Category Archives: Business Plan Marathon

5 Ways to Make Your Projected Profits Realistic

Business Financing, Business Plan Contest, Business Plan Marathon, Business Planning, Venture Contests, , , , ,

I’m well into my business plan marathon again this year, in Houston today looking forward to judging the Rice Business Plan Competition, one of my favorites.

Regarding business plans, instead of just complaining (again) about unrealistically high profitability projections, today I have some specific suggestions. And this has nothing whatsoever to do with the six excellent plans I’ve read for my part of the judging today. dollars

But, as my mother used to say: “if the shoe fits, wear it.”

The underlying problem is that projecting high profits doesn’t usually mean you have a great business plan. It almost always means that you’ve underestimated expenses or direct costs. It’s usually a bad thing, rarely a good thing.

So here are those concrete suggestions:

  1. Compare your projected profitability (net profits or pretax profits as percent of sales) to standard industry profiles. The most well-known source in the Annual Statement Studies published by Risk Management Associates (RMA). These will give you standard profitability rates for more than 700 common types of business. I searched the site for information business, narrowed it down to software publishing, and I was offered a download for $120. Oxxford Information Systems competes with RMA with more profiles for more different types of business. And Business Plan Pro bundles the Oxxford Information profiles with a searchable database linked to the ratios table [disclosure: I’m the conceptual author of Business Plan Pro and my company publishes it.] And there are other competitors in that market. Standard profitability isn’t that hard to find.That doesn’t mean that I recommend your projected profits always match some standard industry profile. Not at all. What it does mean, though, is that you should know what profits are reasonable for similar industries, and don’t project huge profitability that’s 5 or 10 times higher, in percent of sales terms, than the standards. That kills credibility.
  2. Compare your projected profitability to results of publicly traded companies in your industry. You don’t need an exact match, but you should know how different your projections are, and you should satisfy yourself on why they’re different. The publicly traded companies tend to be larger and more established than new startups. Sometimes a startup is so new and innovative that it is much more profitable than industry leaders; but that’s rare. If you don’t know where to find financial reports of publicly traded companies, start with Yahoo Finance.
  3. Do a good web search to see if you can find comments on blogs or in interviews where entrepreneurs talk about actual profits in real businesses like yours. Maybe you’ll find somebody who might be a competitor. People give a lot of information away these days, in blogs, and on the web.
  4. Try to find somebody with actual experience in a similar company. Use social media, use your mentors, talk to the nearest business school or chamber of commerce. Get somebody to tell you, from real-world experience, what kind of profits are likely.
  5. If all else fails, remember that across the real world of business, normal profits run about 5, 10, maybe 15 percent of sales. If you’ve done your best and it still shows 30 percent or more, take a good look at your payroll, headcount, and marketing expenses. When it doubt, add marketing expenses to take your projected profits down to a credible level.

Is this you? Does your business plan project profits way above standard levels? That doesn’t make your plan look better. First, make it credible. Only then are the numbers really interesting.

(Image: Elnur/Shutterstock)

Business Plan Contests Grow Up and Mean Business

Business Education, Business Plan Contest, Business Plan Marathon, Venture Contests, , , , , , ,

It’s time to note a major change. Just a few years ago business plan contests were an academic oddity, a dress-up exercise at a few business grad schools. Suddenly, or so it seems, they’re pretty much for real. Some very powerful new businesses are appearing at business plan contests, winning significant money, attracting investors, getting funded, and turning into real businesses.

Rice ContestFor milestones, try this: last weekend Rice University hosted the first business plan contest to offer $1 million in total prize money. This is a serious event now. If you’re at all curious about how strong some of these businesses are, read Lora Kolodny’s ‘I Want This Drug on the Market by the Time I Need It!’ on her You’re the Boss Blog at the NYTimes.com.

How important are these contests? How real? Well Lora wasn’t the only journalist at Rice last weekend. Fortune and CNN are covering that contest in detail. Expect to see some of these major contests in the Wall Street Journal.

Brad Burke, head of the Rice Alliance for Technology and Entrepreneurship, chief host and organizer of the Rice contest, likes to point out how many of the teams entered have gone on to be successful:

More than 97 past competitors have gone on to successfully launch their business, including 33 of the 42 teams from the 2009 competition. In total, past competitors have raised more than $220 million in funding.

Moot Corp, meanwhile, the first of these competitions, started in 1984, has trouble keeping up with all of its Moot Corp success stories. Moot Corp will be taking place in Austin again this year, in early May, gathering together the winners of several dozen other competitions.

And at the University of Oregon’s annual New Venture Competition, of which I’ve been a judge 12 times, all four of the teams in my semi-finals track looked like real companies with good probability of making it in the real world. That’s impressive. I’ve seen a lot of good companies in that one before, but never before have I done a track in which all four of the four groups seemed likely to be real viable companies in the real world.

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

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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: Business Plans And Investor Returns

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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.

fool's goldI 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)

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

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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)

Do Business Plan Contest Winners Make It in the Real World?

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Craig from trackster.com asked me last week in a comment he added to my Willamette Angel Conference post:

I was wondering with all these business plan competitions that you judge, how many winners or even non winners have you seen turn into successful companies? Are there any examples that you could give?

Yes, a lot of these companies make it. It’s more like half than the one in 10 portion you’d think from the classic assumptions.

I’ve seen lots of these companies launch and become successful, in a much higher proportion than the classic assumption of one or two of every 10.

