Category Archives: Business Financing

Big Mistake: Huge Unbelievable Sales Numbers

Angel investment, Business Plan Contest, Business Plan Marathon, Venture Capital, Venture Contests,

Jeffrey Moskovitz added an important comment to my big mistake post from last week:

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.

Jeffrey didn’t think so and I agree with Jeffrey. Emphatically agree. The idea that everybody winks at inflated numbers is a really bad idea.

My view on this hasn’t changed at all, even as years passed and I moved from entrepreneur seeking investment to angel investor reviewing business plans as part of an angel group. Here’s the way the process works, step by step:

1. Is the sales forecast believable?

Sales forecast credibility is a matter of several factors: understanding the market, size and structure of the market, selling process, channels, decision making, and so on. Granularity is really important, like the details of distribution, margins, buying points, actual names of potential buyers. Real sales already made, letters and testimonials from customers or distributors, are also important. Real Web forecasts, page views, conversion rates, and so on, are important.

If the sales forecast isn’t credible, then investors lose interest in the rest of the numbers in the plan. An unbelievable forecast voids profitability, cash flow, and supposed future valuation and investor return. The process stops.

It is true that a dumb forecast doesn’t necessarily kill potential investment. If there’s good product-market fit, scalability, defensibility, growth potential, management team, and so forth, then bad numbers are forgivable. But a bad forecast is a huge negative.

2. If so, then is profitability believable?

One of the most common errors in business plans, almost pervasive, is unbelievable profitability. As soon as projected profits go over industry averages, I disbelieve the rest of the numbers. In some rare cases (one that I posted about here Monday) entrepreneurs have real justification of those high numbers. But those are uncommon. Most of the time, it means the entrepreneurs don’t understand the business. They’ve underestimated expenses.

Even without researching the specific industry, no industry averages profits much higher than 10%. Most are closer to 5%.

If profitability isn’t believable, then I stop reading the numbers. I have no interest in cash flow or future valuation if profitability is off.

3. If so, then is cash flow believable?

Only if both sales and expenses are believable, do I look at cash flow. Does the cash flow plan recognize the impact of industry and accounts receivable? Does it show the need for investment?

And from there, to be honest, I’m back looking at larger factors, like product-market fit, management, defensibility, and scalability. I still don’t put much stock in what the business plan says the investors will get as return on investment. ROI and IRR projected out five years is an academic exercise, not a real decision factor.

No, You Can’t Just Pull Numbers Out of The Air

Angel investment, Business Plan Contest, Business Plan Marathon, Business Planning, Venture Capital, , , ,

Question: I’m in the process of writing an Internet startup business plan to present to prospective investors. The site isn’t live so I don’t even have a basis for speculation with respect to the financials. I would essentially be pulling numbers out of the air. Being that the Internet business as it pertains to advertising revenues is so mercurial, is it feasible to present the plan without having the financials included? If not, how can I make more realistic financial assumptions?

My answer: No, you won’t get anywhere presenting a business plan to investors without financials. I’m glad you asked me instead of just moving ahead with that idea.

Every new business, including a website business, has to be able to present a reasonable forecast if it’s going to hope to get an approval from outside investors. And it can never be “pulling numbers out of the air.” The assumption is that before you start a new business you have some idea how it’s going to work, based on some experience. If you have no idea, no investor wants to even share the same elevator with you.

In this case, the website business, you need somebody on your team who can project website traffic and sales based on real experience with search terms, search engine optimization, Google ad words and its competitors, conversion rates, and so on. Your traffic doesn’t get pulled out of the air, it’s a function of what you plan to do and what you plan to spend. Know your key search words and the traffic those words and phrases get for others, right now. Know reasonable conversion rates. Make estimates based on real assumptions about real variables.

For more information on this, you could try:

Big Mistake: On Business Plans, Cash, Investment, and Whose Peace of Mind Matters

Angel investment, Business Plan Contest, Business Plan Marathon, Business Planning, True Stories, Venture Capital, , ,

This seems so strange to me. My business plan marathon has turned up several plans calling for way more money than the plan itself says it needs. How can that happen?

For example, a plan calls for $3 million investment for 2010 and its projected cash balance at the end of 2010, and again at the end of 2011, never goes below $2.5 million.

Why would investors ever say yes to that? They’re being asked to take money from their bank account and put it into some startup entrepreneur’s bank account instead; and there it sits. Unused.

That’s just strange. Sure there’s uncertainty, but don’t tell investors you want their money in your bank account. Do a “use of funds” table if you have to, and lay out where the money is going.

