Chapter 2
Understanding the Importance of a Business Plan
IN THIS CHAPTER
Drilling down on your business idea
Planning for the past, present, and future
Understanding the difference between strategy and tactics
Identifying your audience
Discovering the basics about potential investors
A famous shoe company once proclaimed, “Just do it!” That sounds like good advice, so why waste time overthinking about what it is you need to do to accomplish your objectives? Just start moving and git ’er done, right?
No. Not good advice. Definitely not. Why? We will be the first to admit that planning is not a predictive science; indeed, far from it. But when you really drill down, you begin to realize that the point of planning (business or otherwise) is not to predict the future. The point is to better inform yourself and your associates about your goals and the levers that you can pull to move up and impediments that can thwart achievement. That is, planning is about the willful pursuit of knowledge, about thoughtful and rational consideration of all the elements involved in your defined quest, and how you can best navigate the surest path forward.
But aren’t there “unknowns” out there (even unknown unknowns) that can’t possibly be unearthed through any systematic approach to planning? Time, after all, is fleeting, especially in today’s hyper-charged global business environment — you linger, you lose; the race goes to the swiftest; and all that. And if so, then ditto — why not just put your head down and plow forward (and indeed save the money you just spent for this book)?
The answer, of course, is that yes, there are unknowns, greater today than perhaps ever before, and yes, it is often better to be first. But to reiterate, planning is about process as much as (if not more than) outcomes. This business-planning process, when done systematically and conscientiously as we describe it in the pages that follow, will greatly improve your chances of success by forcing you to consider, in sometimes excruciating detail, just what it is you’re up against — and how to leverage the advantages and circumvent the pitfalls that emerge.
A “good idea” is not a passport to success — lots of people have good ideas every day. In fact, the business terrain out there is littered with the desiccated remains of what once sounded like a “good idea” but never got beyond that point (anyone recall Pets.com?). Meanwhile, a good idea hitched to a sound plan for moving ahead is something that both experience and history have shown to be a highly positive factor — take a look at Amazon.com for just one example. Your purchase of this book is not an expense. Rather, it is an investment — and one that will yield dividends to those who take the process seriously. We don’t, and can’t, guarantee success with our suggestions for how to plan your business venture, but we do believe that the odds will improve substantially by following the guidelines we offer. So, OK, just do it — but first do your homework (and also eat your spinach); you won’t regret it. And as for that need for speed, just ask the second mouse at the cheese trap what it thinks of being first… .
In this chapter, we look at why having a plan is so important and how you can use your business plan in different ways. We talk about your business plan as a guide to your company’s future and a record of where you’ve been and how you’ve done. We help you take the first steps in describing what you actually plan to do and how you plan to do it. Finally, we look a little closer at two important groups: investors who may want to own a piece of your business and lenders who provide funds to help you grow.
Bringing Your Ideas into Focus
The concept of a plan originated with the early builders of, well, buildings, not businesses. If you’ve had a house built or have remodeled one recently, you know that this kind of plan is still around (and is expensive). Over the centuries, however, the meaning of the word plan has expanded to include time as well as space. A plan in the modern sense also refers to a view of the future, as seen from the present. You make plans for a business trip next month or a holiday next summer (holiday, you ask; what’s that? Is it an Italian word?).
A business plan is a particular view of your company both today and into the future, planning for the following things:
- What your industry will look like
- What markets you want to compete in
- What competition you’ll be up against
- What products and services you want to offer
- What value you can provide customers
- What long-term advantages you think you’ll have
- How big and profitable your company can become
To create this detailed view of the future, you have to make a whole bunch of predictions about what’s going to happen down the road. If your company manufactures crystal balls, of course, you’re in luck. If not, you have to find other ways to make some basic business assumptions about the future.
In the end, your business plan is only as good as all the assumptions you put into it. To make sure that your assumptions make sense, much of your planning should involve trying to understand your surroundings today — what goes on right now in your industry and marketplace. By making these assumptions, you can better predict the future of your business. Will your predictions actually come true? Only time can tell. Fortunately, the planning process better prepares you for what lies ahead.
