Table of contents
The entrepreneur is admitted to the funding process after submitting a business plan. Many investment organizations will not even give you an interview until you have a strategy in place. And if the idea is to attract investment capital, it must be exceptional.
Too many entrepreneurs, on the other hand, still assume that if they construct a better mousetrap, the world will come knocking. A decent mousetrap is essential, but it’s just one part of the solution. It’s also crucial to meet the demands of marketers and investors. Marketers are looking for proof of client interest as well as a feasible market. Investors want to know when they will be able to cash out and how accurate the financial forecasts are. The writers explain to entrepreneurs how to build persuasive and successful business plans based on their own experiences and those of the Massachusetts Institute of Technology Enterprise Forum.
Entrepreneurs and corporate executives need a detailed, well-thought-out business strategy to succeed. You will never encounter a more difficult writing task than the drafting of a business plan, whether you are beginning a new firm, seeking extra finance for current product lines, or proposing a new activity in a corporate division.
Only a well-thought-out and well-presented strategy can get the required funding and support for your concept. It must correctly and attractively represent the firm or planned initiative. The plan must define the company’s or project’s current state, current demands, and predicted future, despite the fact that its topic is a shifting objective. In a rational and compelling manner, you must explain and justify continuing and changing resource requirements, marketing choices, financial predictions, production demands, and personnel needs.
It’s understandable that managers ignore the basics since they’re working so hard to gather, organize, explain, and record everything. The most crucial one, we discovered, is the proper representation of three constituents’ points of view.
1. The target market for the proposed product or service, which includes both current and future clients, consumers, and users.
2. The investors, whether they are financial or non-financial.
3. The creator, whether he or she is an entrepreneur or an invention.
Too many company strategies are prepared entirely from the perspective of the producer, the third stakeholder. They extol the proposed product’s or service’s underlying technology or creativity in glowing terms and at length. They overlook the market and the investor, two key stakeholders that ensure the venture’s financial sustainability.
Consider a group of five executives who are looking for funding to start their own technology consulting business. They identified a dozen different sorts of specialist engineering services in their business strategy and projected a 20% yearly sales and profit increase. However, the executives were unable to establish which of the twelve services provided by their prospective customers were really required and which would be the most lucrative. They dismissed the idea that the market would demand services other than the twelve specified by failing to investigate these concerns thoroughly.
They also forgot to mention the price of new shares or the proportion of the stock accessible to investors. Dealing with the investor’s point of view was crucial since, at the very least, new venture investors want a return of 40% to 60% on their investment, compounded yearly. The predicted 20 percent sales and profit growth rates could not offer the required return unless the founders handed up a significant portion of the firm.
In actuality, the executives had only evaluated their own point of view, which included the new company’s offerings, structure, and expected outcomes. Their business strategy lacked the credibility required to raise the necessary investment money since they had not clearly explained why prospective consumers would purchase the services or how investors would get an appropriate return (or when and how they might payout).
We’ve evaluated company proposals before, as well as organized and observed presentations and investor reactions during MIT Enterprise Forum meetings. We think that company strategies must address marketing and investor concerns persuasively. This reading examines and discusses those factors, as well as how business plans might be designed to meet their needs.
Market should be emphasized.
Rather than technology- or service-driven businesses, investors prefer to invest in market-driven businesses. The product’s market, sales, and profit potential are significantly more important than its aesthetics or technical characteristics.
By proving user benefit, establishing market interest, and verifying market claims, you may create a compelling argument for the existence of a good market.
Demonstrate the User’s Advantage
Even specialists may easily ignore this fundamental concept. An entrepreneur spent the whole of his 20-minute presentation at an MIT Enterprise Forum session promoting the merits of his company’s product—an instrument to regulate specific areas of the textile industry’s manufacturing process. He wrapped off with some financial estimates for the next five years.
The first panelist to respond to the business plan—a partner in a venture capital firm—was entirely dismissive of the company’s chances of attracting investment funding, claiming that its market was in a slump.
“How long does it take your product to pay for itself in reduced manufacturing costs?” another panelist said. “Six months,” said the presenter right away. “That’s the most significant thing you’ve said tonight,” the second panelist said.
The venture investor rapidly changed his mind about his first assessment. He said that if a firm could demonstrate such a significant user benefit—and stress it in its sales approach—he would endorse it in practically any sector. For example, if it paid back the customer’s money after six months, the product would basically “print money” after that period.
