When is a business plan needed?

I saw this question today on a forum in LinkedIn and decided to write this quick post, about when exactly a business plan is needed.

One of the participants in the discussion even suggested that VC’s should be more trusting of entrepreneurs, which caused me to scoff and cough. Anyway, here’s how the world really works:┬áNobody trusts anybody. People don’t even trust themselves. We are all human beings. Human beings invented the atomic bomb, and human beings orchestrated the holocaust. So nobody should trust you that your idea just works – that just makes no sense.

If you have a great idea, one you think will revolutionize some thing or other, you need to first create a working prototype. This is the ultimate proof that you can actually make something happen, and not just talk about, or write a word document about. If you create a working prototype it means so many things: You have the team. You have the skills. You have the motivation. You validated your concept. You invested your own time and money into your vision, instead of waiting for someone to shower you with money.

What if creating a prototype costs way more money than you have? That’s where investment is needed. And that’s also where you’ll need a business plan. But you need to realize that a business plan is something that will change many, many times over the course of a company’s life. Below, I detail to some degree, how that business plan changes, as you progress in the investment/stage ladder.

And it goes in this order of precedence:

You are the first investor: Do you have a day job? Don’t hurry to quit your day job. Maybe you can move to a cheaper apartment, maybe that will mean you can divert some of your salary to building your product. You are your best investor. And you should become your own devil’s advocate, and ask yourself: Would I invest in myself? And this is where your first business plan comes. This is a simple spreadsheet. Put your costs, and put the costs of your product, put the market size, and try to include the element of time. Nothing happens overnight. Just creating this first spreadsheet will be very revealing even to yourself. And you should ask yourself difficult questions: Will people pay X for Y? How much % of the market will actually purchase?

Friends and Family: You’d be surprised and enlightened, when trying to pitch the idea to your friends and family. How fast will they get it? Will they shoot you down? Will they have other great ideas to contribute to you, for free? An idea is great, but presenting it to someone other than yourself is an enlightening experience. You can trust your family, and sometimes you can trust your close friends. Maybe some of them will help you with money. I’ve seen it happen, so don’t rule it out. This is where your business plan will probably change again, and improve. It needs to look simple for your friends and family. Is it overly complex? Chances are your friends and family are not going to be the only ones who will lose interest in your spreadsheet.

Crowd funding: This new investment channel is revolutionary in itself. If your product appeals to consumers, you can sell it before it even exists. Isn’t this extraordinary? Many projects are now starting their way in crowd funding. One of those projects that is close to my heart is the Oculus Rift. Here’s an absolutely perfect example of a product that no VC would ever fund. And worse! The world of VR was considered worse than dead. Why do I say worse? Because there have been several attempts at VR, all have failed miserably. But here comes a guy with a vision (Palmer Luckey), and a promise to make it happen. And guess what, I now have a Rift and I can testify it works, and Palmer delivered on his promise. Not only that, but due the wild success of his campaign, game companies joined in the effort, and many games are now adapting their software to work with the Rift. And with all this incredible success, Oculus can now raise money from VC’s and bring the product to the masses. But even here, you need a business plan. Why? Because if you promise a product for $300, but spend $500 building it, you will not be able to supply this product to all the customers who ordered it, and you fail miserably. A business plan is ALWAYS needed, even a simple one that makes sure you are at least in the green.

Angel Investors: And I am talking about REAL angel investors here, not VC/Bankers who are masquerading as Angels. An Angel investor loses money if you go bust, and you are not expected to return any “loans”. It is more like receiving a Grant. You receive it based on trust, that you can make it happen, and that your idea is worth trying. The Angel investor should sit down with you, one on one. Do not fall for the trap of meeting “flocks”. Insist on meeting one on one, and if that angel wants to bring more people in on the investment, let him do the work of convincing additional angel investors into joining. If they have questions, they will ask him, and he will ask you in turn. And this is where a good Angel Investor who has experience, will help you revise your business plan again. They will ask for more details, and help you structure your business plan, and make it look more professional. In some cases, if they put money into your idea, some of that money will go to a professional business plan analyst who will make your business plan look like a tasty cake.

The banks: Sometimes banks are seen in a negative light, but I avoid falling into that trap. Same thing with VC’s, but more about that in the next section. So banks are in a position to give you a business loan. Depending on your relationship with the bank, you could get a loan with more, or less, favorable interest rates. And yet, they do not expect a x5 ~ x20 times return on investment. They only expect the money back with interest, and you can usually refinance and spread it over a period of time. If you have reached the prototype stage, and spoken to a few customers and realized they want to buy it or lease it, and you have orders, say 200 orders for a device that cost $200 to make, and sells for $400. You need $40,000 which the bank will usually give you quite easily. You then sell your customers the device for that 100% profit, give the bank their 3% ~ 12% and you are still left with 80%+ of the margin, and no VC meddled into your business, or replaced you with his brother in law CEO, just because you failed to produce a x20 time ROI. This is where your business plan might change again, you need to show your bank that there is a very high chance that you are making your money back. This should boost their confidence in you and your business, and increases your chances of getting the business loan.