Looking forward
A business plan provides a view of the future. Whether your company is large or small, whether you’re just starting a business or you’re a part of a seasoned company, you still need some sort of planning process to point you in the right direction and guide you along the way:
- A brand-new company makes a business plan to get its bearings and often uses the plan to get funding.
- An up-and-running company uses a plan to prepare for the inevitable changes in the marketplace.
- A large company needs a plan so everybody sees the same view ahead.
- A small company constructs a plan to make sure it has the necessary resources to survive year-in and year-out.
In fact, a small company needs a business plan most of all; unfortunately, small businesses are often the last to prepare a formal business plan. If you own or manage a small business, you already know that you’re the jack-or-jill-of-all-trades. You hardly have enough time to get your daily business chores done, much less plan for next week, next month, or next year. But because you run a small business, you simply can’t afford not to plan.
When a giant corporation stumbles, it usually has the financial reserves to break the fall and get back on its feet. General Motors, for example, filed for bankruptcy not that long ago, but it’s still churning out millions of cars a year. If your resources are limited, however, a single mistake — such as exaggerating the demand for your product or underestimating how long you have to wait to get paid — can spell the end of everything you’ve invested in and worked so hard to achieve. A business plan points out many dangers, alerting you to the hazards and obstacles that lie ahead, so that you can plan to avoid such pitfalls.
Three-quarters of all new businesses fail within two or three years. And untold numbers never even make it off the ground. Smart business planning up front can reduce these dismal casualty rates.
Looking back
A business plan paints a picture of where your company has been and how it has changed over the years. By reviewing your past performance or the track records of your newly discovered competitors, you can use your plan to figure out what worked and what didn’t. In effect, your business plan offers you an opportunity to keep score, allowing you to set goals for your company and then keep track of your achievements. For example:
- Your plan creates a view of the future. In years to come, you can use old copies of your plan to look back and determine just how well you predicted the future.
- Your plan maps out a direction in which to go and the route to take. You can use it to gauge how skillfully you accomplish what you set out to do.
- Your plan forecasts where you want to be. You can use it to check out how close you come to your targets for the industry, your market, and your finances.
Your history, as described in your business plan, teaches you important lessons about the business you’re in — so you aren’t doomed to make the same mistakes over and over. If you can’t remember exactly where your company has been, you probably can’t see where you’re headed.
Looking around
You can use your business plan to tell the world (or at least anyone out there who displays an interest) meaningful information about your company. No matter who you deal with or why, your plan has a ready-made description to back up the claims you make. Your plan comes in handy when you deal with the following constituencies:
- People you want to recruit to join your organization as staff associates
- Suppliers you want to work with on a regular basis
- Distributors interested in carrying your product or service
- Customers you want to establish long-term relationships with
- The board of directors or other advisers who want to offer their support
- Outside consultants you hire to help out with specific issues
- Bankers who decide to lend you money or shut you out
- Investors who show interest in taking a stake in your company
- The general public in your community who might have an interest in your activities
All these constituents have their own special reasons for wanting more information about you. Each group is probably interested in a different part of your plan. A well-written business plan satisfies all these groups and makes your company stronger in the process.
Taking the first step
With so many people to keep in mind and issues to think about, you may be feeling a little overwhelmed. Well, we’re not going to sugarcoat this: Business planning does take time and effort. But if you’re excited about the business you’re putting together, the process can be a lot of fun. In fact, maintaining your sense of excitement and enthusiasm and making sure you reflect it in your business plan is important.
Now’s the time for you to capture that can-do enthusiasm and take the first step: Get your big ideas captured either in a Word doc or on paper. Don’t worry about writing beautiful prose. Get right to the point. Devoting no more than a sentence to each of these items, explain
- What you want to do
- How you plan to do it
- Who your customers will be
- Why they should come to you and not the competition
- The number one reason you’re convinced that this business will succeed
After you finish, be sure to drop the doc into several different files so you don’t accidentally delete it. For more information on describing your business in 50 words or less, check out Chapter 4.
