therefore, investors require a higher rate of return on investment in start-ups. The cost of capital can be reduced by operating on a small scale initially and then seeking finance for growth. It may make sense to initially use self-finance and bootstrapping and then only raise external finance once you can demonstrate the viability of the venture. The deal has to be plausible, include value-enhancing stepping-stones, and provide a realistic valuation allowing the investor to earn a sizable multiple to justify the investment.
- Management team
Investors look for a capable, ambitious, trustworthy management team that consists of doers who can motivate themselves; kick down doors to get customers posses market insight, show adaptability, are hands-on, and ideally have a track record in the industry. The management team should show financial commitment to the venture as it reflects the team’s self-belief in the business.
Furthermore, keep the business plan simple; avoid jargon and ambiguous and unsubstantiated statements. A business plan should tell a story, and hold the investors’ attention to want to read more. Try it out first on people you know and whose commercial acumen you respect. Finally, always keep in mind: having a business plan does not mean the business will be an automatic success. However, on the basis of experience, business plans will help to beat the odds!
By Dr Stephanie Hussels, senior lecturer in entrepreneurship at Cranfield School of Management