Finally, Venture Capitalists: Those guys are last in the list, and for good reason. A VC usually sits on a pretty large amount of cash. Say $100M to $500M, many times more (I’m not going to talk about Micro-VC’s, they are a slightly different creature). The VC’s goal is to make at least x5 ~ x10 ROI. To achieve this fantastic ROI, they need companies that are at a very mature stage, selling an existing product to existing markets. In other words, a company that has already proven its business model and is on the verge of international success, but now needs more money in order to replicate that success. The VC then invests the money required to reach those new markets, to produce more products that will sell to those untapped consumer markets, to advertise the product to more people, to raise brand awareness, to hire more teams to produce the product faster, and so on. So primarily, their investment is focused on maximum ROI, always, forever. They do not need or want to trust you, and they do not need to have a vision – they only need to focus on ROI. That is their job, and don’t take it personally. This is why their due diligence is a long, painful process. To get to this point, you must have a very mature business plan, where all the numbers are REAL numbers (data collected in the field); You know how many people bought the product, you know how much it cost to produce, you know your own costs (burn rate, production costs, advertising costs), you know everything there is to know about your business!

 

Venture Capitalists Hijack “Angel Investor” Term?

I read an article today about some “Angel” group in New York City, and I realized something horrible is happening. It seems VC’s are trying to disguise themselves as Angel Investors. Maybe to attract more startups? Maybe to appear less frightening? Maybe to shed the negative “aura” attached to VC’s?

It used to be that Angel investors gave small amounts of money to startups, not because they were looking to make an “Exit”. The meetings were one-on-one, it was personal, it was friendly warm and humane. The Angel investor remembered himself being in the Entrepreneur’s shoes, and was not afraid to say things that were perhaps not very politically correct. When you’re doing a one-on-one, that works fine, but when you’re in a group, you will most likely remain politically correct, and refrain from giving the kind of advice you’d give in a one-on-one session.

So when I read that article about how that group of “Angel Investors” operates, it sounded to me more like a group of Bankers or VC’s, than a group of Angels. I was quite annoyed to say the least. While I have no problem presenting my company to a crowd, when it comes to an investment meeting, I do not believe elevator speeches or 15 minute presentations are the right tool to present to Angel investors (or in fact to any investor).

How it’s actually supposed to work

I believe in two people meeting and taking a deep dive into the core of the startup being presented. One is the Entrepreneur, who may be seeing his own startup for the first time being reflected from the perspective of the Angel investor (an eye opening experience, to some!), and the second is the Angel investor, who has the challenge and responsibility of getting into the Entrepreneur’s mind.

I do not believe in a murder of crows (bunch of VC’s sitting in a room, with a lone entrepreneur presenting to them). This is not “American Idol”. It is criminally presumptuous to think that you can judge a startup from one short presentation. It’s also sad to think that a startup might get filtered out because the entrepreneur fumbled some of the answers. Not everybody was born a Steve Jobs, and even Steve Jobs was not born Steve Jobs. He was shaped and hardened by his life and experiences, over a very long period of time. An entrepreneur is not there to entertain with a magical presentation that came out of a unicorn ass hopping happily on a rainbow.

Any veteran partner of any business will tell you – A partnership is like marriage. And like in most good marriages, you will find people who nurture each other, allow each other to grow, allow each other to make mistakes and learn from those mistakes, not judge each other so harshly all the time, etc.

So yes – I believe in one on one sessions, where even if the entrepreneur is rejected by the angel investor, at least he came out of it with tons of personal advice; he came out of it smarter. Maybe the angel investor also learned something. Maybe he learned something he would never have learned, about that person standing in front of him, if he were in a room full of other angel investors. Something that might have changed his mind, and made him into a fan and a believer, rather than a minute-judge.

Angels can’t possible know everything, right? After all, while many of them succeeded because of personal sacrifices and some very hard work, some of it was also pure luck, being in the right place in the right time, and knowing the right people – How many people know the right people? Despite the world being small, not too many.

So be humble, be humane, be respecting of yourself and others, regardless of how many silly ideas were/are presented to you. You are dealing with people, and while money is important, so is the journey. Do you feel a bit “burnt”? Do the right thing and take a short (or long) vacation from investing, just whatever you do, don’t vent your accumulated frustrations on entrepreneurs.

So am I doomed as an entrepreneur?

No. I believe the good old Angel Investors still exist, and are out there somewhere. You just need to steer clear from the rotten ones. When you consider meeting with an angel investor, check the following list:

  • Was it easy to get a meeting with the angel investor? or did they do you a favor and gave you a meeting some 30 ~ 50 days from today? Bonus points if you managed to talk to the Angel Investor directly, and did not have to go through bureaucracy or secretaries.
  • Are they investing on their own, or in “packs of wolves”? I recommend you avoid “panels” with 3 or more investors. If an Angel investor is incapable of deciding on his own whether or not he likes your idea, you don’t want him or his money.
  • Are you expected to prepare a detailed business plan? show traction? That’s not angel investment, that’s venture capital. Stay away from those clowns looking to make money on your exit, and find a real Angel Investor.
  • Is the investor constantly late, difficult to reach, canceling/postponing meetings, and is generally flaky? You should ask yourself if you really want to do business with a disorganized entity. Especially as you take your first steps setting up your venture, you can not afford wasting time on cancelled meetings and flakiness.
  • Are they behaving like assholes, trying to lump sum your ideas into a narrow category, and completely missing the point? Telling you there is already a company like yours out there? (Google was not the first search engine, Yahoo was not the first news portal, and Skype was not the first VoIP app!). Are they just plain being rude? Get out of there and don’t come back. And warn your friends.
  • Is the Angel Investor knowledgable? Are they asking you smart questions? Do they understand your answers, or are they foggy at best? The best investors, are investors who understand your venture on a deep level. They may even become your fans and followers, if your idea really touched them. That’s the kind of Angel Investor you want, and should strive to find.