Understanding the Planning behind the Plan
Some companies think that planning is a total waste of time. They would never think of using the term in the context of their own organizations. These companies still move forward; they just don’t talk much about it ahead of time. So why does planning have such a bad reputation in certain quarters? One reason is that far too many organizations simply go through the motions rather than taking the exercise seriously: Someone high up read somewhere that having a plan looks good to an external audience, so the firm commissions one and then promptly forgets about it. More than likely, the companies that don’t plan don’t understand what it really means to plan. Planning has become such a buzzword in today’s business world that its real meaning has been lost.
Is planning an art or science?
Planning is both an art and a science. Putting together a serious business plan requires you to gather data, analyze the information, and then turn it into knowledge about your situation. A serious business plan requires that you think strategically. What do we mean by that? The word strategy comes to us from the ancient Greeks and translates literally as the art of generalship. So it shouldn’t be surprising that when you start thinking strategically about your business, you feel that you’re suiting up for battle and jousting with your competitors for the hearts and minds of customers (to say nothing of their wallets and purses).
Modern definitions of the word strategy have become a bit fuzzy. But what matters isn’t so much how the term is defined, but what it does. When you think strategically about business plans, you do the following:
- You clearly describe how to reach the goals and objectives that you set for your company (see Chapter 4 for more info).
- You take into account the social values that surround your company and drive your staff, you included (see Chapter 3).
- You think about how to allocate and deploy your human and financial resources (see Chapters 12 and 16).
- You create an advantage in the marketplace that you can sustain, despite intense and determined competition (see Chapters 10 and 14).
Don’t misunderstand us here: Planning is not always rational science, and business success sometimes can be an inspired outcome of “art.” Some people are intuitive by nature and “go by their gut” more than engaging in a lengthy planning process such as we encourage in these pages. The late Steve Jobs of Apple, Inc., was supposedly one of these creatures. Good for him and them. But let’s be honest: People like Steve Jobs don’t come along often, and the probability that you are one of them is negligible at best. In fact, now that we think about it, Mr. Jobs — one of the most remarkable and admirable business leaders of modern history — could have saved himself a decade of time and boatloads of money if he had devoted a bit more effort to understanding the threat of competition for his original Apple I and II machines. So when that Blinding Flash of Brilliance strikes, grab it and thank your lucky stars. But please don’t run with it until you’ve finished our book. You and all your involved associates will be thankful not too far down the road.
Make sure you don’t forget the strategy behind your business planning. Without strategic thinking, business plans often turn into those neatly bound fantasies that begin and end with numbers — revenue projections, cash flows, expense allocations, and the like — that alone don’t help you figure out what to do. This is what we call the “SPOTS Syndrome”: Strategic Plans On Top Shelves, where the document ends up gathering dust and little more. Trust us, we’ve seen this. They don’t represent planning; they represent a waste of time.
What can you do to make sure your business plan includes a strategy? When it comes to strategic thinking, a healthy dose of plain old common sense and logic works wonders as you pull all the pieces of your plan together. Experience in your industry and some smarts are advantages, too. Unfortunately, we can’t give you any of these gifts. But we can offer you some solid advice to keep you on track. Go to Chapter 14 for more on strategy.
Why planning matters
Planning doesn’t guarantee success, but it does go a long way toward bettering your chances. We’ve seen it with our own eyes. And a recent survey of close to 1,000 small businesses backs up the claim. The survey found that companies that have business plans enjoy 50 percent more revenue and profit growth than companies that fail to plan. It’s that simple.
Planning works best when your company integrates strategic thinking into every aspect of your business, every day of the week, and every week of the year. An ongoing process means that you do the following things:
- Always question what makes your company successful — it’s more than mere luck.