For example, take a look at this page from the Rice Business Alliance, which has run one of the best of these contests since 2002. The graph here shows the success rate for all of the 166 ventures entered in the Rice contest from the beginning. The trend is very clear. The Rice Alliance says that since 2001 (quoting their website):

  • 66 of our past Rice Business Plan Competition teams are successful business start-ups
  • 192 business teams from national and international schools have participated
  • More than $90 million in capital raised by Rice Business Plan Competition participant companies

Although they make the raw data quite as accessible as the Rice Alliance does, the University of Texas’ Moot Corp, the oldest and most respected of these contests, has to have a similar success rate. I say that because I’m involved with both and the plans and the people are excellent in both. And Moot Corp does post a very long page full of specific successes, with a lot of details. I saw all of the companies they have there from the 2007 and 2008 contests, and I’m not at all surprised that they’ve made it.

I particularly liked cQue, which recently landed a contract with the San Francisco Giants to revolutionize ticketing technology; and Evapt, an automated billing system for software as a service; and several dozen others. They are up and running, they are raising money, they are making it.

To be fair, these two competitions tend to be the best of the best. The entrants are carefully selected. Most of them have won local or regional contests. They are grad students and people in the real world. I’m also involved in some less ambitious business plan contests, like ones for undergrads, that don’t produce a lot of real companies.

And this year I’ve added angel investment, which is a different thing entirely. Like the major academic contests, it is about business plans, ventures, presentations, questions and answers, investors’ points of view, exit strategies, and so on. Unlike the academic contests, there are no MBA requirements, and no faculty advisors.

And specifically, the angel group I’m in, the one I posted on last Thursday morning: there were five finalists that presented to the group. All five of them are very real companies already, even thought they want and in some cases need angel investment of $125K. All five will be there a year from now. The one with the lowest need and least ambitious forecast, a software company called CenterSpace, won the investment. But the four others that didn’t win, led by my personal favorite, Zapproved, have good future prospects. That was also Zaps Technologies, Wicked Quick, and Floragenex. All of these are going to survive and grow.

Turning Good Advice into Bad News

Angel investment, Business Mistakes, Business Plan Marathon, Venture Capital,

Imagine, if you will, this scene:

You are in a group of angel investors talking with entrepreneurs looking for funding. Or you are in a group of venture competition judges giving feedback to teams after the judging is over. The entrepreneurs listen intently, nod, they’re understanding, and then suddenly one or more of their faces change, crestfallen, disappointed, cheated. Something that was just said triggered an immediate reaction:

But we put that in, they say, because so-and-so (the last angel group they talked to, or the judges of the last contest they entered) recommended it.  We specifically changed our plan to accommodate feedback. And now your feedback is in exactly the opposite direction.

I see it a lot. I’ve seen it for years in the judging of the venture competitions. Lately I’ve seen it in reviewing potential angel investments.

For example, one that comes up a lot is whether you go for the broad sweeping expansive view of future market potential, which some groups like and other groups tag as lack of focus or realism.

I like focus myself. Keep it manageable. Narrow targets. Getting to $5, $10, $20 million in three or five years, but more in control. More realistic.

A lot of other judges want to see a bigger pot of gold at the far end of a more distant rainbow. “How do you get to hundreds of millions?”

So they go for big, because the judges say so. Then the next time, it’s “but you have too many targets; you’re doing too much.” And then there’s that look again, the disappointment. We’re supposed to do what the last judges suggested.

Don’t Shade Your Eyes, Summarize

Business Education, Business Plan Marathon, Venture Contests, , ,

What if you had to take the classic business plan, developed for an MBA-level venture competition, and shrink it down to 10 pages?

Last Friday I spent a fun and fascinating day as a semi-finals judge at the University of Oregon New Venture Competition. My part of the program was evaluating four ventures developed by MBA students from Clemson, Northwestern, Penn State, and Michigan, along with three other judges. That was one of five flights, so there were 20 teams, selected from more than 100 entrants.

The new rules for this year gave them 10 pages for the business plan, plus up to 10 pages for appendices. The judges loved it, of course, because we have to read all the plans. The teams had mixed feelings.

Summarize. In this context, the venture competition, with teams of smart MBA students, it should have been duck soup (although that particular expression isn’t that popular at the University of Oregon, because the home team is the Ducks).

Keep the highlights. Stick to the headlines. Summarize. I don’t care if you’re the next big thing, with an unimaginably exciting new idea and a great team, you can still create a meaningful summary in 10 pages.

Start with a one-page summary. Then tell a story about the need, and your solution, your market, your secret sauce, your strategy, and your great team. Add in a financial summary, and don’t forget to highlight your capital needs, valuation, and exit strategy. If you do no more than 3 paragraphs in any one of these 10 main topics, you ought to be able fit that in 10 pages using a lot of bullet points and white space. Make it an attractive document that the judges, who tend to have older eyes, can read. Leave some space for some snappy graphics, a bar chart or two, and then include the financials in more detail in the appendices.

Some of the teams struggled too much with the page limitation. Some chose the dark-side option, filling the page with dense, small text. Some skipped important topics.

As we get used to these competitions, with page limitations growing more common, I’m expecting more teams to realize that there ought to be a master plan, from which these summary plans, and the presentations, and the elevator speeches, are just alternative output.

Once they get that, they should then start thinking more about the combined communication impact of the plan, the presentation, and the other elements. Can they summarize strategy briefly in a plan, and then explain it more in a presentation? I think so.  The plan and the presentation obviously overlap, but they both don’t have to cover exactly the same territory.

So today my business plan judging marathon month continues. After the event in Portland over the weekend, this evening I’m going to a three-hour meeting of the Willamette Angel Conference, reviewing business plans, listening to presentations, doing due diligence on plans.  On Thursday I leave for Houston, to judge the Rice University Business Plan Competition.