Instruments, machines and services that pay for themselves in less than a year are required purchases for many prospective clients, according to the venture investor. If the repayment term is shorter than two years, it is a likely buy; if the payback period exceeds three years, they will not support the product.
The MIT panel suggested that the entrepreneur rewrite his business strategy to stress the short payback time while downplaying the self-serving talk about product innovation. The CEO heeded the advice and reworked the strategy in plain English. His business is thriving, and it has successfully transitioned from a technology-driven to a market-driven one.
Find out what the market is interested in.
The first stage is to calculate the user’s benefit. Customers must also be captivated by the user’s benefit claims and appreciate the product or service, according to the entrepreneur. The company strategy must exhibit unequivocal favorable replies from potential prospects when asked, “Will you purchase after hearing our pitch?” Investment is unlikely to be made without them.
How can start-up enterprises, some of which may just have a prototype product or a service concept, accurately assess market response? A small-business CEO had built a prototype of a system that allows personal computers to process telephone communications. He wanted to show that people would purchase the product, but the company’s monetary resources were depleted, so he couldn’t create and sell it in large quantities.
The executives were stumped as to how to solve the situation. Two options were presented by the MIT panel. To begin, the founders may enable a few consumers to try out the prototype and provide written feedback on the product as well as their level of interest when it becomes accessible.
Second, if a few prospective consumers paid a portion of the cost—say one-third—up advance so that the firm could develop it, the founders might provide the product at a considerable discount to them. The firm was able to not only determine if there were any prospective consumers but also show the product to possible investors in real-world settings.
Similarly, an entrepreneur may give a planned new service at a reduced price to early consumers as a prototype if the customers agree to act as references in promoting the service to others.
Nothing beats letters of support and thanks from certain key prospective consumers, as well as “reference installations,” when it comes to launching a new product. You may utilize third-party statements—from potential consumers who have seen the product in action, first users, sales reps, or distributors—to demonstrate that you have found a viable market for your product or service.
Even if the product is simply a prototype, you may get letters from consumers. You may test it out with a prospective user, who you will offer it to for free or at a discount in exchange for information on its merits and an agreement to speak with sales prospects or investors. You may add letters from trial customers attesting to the value of the product in an appendix to the business plan or in a separate volume.
Your Claims Should Be Documented
After you’ve developed a market interest, you’ll need to back up your claims about the market and the pace of growth in sales and earnings with well-examined facts. Too frequently, CEOs believe that “if we’re clever, we’ll be able to capture roughly 10% of the market” and “even if we only get 1% of such a massive market, we’ll be OK.”
Investors understand that, regardless of market size, there is no certainty that a new firm will obtain any business. Even if the corporation makes such statements based on fact—as shown by evidence of consumer interest, for example—they may soon fall apart if the company does not thoroughly obtain and evaluate supporting facts.
A business strategy that was presented to the MIT Enterprise Forum exemplified this risk. Small companies were the target market for an entrepreneur who wanted to provide a service. He reasoned that if he penetrated even 1% of the 17 million small businesses in the United States, he might have 170,000 clients. According to the panel, between 11 and 14 million of these so-called small firms were really sole proprietorships or part-time businesses. The overall number of full-time small enterprises with workers was really between 3 million and 6 million, indicating a genuine market significantly below the company’s initial projections—and prospects.
In a business proposal for the sale of particular equipment to apple producers, you’ll need U.S. Department of Agriculture data to figure out how many growers may benefit from the equipment. If your equipment is only effective for farmers with 50 acres or more, you’ll need to figure out how many growers have that much land, or how many are small-scale growers with just an acre or two of apple trees.
A realistic business plan should include information on the number of possible clients, the size of their enterprises, and which size is best for the items or services being supplied. Bigger isn’t always better. For example, a $10,000 annual chemical savings may be substantial to a small business but negligible to a Du Pont or Monsanto.
Such market research should also reveal the industry’s character. Banking and public utilities are two of the most conservative businesses. The number of prospective clients is generally limited, and industry adoption of new goods or services, no matter how wonderful they have shown to be, is excruciatingly slow. Nonetheless, the majority of the clients are well-known, and although they may be hesitant to respond, their purchasing power makes the wait worthwhile.
Franchised weight-loss clinics and computer software enterprises are at the other end of the industrial spectrum, with highly fast-growing and fast-changing operations. The situation is inverted in this case. While some businesses have grown to multimillion-dollar revenues in a few years, they are exposed to comparable reductions from the competition. These businesses must continually innovate in order to deter prospective rivals from joining the market.