- Observe customers and markets, tracking their wants and needs.
- Relentlessly examine the competition and what progress it makes.
- Steadily work at maintaining your competitive edge.
- Optimize the organization to rapidly transform if and when change occurs.
- Continue to search for ways to take better advantage of what you do best.
Some managers may follow all these tips automatically and intuitively. But if you want to make sure that strategic thinking extends into all parts of your company, you have to create a framework to ensure that it happens. When you make planning a basic responsibility for the whole enterprise, you get the added benefit of including all levels of employees in the process. Employees — especially those closest to the customer — often have different and equally valuable viewpoints about shaping strategy. Having a planning framework ensures that you hear their voices.
Satisfying Your Audience
Whether you write your business plan on your own or do it by committee, always keep in mind who reads the written document. A business plan is meant to communicate your vision and strategy — what you plan to do and how you intend to do it. The best way to convey your message is to consider your audience. You don’t speak French to someone who only speaks Italian, right? (Well, maybe the French do.) For the same reason, you don’t want to fill your business plan with all kinds of techno-jargon if your audience is made up of people who don’t know the first thing about the cool new technology you work with.
What if your whole business idea is based on something brand-new? Don’t you need to describe it in detail? Sure you do. But you can address different audiences within the same document. For example, your plan may include an overview of the new technology that anyone who reads it can understand, and if necessary the techno-speak can go into an appendix. Before you can really think about how to address different audiences, however, you have to know your readers.
For the sake of simplicity, we lump them all together and call them your stakeholders — as in everyone who has a possible stake in what your company does or how it operates. Some of these people may have direct stakes: They rely on you for their income, for example, or they own a piece of your business. Others may have less tangible interests: government watchdogs who occasionally survey you to ensure that you’re complying with legal standards or civic organizations who want to make sure that you remain a good corporate citizen.
Whatever the interest group, your business plan is one of the most important tools you have to communicate with them. But there is a catch: Each of these groups is likely to look at your plan in a different light. So take a closer look at two very important types of stakeholders: investors and lenders.
Venture capital
If you need money to fund your business and you want to minimize your financial risk, one place to turn to is the venture capital (VC) marketplace. Venture capital firms are in the business of raising money and then putting it in the hands of businesses that make their money grow. They usually invest capital in new ventures, hence their name. So for start-up companies, venture capitalists can be a very important (and discerning) audience when it comes to the business plan. You can bet that they will read your plan very carefully before handing over any cash.
Sounds simple, right? Well, lining up venture capital funding isn’t easy. Would-be entrepreneurs have been led to think that a great idea and plenty of enthusiasm are enough to shake the money tree. You need both, of course, but now you’re only at the beginning. According to a recent survey, venture capitalists fund less than 1 out of every 500 business pitches (proposals) they hear.
What do you need to succeed in the venture capital sweepstakes? First, it helps to know about the nature of VCs. Venture capitalists come in all sizes, from small, independent operators to large national or even global VC firms that evaluate thousands of new business proposals every year. Some VCs specialize in certain industries — biotechnology or e-commerce services, for example. Others tend to stay close to home, funding companies in their own geographic area so that they can keep close tabs on their investments. Some VC firms prefer to invest in companies working in the early stages of development. Others look for companies that need a final push into the big leagues.
Now comes the $64,000 question — or if you’re lucky, make that $64 million: What’s the best way to get your business idea and plan in front of real, live investors? We wish we could give you a sure-fire, one-size-fits-all answer. There isn’t one. Still, entrepreneurs who’ve been successful before can provide you with valuable knowledge. The following sections provide a few tips that should help you distinguish yourself.
Making connections
As almost all successful entrepreneurs can tell you, it’s not just what you have, it’s who you know. The more networking you do — those people who can say nice things about you, your business idea, and your plan — the better your odds of actually getting onto some venture capitalist’s radar screen.