And if it’s in the cash balance at the end of the year, then you didn’t need it. Revise your plan. Sure, a reasonable cushion is fine, but I’ve seen a bunch of them this year, asking for money that ends up all, or mostly, in the end of year cash balance. That doesn’t work.

There’s supposed to be a match: the investment is as close as possible to what the company needs to grow on. The money is your best guess on what you need to spend to launch the company. It doesn’t sit in the bank.

If your business plan cash flow has disproportionate ending cash balances, then the fix is obvious. You should be asking for less money from investors. You’ll suffer less dilution.

Yes, I know, there are people out there advising entrepreneurs to seek more money than they think they need. That’s not horrible advice, if you have the kind of startup that can pull those amounts in. But hey, please, don’t insult your readers’ intelligence: show the money being spent on growth. Don’t show it in your projected cash balance.

True story: at one of the business plan contests I’ve judged (and I won’t say here which, or when) one of the contestants was challenged by one of the judges:

“But why do you need $600,000,” he asked? “Your plan doesn’t support that.”

“Oh, I know that,” the entrepreneur answered, “that’s peace of mind money. I need a cushion in case things go wrong, so I can sleep at night.”

The room went silent. After a pause, one of the other judges said the obvious:

“So you’re asking us to write you a check from our money so you can put it in the bank as your money?”

That’s a true story.

10 Requests From Your Business Plan Reader

Angel investment, Business Plan Contest, Business Plan Marathon, Business Planning, , , , , ,

I’ve started my business plan marathon season again. Between now and the end of May, I’ll read several hundred business plans: some for my angel investment group (Willamette Angel Conference), and others for judging business plan contests at the Universities of Oregon, Texas, Rice, Princeton, and Notre Dame.

paperworkI’d like to use the famous T.S. Eliot line from The Wasteland: “April is the cruelest month.” The trouble is that I like reading business plans, so that wouldn’t fit. I posted about his last year around this time, and here I am again, reading plans.

What does seem appropriate, however, is my plea to business plan writers, wherever you are, if you’re going to produce a plan that I have to read:

  1. Convert it to PDF please. I hate those big honking bound documents. They weigh a ton. Most of my business plan judging involves planes, hotels, and airports.
  2. Give my aging eyes a break. Learn the definition of presbyopia and then reflect on the demographics of angel investors and business plan judges.
  3. Make it about the business, not the science. I want to see target markets, channels, sales, costs, exit strategies, defensibility, scalability, and things like that. Unless it’s software or Web stuff, where I’m more at ease, I’m not going to read or understand your science. I’ll look at your experience and degrees and I’ll take your early sales, testimonials, and such as validating your science.
  4. Summarize well. Make sure you hit the high points. Don’t ever let me finish a summary without knowing what you’re selling to what market, why they’ll buy it, what it does for them, how much money you think you need, how fast and to what sales level you can scale up, strengths, core competence, and a quick sense of your team.
  5. Tell me stories. Make me understand what problems you solve, for whom, and how they find you. Make that story credible. Give me some real examples, real situations, real people, and make it believable.
  6. Show me milestones: milestones you’ve achieved, and milestones you need to achieve.
  7. Don’t give me dumb profits. If you’re going to generate margins at twice the average industry levels, then you better have a convincing reason for why that’s possible. When I see huge profitability, it doesn’t make me think you’re going to be amazingly profitable; it makes me think you don’t know the business you’re in.
  8. Show me your patents if you have them but if you do, show me something about how defensible they are (if at all) and make sure your projections include legal expenses to defend them.
  9. Show me that you know something about cash flow: inventory management if you have products, receivables and collection days.
  10. Think of your reader. We don’t all have hundreds of plans to read, but whether it’s for angel investing or a business plan contest, we do all have a good number.

(Image: AVAVA/Shutterstock)

Is Your Startup Fat or Lean?

Back to Fundamentals, Starting a Business, Venture Capital, , , , , ,

When two clear big winners in the high-end startup world disagree on something as basic as lean vs. fat startups, I’m fascinated. First, because both of them have a lot to say to the rest of us. Second, because it illustrates, once again, how much of startups and entrepreneurship defies rules of thumb and generalizations.

measure the appleIn The Case for the Fat Startup, Ben Horowitz tells how he burned hundreds of millions of investor dollars while building up Loudcloud/Opsware  for a stunning $1.6 billion exit in 2007 when it was acquired by Hewlett-Packard. Clearly, this was a huge win. It’s a hall of fame story. And he makes raising a ton a money one of the keys to success (I’m quoting):

As you listen to the virtues of the lean start-up–lightweight sales, light engineering, and so on–keep the following in mind:

  • If you are a high-tech start-up, your value is in your intellectual property. Don’t stare at your spreadsheets so long that you get confused about that.
  • You cannot save your way to winning the market.
  • The best companies can raise money even in this market. If you are one of those, you should consider raising enough to wipe out your competition.