You must estimate the product or service’s rate of acceptance—and the pace at which it is expected to be sold—convincingly. You may start putting up a viable sales strategy and forecasting your plant and personnel demands based on the marketing research results.
Meet the Demands of Investors
The pleasure of investors is linked to marketing difficulties. Once executives have made a compelling case for their market penetration, they may develop financial predictions to assess if investors will be interested in reviewing the endeavor, as well as how much and at what price they will commit.
Before you consider investors’ concerns while analyzing company proposals, it’s a good idea to figure out who your possible investors are. Most of us are aware that professional venture capitalists and rich people may be interested in investing in new and developing private enterprises. They are the company itself in corporate initiatives. Individuals of varied means, as well as numerous institutions, become investors when a corporation distributes shares to the public.
However, one segment of the investor community—the creators of new and expanding businesses—is sometimes disregarded in the planning process. They commit to years of hard labor and personal sacrifice when they decide to create and operate a company. They must take a step back and assess their own company to see if the potential for return in the future genuinely justifies the risk taken now.
The choice to invest may vary if an entrepreneur examines a concept objectively rather than through rose-colored glasses. Because the product was extremely specialized and had, at most, a few clients, one entrepreneur who believed in the potential of his scientific-instruments firm confronted tough marketing challenges. The venture’s chances of ultimate success and financial return were minimal due to the entrepreneur’s high debt.
The judges came to the conclusion that the entrepreneur will make only as much money as he would have if he had stayed at his employment for the following three to seven years. On the negative, he may end up with far less in return for more hassles. The entrepreneur ultimately agreed and gave up the idea after seeing it in such a dispassionate light.
The following are the most important factors for investors to consider:
Many entrepreneurs are perplexed as to why investors have such a short attention span. Many people who consider their businesses as a lifelong commitment assume that everyone else who joins them would feel the same way. When evaluating a company strategy, investors assess not just whether or not to invest, but also how and when to exit.
Investors may benefit from the sale of their own when the firm becomes public or is sold to another business since tiny, fast-growing businesses have limited cash available for dividends. (Large firms that engage in new ventures are not permitted to sell their ownership if they intend to integrate the venture into their organizations and realize long-term revenue gains.)
Typically, venture capital organizations want to dispose of their small business investments in three to seven years in order to pay profits and produce cash for new projects. The professional investor desires a significant monetary gain when cashing out.
Investors want to know that business owners have considered how to meet this need. In three to seven years, do they plan to go public, sell the firm, or buy out the investors? Will the profits give investors a return on invested money that is proportional to the level of risk—in the range of 35 percent to 60%, compounded and adjusted for inflation?
Investors’ holdings are often not shown when and how in business planning. One entrepreneur, for example, needed $1.5 million to develop his software firm. However, according to one panelist, the investors “would need to buy the whole firm and then some” to achieve their objectives.
Creating Audio Projections
Profit estimates over the next five years might assist investors to negotiate the amount they will get in return for their money. Investors use financial projections as a measure for evaluating future performance.
Entrepreneurs often go to extremes with their figures. They don’t put enough effort into their financials in some situations, relying on statistics that are so skewed or overly optimistic that anybody who has read more than a dozen business plans can see right through them.
A management team proposing to produce and distribute scientific equipment predicted a net income after taxes of 25% of sales between the fourth and fifth years after investment in one MIT Enterprise Forum presentation. While certain businesses, such as computer software, have such high-profit margins, panelists remarked that expecting similar margins in the scientific equipment industry is unreasonable.
In reality, the management had severely undervalued — and carelessly — some significant expenditures. The judges encouraged them to go back to the drawing board with their financial projections and to seek financial advice before contacting investors.
Some company owners believe the financials are the business strategy. They might cloak the scheme in a cloud of numbers. Many investors are turned off by “spreadsheet merchants,” who have pages of computer printouts covering every business variation imaginable and assessing product sensitivity.
Even when financial estimates are securely founded on genuine marketing data, investors are apprehensive since emerging firms almost never realize their optimistic profit expectations. When new companies meet 50% of their financial targets, officials from five big venture capital firms state they are happy. They agreed that the “projection discount factor” has an impact on the talks that decide the proportion of the business acquired with investment cash.