Doing your homework
Venture capitalists have been to the rodeo before, many times in fact. And although they love to see excitement and enthusiasm in the entrepreneurs they talk to, they absolutely need to know that you’ve also done all your homework — everything from scoping out the competition and sizing up the market to crunching the numbers and identifying the strengths, weaknesses, and uncertainties inherent in your business model (see the earlier section “Bringing Your Ideas into Focus” for tips on finding this info). You need to be enthusiastic, definitely; who goes into business without a strong dose of optimism? In short, your investors assume the happy talk … but they want an ironclad business plan.
Perfecting your pitch
What do successful entrepreneurs have in common with hotshot Hollywood show runners and baseball Cy Young award winners? They know how to throw a good pitch. And knowing how to pitch your idea is absolutely critical in all of these fast-moving worlds. Like movie producers, venture capitalists have crowded schedules and short attention spans. You have to wow them quickly and keep them listening. For more help, turn to Chapter 4.
Bankers, backers, and bootstrappers
Before you jump on the venture-capital bandwagon, here’s something else to remember: VCs are definitely not philanthropists. They take a big chunk of your company in return for the cold cash they provide. And they often demand a role in directing or even running your business, taking seats on your board of directors, or even naming the CEO. You’d probably do the same if it was your money.
On the other hand, you can fund your start-up the old-fashioned way — from pay-as-you go bootstrapping, family and friends, or via a formal business loan. There are even crowdfunding sites that can provide you a platform to source online equity financing. One key advantage of this route is that you get to keep all the voting equity (legal ownership) in the company. And you get to run your business any way you please — you’re the top dog and no questions asked.
Stop for a moment here to consider just what kind of new business you’re contemplating. If it’s a software-based venture — such as an online dating service, a YouTube.com video sharing site, or an educational tutoring site — you might not need much to get started other than a computer connection, your own ability to code, and the time to do so. If this is the case, perhaps clearing out some space in your room and draining your pitiful little so-called savings account is all that’s needed, since “sweat equity” is your major contribution as you bootstrap your way to riches. But on the other hand, if your new venture requires raw materials, dedicated manufacturing space, machinery, and trained personnel, it’s going to cost you up front before a penny of revenue comes in. Is that little piggy bank account up for this level of drainage? If you do have large start-up costs, another option is to take the route that many businesses follow and pay your way forward with either donations from close relatives or a more formalized business loan.
Family and friends
Hitting up the family or friends can be one way to start that many have used. One recent survey found that nearly 40 percent of small business owners turned to family for funding needs. Fred Smith, for example, the founder of the enormously successful FedEx overnight delivery service, started the firm in 1971 with the help of a whopping $4 million from his family. Obviously, however, this isn’t something that everyone can do — in a world of growing income and wealth disparity, a lot of worthy would-be-entrepreneurs are getting left out, and that’s neither fair nor good for the economy. But if you think there is some spare cash sloshing around out there in your network, give it a try. If your idea for wealth creation is as good as you believe, then why not circulate it among loved ones first? (But on the other hand, don’t forget that money obligations are something that can separate friends faster than a sneeze in a packed elevator.)
Credit cards and crowdfunding
Another tactic that some start-up founders pursue is to max out their credit cards. The co-founder of SellMax, a nationwide used-car buying service started in San Diego, California, used his business card to pay for critical media advertising as no other funds were available; this was a lifesaver, and the firm is thriving today some 25 years after launch. Additionally, the fraud protection benefit offered by many credit card suppliers gives a safeguard to business newbies who might otherwise fall prey to the many scammers out there offering (false) help. And don’t forget those points that accumulate when you use a credit card for purchases; they can be converted into payment for travel expenses such as airfare, hotel stays, and meals needed to get the business up and running when cash is short.
