Another problem that comes up a lot as I read on with my business plan marathon: too many business plans are taking too much time and effort telling supposed investors what their supposed return on investment will be. This is usually a waste of time, energy, and space. It’s certainly a mismatch between what the entrepreneurs are thinking and what the investors are thinking.
I was surprised a couple days ago, talking to entrepreneurs, at how much emphasis they put on wanting to know what return on investment was satisfactory to investors. It was as if they thought what the plan says the company will be worth five years from now makes a difference. And it doesn’t. The illustration here is a piece of fool’s gold, iron pyrite.
It felt like these entrepreneurs are thinking: investors want to see X in returns so I have to show that in my plan. I pop up the sales forecast, pop up the profitability, and that generates a great projected valuation. So I show that I can deliver a great return.
Investors, meanwhile, are actually thinking: I want to look at the product-market fit, scalability, management team, and factors like that to determine whether the company is going to make it. If they have all that right, then they have a shot; and if not, they don’t. Projected investor returns depend on a future valuation, which depends on the sales forecast or income forecast or both. Most investors look hard at the sales and profitability projections, because they want to see credibility; I use them to get a feel for how well the entrepreneurs know the business. There’s so much cascading uncertainty on future valuation that I don’t put much stock in it.
There’s a Catch-22 about sales and profitability forecasts: credibility of the numbers means more than the numbers themselves. A plan that has both big numbers and credibility is rare.
(Image: Vakhrushev Pavel/Shutterstock)
5 thoughts on “Big Mistake: Business Plans And Investor Returns”
Interesting perspective. I read an blog yesterday, written by someone I respect, who asserted that investors know and even EXPECT that projected sales and profits will be overstated. Aware of this expectation, the entrepreneur plays the game by inflating the numbers, fully aware that the investors will give the numbers a “haircut,” and everyone will be happy. Personally, I don’t ascribe to this theory, because, as I argued to the writer of the blog, the entrepreneur is going to be around when that plan is executed and, in most cases, whether the investors were expecting pumped-up numbers or not, the entrepreneur loses credibility if (or actually, when) the projections don’t pan out. The entrepreneur loses credibility, which, in many cases, is his or her primary offering initially. We all know how important credibility is and how extremely difficult it is to re-establish. As a former CFO, I have first-hand experience with this. While preparing for a transaction, the investment bankers flat-out told me to pump up the numbers, at which time I had to make a choice. They had nothing to lose – they weren’t responsible for the numbers. My choice was to go because I wasn’t going to stick around and have the responsibility of executing an unattainable dream.
On another subject, if the business plan is sound, and I mean from the unique value proposition right through the projections, I don’t see anything wrong with including a brief description of what investors can expect if the plan is executed as written. Am I wrong?
Jeffrey, thanks for the comment. I’m with you completely on this, on both points:
First, as far as I’m concerned, you’re right, because investors don’t get fooled by pumped-up numbers. And I write this as the chairman of an angel investor group. Pumped-up numbers kill credibility and do nobody any good. Nobody wants dumb investors. And I agree that in the case you mention here, the investment bankers offered bad advice. Incredible, given the events of the last couple of years regarding investment bankers, that they might give bad advice. Right?
Second, on your second point, if the plan is sound all around, and the projections credible, then a discussion of possible exit valuations, just as you suggest, is a good addition. You’re not wrong on that, at least, not in my opinion.
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