The Stage of Development
Every investor wants to lower their risk. They analyze the state of the product and the management team while assessing the risk of a new and developing enterprise. The smaller the risk, the farther forward a business is in each area.
A solitary entrepreneur with an untested concept is at one extreme. Such a company has a limited chance of acquiring investment capital unless the creator has a stellar track record.
A venture with an acknowledged product in an established market and a skilled and fully staffed management team is at the more desired extreme. This company has the best chance of attracting low-cost venture capital.
Entrepreneurs who become aware of their investor status and believe it is insufficient might work to enhance it. Consider the story of a young MIT engineering graduate who presented written schematics for improving semiconductor-equipment manufacture during an MIT Enterprise Forum event. He had received interest from a number of producers and was searching for funding to finish development and start production.
The judges encouraged him to focus first on developing a prototype and putting together a management team with marketing and financial experience to supplement his product development knowledge. They emphasized that since he had never established a business before, he needed to demonstrate a lot of tangible progress in order to assuage investors’ concerns about his lack of expertise.
Investors might start doing quantitative research after they have a qualitative understanding of a firm. One common method is to determine the company’s worth based on the predicted outcomes in the fifth year after investment. Because risk and reward are so tightly linked, investors anticipate firms with completely developed goods and proven management teams to return between 35 and 40% on their investment, whereas companies with unfinished products and management teams to return 60% annually compounded.
Investors analyze a company’s prospective value after five years to estimate what proportion they need to hold to achieve a profit. Consider the instance of a well-developed corporation that is predicted to provide a 35 percent yearly return. Over a five-year period, investors would want to gain 4.5 times their initial investment before inflation.
After factoring in the projection discount factor, investors can estimate that a business would generate $20 million in yearly sales and $1.5 million in net profit in five years. The firm would be valued at $15 million in five years based on a traditional acquisition multiple of 10 times earnings.
To satisfy investors, the firm should expand to $4.5 million after five years if it wants $1 million in funding. The investors would need to hold a little less than one-third of a $15 million firm to get that return. However, if inflation is predicted to average 7.5 percent per year over the next five years, investors could expect a value of $6.46 million, or 43 percent of the firm, as an acceptable return.
With inflation at 7.5 percent per year, a $1 million investment in a less mature enterprise would have to earn close to $15 million in five years, net of inflation. However, few companies can make a compelling argument for such a high return unless they already have a product in the hands of certain key consumers.
Of course, based on planned profits and estimated inflation, the ultimate proportion of the firm bought by the investors is open to some discussion.
Bring It To Life
Unless you are affluent enough to provide your own cash to fund the enterprise and try out the pet product or service, the only option to meet your demands is to satisfy those of the market and investors.
Of course, you’ll have to deal with a variety of additional challenges before you can persuade investors that your business will flourish. What, for example, are the product or service’s exclusive features? How will you ensure that quality is maintained? Have you narrowed your emphasis on a certain market group, or are you attempting to accomplish too much? If you respond in terms of the market and investors, the outcome will be more effective than if you respond in terms of your personal desires.
An example exemplifies the possibilities for conflict. At an MIT Enterprise Forum event, an entrepreneur predicted that his specialty chemical company would spend nearly half of its gross sales income on research and development. A panelist who had looked at similar organic chemical suppliers questioned why the company’s R&D expenditure was so much greater than the industry norm of 5% of gross sales.
The businessman added that he wants to keep developing new items in his industry. While the panel agreed that his goal was good, it unanimously recommended that he cut his expenditure to match the industry. The presenter disregarded the advice; he was unable to get the necessary funding and ultimately went out of business.
Once you embrace the notion that you must please both the market and investors, you must organize your facts into a persuasive paper in order to sell your enterprise to investors and clients. In the section under “Packaging Is Important,” we’ve included some presenting tips.
Writing great business strategies is as much an art as it is a science, despite what we would hope. The concept of a master contract with blanks for executives to fill in, similar to how attorneys use example wills or real estate deals, is seductive but unachievable.
Key marketing, manufacturing, and financial challenges vary amongst businesses. Their strategies must reflect these variances, emphasizing suitable areas while downplaying minor concerns. Keep in mind that investors see a business plan as a distillation of the company’s goals and personality. They will be turned off by a cookie-cutter, fill-in-the-blanks strategy, or, worse, a computer-generated product.
Instead of focusing on what fits you best, write your company strategies by looking outward to your important constituency. This will save you time and effort while also increasing your chances of attracting investors and clients.