But keep in mind that credit card financing terms are typically some of the most onerous on the planet, short of funds from organized criminal syndicates — and even some of the latter look good by comparison! If you need to leverage your wallet plastic in order to fund your start-up, it should be a desperate last resort when you are absolutely and unequivocally convinced of the soundness of your plan; you have exhausted all other means of funding; and you — and your dependents — can take the financial hit if your great new business idea dies in the cradle. So be forewarned, and not excessively foolish.
How you get funded today through more formal means has become interesting, to say the least. Like so many other sectors of the economy, deregulation and modern technology have transformed the banking business into a kind of Wild West with the emergence of cryptocurrencies and their disruptive variants (many originating from new venture firms that could benefit from reading this book). In the past your friendly local banker was the go-to source — and you had to go through many ritual genuflections to come away happy. But, for good or bad, not today: Available funds can be no more than a computer click away and available in a flash through a so-called “De-Fi” lender (decentralized finance). If you have even minimal assets — and sometimes even if your only advantage is that you’re breathing — there’s likely some place out there that will consider or grant funds if your idea is solid and your business plan coherent.
These new kids on the block are increasingly online in nature, from subsidiaries of established lenders such as big banks to go-fund-me and crowdsourcing sites that have sprung up like lilies after a hard rain. It’s likely worth your time to investigate some of that terrain if you think your chances with a more traditional lender look shaky. You might want to create a fundraising page on the web (one current how-to-do-this site: www.spotfund.com). Conversely, just Google “crowdsourcing” on your laptop, and you’ll instantly find numerous hits. Here are a few you might consult (chosen randomly with no endorsement implied or intended):
Traditional banks
If you do choose a traditional bank loan route (from so-called “Ce-Fi” or centralized finance firms), most of them are more than willing to lend money to local businesses, provided that they can present convincing business plans. The simplest arrangement: a standard commercial loan. In this case, the bank loans you the money, and you pay it back, usually in monthly installments and with interest. But you can find all sorts of variations on this theme, from real estate loans on commercial property to loans secured by your inventory or accounts receivable and even to your personal assets such as a home (see Chapter 11 for more info). If business assets secure the loan, you usually pay a lower interest rate.
If you don’t intend to use all the money at one time, consider applying for a commercial line of credit. A credit line allows you to draw on the funds when you happen to need the cash. Given a firm’s circumstances, banks don’t usually require collateral to secure small lines of credit. Larger lines (some banks loan up to $10 million or more) are typically secured against accounts receivable, inventory, machinery and equipment, or real estate.
A quick note for our global fans: Many other nations have comparable lending programs for small business owners or entrepreneurs in their own countries, especially in emerging markets. Quite a few of them have developed impressive micro-lending facilities designed specifically for small, even tiny, businesses. See, for but one example, a program offered by FNB Bank, a leading financial institution in South Africa: www.fnb.co.za (and then click on “For My Business” on the top line menu bar). For a more comprehensive list of such opportunities, see www.kiva.org; this is a Silicon Valley–based nonprofit organization that connects worthy small-business entrepreneurs with lending resources both domestically and internationally.
Regardless of the source, by securing an external loan to fund your company, you get to use one of the greatest things ever invented: OPM — that is, Other People’s Money! Using this channel to build up your business means you get to keep all the growth and profits for yourself — at least in theory. But it doesn’t mean that borrowing money is without risk. Somebody has to pay back the loan, after all, and that somebody is you and/or your business entity. To minimize your risk, make sure that the business idea is fundamentally sound and that you have a solid business plan in place. Rest assured, your lenders will also do the same. And those papers you need to sign? They are legal documents that can impose significant penalties for noncompliance with terms. Be sure to read the small print before giving your John Henry, or your next job might be making license plates.
And it’s always worth asking one further question: If you put up your own funds to get the business going, can you afford to take the loss if it fails? See our comments about credit-card borrowing in the previous section. We don’t want to be the ones who yank out the punch bowl just as the party’s getting started, but we also don’t want you to have to run for cover whenever you encounter that former family member or friend who you haven’t been able to re-pay (or worse, end up in some modern version of debtors’ prison).