Thin is in, but sometimes you gotta eat.

Fred Wilson, founder of Union Ventures, a big winner as professional investor, and an eloquent blogger, answered that post with Being Fat is Not Healthy. He says:

The very best investments that I have been involved in established product market fit before raising a lot of money. That’s how Geocities did it. That’s how Twitter did it. That’s how Zynga did it. That’s how every single one of my top twenty web investments in my career did it.

I have to admit, I like the lean option better, but then most of the companies I’ve built or helped to build were bootstrapped. And times have changed, too, so what Horowitz is calling “fat” isn’t really an option very often. But the dialog doesn’t stop there. Horowitz came back and responded with The Revenge of the Fat Guy. He makes two points back:

  • Product market fit isn’t a one-time, discrete point in time that announces itself with trumpet fanfares.
  • My experiences [with Loudcloud/Opsware] are highly relevant to other entrepreneurs. In fact, they are more relevant than Fred’s pattern matching.

Ouch? Pattern matching? Really. Read the Fred Wilson post, see if that’s fair. Also ask yourself whether he’s really guilty of underestimating the time it takes to get the product-market fit. I can’t resist adding this quote from the Fred Wilson post favoring lean. It rings true to me:

In short, since I started investing in the web in ’93/’94, I have invested in about 100 software-based web companies. And the success rate of fat companies versus lean companies is stark. I have never, not once, been successful with an investment in a company that raised a boatload of money before it found traction and product market fit with its primary product.

The rest of us, meanwhile? I think we have to admit, the debate is pretty much moot for the rest of us. There might be a few dozen people around who can still raise hundreds of millions of dollars based mainly on their name and track records. Ben Horowitz and his partner Marc Andreessen are two of them. But I’m not; and, no offense, but the odds are you aren’t either.

Apples, Oranges, and Making Startups Pay to Pitch.

Angel investment, Business Plan Contest, Venture Capital, Venture Contests, , , , ,

I hate it when people push issues way too far, diluting their points by overextending them. Stretch your generalization net too far and you catch a lot of innocent fish along with the sharks. Do that and you kill your own argument.

For a great example of that, Jason Calacanis’ rant against startups having to pay to pitch investors. You can click here to read it. He’s very angry at businesses charging startups fees of thousand of dollars to pitch investor groups. I agree with him. I also dislike most (but not all) of the mostly-web-based listing services that charge startups hundreds of dollars to list themselves somewhere were investors will see them.

By the way, for a rant-free and more balanced discussion of the same problem, click here for Lora Kolodny’s summary on NYTimes. com.

But my beef with Jason’s rant is his total lack of distinction between thousands of dollars as a pay-to-pitch fee, charged by for-profit middle-men companies, and the normal fees of tens or hundreds of dollars charged by angel investment groups as part of the pitching process. That’s like apples and oranges. And the oranges are getting smeared with the bad apples.

I read, cringing,  as Jason and his followers (in the comments) seethe with anger at entrepreneurs being forced to pay anything, in any context, to present to investors. And that’s way off base. You simply can’t lump these pitch predators and their big fees with the hundreds of angel investment groups and community organizations that charge tens or hundreds of dollars to cover real costs.  He’s got so much sound and fury, without making some important distinctions. It’s scary.

Let’s take a real-world case, one that I know well. I’m a proud member of a local angel investor group that charges the startups who enter our annual business plan competition $199. We’re not exploiting anybody. Not one of us ever sees a dime of the entry money. It goes to support the costs of the event, including the location, coffee and such, collateral. It’s controlled entirely by the organization itself, a collection of non-profit civic groups trying to contribute to small business development in our local area. Where’s the harm in that?

While a few of Jason’s commenters hint at this kind of distinction, the general feel is about as friendly as an angry mob with torches and pitchforks.

So there’s the problem. Generalize that pay-to-pitch is exploiting startups, and you make the world harder for well-meaning groups of investors that are giving startups a pretty good deal. So why not make the distinction, apply some gray tones instead of all black and white, and make a better point? Oh dear, all those nerdy pointy-headed distinctions are so undramatic.

Just to make sure, I asked a local entrepreneur, Nathan Lillegard, president of Floragenex, who describes himself as “as someone who has paid way too many fees to talk to people about my company.” He said:

“A truly dedicated entrepreneur finds just as much value in the experience of pitching as in the investment payoff. If an event, like the WAC can help startups improve their pitch, enhance their skills, and make at least one useful connection, then it’s worth a small fee to participate. If, on the other hand, all that the entrepreneur gets is a quiet crowd and no feedback nor chance to network, then I wouldn’t pay $1 for the privilege of talking to a room full of people with money.  Caveat Emptor! It’s up to the entrepreneur to know that there is a cost to raising money and these types of events can be a very efficient way to meet lots of potential investors, just one of which can change their world as they know it.”

And if you’re a startup anywhere in Oregon, especially in the southern Willamette Valley, and you have an interesting business with a good chance to grow, and a real exit strategy, then pay no attention to that angry man behind the curtain, and please apply to pitch to the Willamette Angel Conference. And yes, it will cost you $199.

(Image credit: istockphoto.com)

Business Plan Contest: You Be the Judge

Business Pitch, Business Plan Contest, Venture Contests, , ,

Five very interesting young businesses, five excellent presentations, six judges with questions, and all of it available as online video, where you can watch the whole thing and vote for the winners.

What I like best about the Forbes annual $100K Boost Your Business contest is that it is open to everybody. I love being a judge of that event. And I also love that you can be a judge too.

This is also a good opportunity to see good examples of the classic 10-minute slide pitch to investors.

I’ve already voted. Now it’s your turn. Here’s the link (or you can click on the image):

Boost Your Business Finalist Voting 2009

forbesvote2009

True Story: My First Experience in Angel Investing

Angel investment, Business Planning, True Stories,

Today’s a good day to post on my angel investment experience, because this afternoon I’ll be speaking to a group on this subject in Corvallis, Oregon. What I want to do is just describe how it went for me, one set of eyes, one viewpoint, without making any generalizations about the rest of the world of angel investing.

Last February I joined Willamette Angel Conference (WAC), an angel investment group in the southern Willamette Valley, including Eugene and Corvallis. Here’s what happened. 

  • It started for me with the discovery, in early February, that the buy-in price was $5,000 plus $250 in fees. I always thought of angel investment as a matter of putting $50K or $100K or more into a startup. But I could manage $5K.
  • The group entity was an LLC of which every member had shares depending on how many $5K shares he or she signed up for.
  • I had to certify that I’m an “accredited” investor. Nobody audited my books or anything, but I did have to sign a paper guaranteeing that I met the Securities and Exchange Commission (SEC) guidelines. Details of that here. The point is that this is a very risky investment, and you have to be able to just plain lose that money.
  • I got access to Angelsoft.net for the WAC group. There were 43 potential investments submitted to the group by late March.
  • We – about 25 members, each of whom had at least one $5K share in the group — met in the evening every Monday in April. In our first meeting we narrowed the 43 plans to 13 (we had aimed for 15, but there was a natural break at 13). In the next two meetings, we studied the 13 remaining plans. We listened to pitch presentations by the entrepreneurs, and asked questions. We divided into smaller teams to visit their offices, if possible, and talk to them. In the last April meeting, we chose five finalists, and divided into groups, again, to look at them in more detail.
  • In a last evening meeting in early May, we shared additional information on the five finalist companies.
  • At an all-day event in middle May, we heard presentations again along with an audience of several hundred people, and voted a winner.
  • My wife an I now have a small equity share in CenterSpace Software, of Corvallis, the winner we (the investor group) chose.

From my point of view, as someone who’s raised VC money for my own company and been on the board of a company that raised VC money and went public quickly, has taught entrepreneurship and consulted to VCs, and has mentored a lot of startups, and judged business plan competitions, it was an extremely satisfying role reversal to sit on the investor side of the table. I enjoyed the meetings thoroughly. I read the business plans, paid attention to the pitch presentations, asked questions, and enjoyed meeting and working with the other investors. This was all good.

I liked this experience so much that this autumn I agreed to be investor chair for next year’s version.

If this sounds interesting to you, look for local angel investment groups in your area. Ask your Chamber of Commerce. Browse the Web. Go look at Angelsoft.net.

(Photo credits: Willamette Angel Conference)

Business Pitch for Fun and Profit

Business Pitch, , , ,

(I just posted this on my Up And Running blog over at Entrepreneur.com. For the record, I rarely post the same thing in both places, but today, because I’m announcing this new pitch site, I’m making an exception.)

Consider yourself one of the first to know about the new Bplans.com pitch site at pitch.bplans.com. That means you can be one of the first to pitch and one of the first to get posted.

No, it’s not about putting your business in front of investors, although maybe it could be partly related to that. Instead, it’s about the art of the pitch. Free publicity perhaps too, and tips or comments. What it is about is the art of the pitch. Doing it right, doing it well, and getting yourself and your business up and showing up. (And let’s pause here to note that The Art of the Pitch is a chapter in Guy Kawasaki’s The Art of the Start book. Click here for his reading of that chapter.)

Take your browser to pitch.bplans.com and you’ll see the “Add pitch” button you can use to upload your pitch. What follows is a page of basic information (name, address, logo, etc.) and then a second page where you can add a YouTube video URL if you want, or short texts to deal with 10 key topics. 

This is all free to the users. What do you get out of it? A dedicated URL you can use to refer people to your business summary, plus the possibility of comments; this is free publicity, and publicity is assumed to be good. What do we get out of it? Bplans.com is about starting, growing, and planning a business, so we get more interesting stuff on our site.

And me? I like business pitches. That goes from the 60-second so-called elevator pitch to the 10-20 minute business pitch with slides. To me, business pitches, when well done, are fascinating. I see a lot of them. I see them in my role as a member of the Willamette Angel Conference, and I get to see them as a judge at venture competitions including Forbes and several business school contests. And I’ll be watching them on this site too.

Like they say in the commercials: do it today. Do it now. Click here.

Angel Funding Waiting for the World to Change

Angel investment, , , ,

Ever since I started in high tech in 1979, angel investment has been an amorphous, thoroughly disorganized, ad-hoc phenomenon that occurred somewhere between friends and family, on one end of a scale, and with venture capital, on the other. It was hard to find and hard to describe. People were selling lists of angel investors to entrepreneurs who were looking for investment.

I can’t say that the system worked; actually, I can’t even call it a system. Angel investment just happened. Securities law severely restricts the process of looking for investors, and, furthermore, also limits who is legally allowed to invest. An accredited investor has to meet minimum wealth requirements.

Last week I had a chance to talk at length with David Rose, founder of angelsoft.net. He  guest posted on this blog last Spring. Meanwhile, I’m getting more involved in my local angel investor group (Willamette Angel Conference), and using angelsoft.net software more. And David told me he’s continuing to bring angel groups together, and organize. So I’m hopeful about that.

The long-term dream is a smoothly working market bringing startups together with investors who understand the risks, have money, and want to invest it.

There are at least these three problems to solve:

  1. Organizing the information into a market-like system. Angelsoft.net is making real progress. Startups get an orderly application process, angel investors and groups of investors get better deal flow, and there’s more information for both sides. Also thefunded.com continues to add to its database of founder reviews of investors. Not to mention how much more information about angel investors is now available easily through simple Web searchs.
  2. Legal restrictions. And here I’m not sure how long it will take, or even if a solution is necessarily a good thing. It’s not simple. Restrictions on soliciting investors and qualification hoops for investors were made law back during the Great Depression because people were getting swindled. The law regarding information is way behind technology. The assumption that wealth is equal to sophistication in startup investment is questionable.
  3. Processing investment opportunities. I’ve been meaning to post for three months now about Revolutionizing Angel Funding on The Emergent Fool. That post, by Kevin Dick, talks about setting up a system to process startup deals automatically, using an online screening process. I’ll be watching that one. I’m not convinced that the way angel investors process deals, one by one, case by case, is really a significant problem. But it’s an interesting idea.

Overall, I’m intrigued by how much organization has happened in the last year or two.

I do believe there’s an opportunity for healthy disruption in this marketplace. It may be something like what kiva.org is doing for microlending, or what prosper.com was doing for peer-to-peer lending before (gulp) it got a cease and desist order from the Securities and Exchange Commision (SEC). On one side, a lot of people who know what they’re doing would like to invest in some selected startups. On the other hand, a lot of startups would like to work with investors.

The toughest part of all this is securities law. A lot of what might really make a huge difference in organization of angel investment is on the brink of breaking laws governing fishing for investors. I’m waiting, cautiously optimistic, to see how this develops. And how long it takes.