It’s an old saying that “no one plans to fail, they just fail to plan.” For most new entrepreneurs, the business plan is the hardest part to develop. The reason why is that there are so many unknowns, contingencies, pie-eyed optimism, and an utter lack of a track record.
Big corporations have it easy when planning because they have last year’s numbers to work from. Whether it is last year’s budget or the sales numbers, they have a foundation. But a new business has nothing upon which to build their projections. Frequently they are just taking a wild guess at what they think they their costs will be, and how many clients they will have.
The problem with this is that a person who is coming out of a corporate culture and beginning their own company still has the mindset of an employee. They are used to having support staff and they don’t realize how much they actually relied on others.
Depending on the type of business contemplated, the plan can be very basic or extremely intricate. It’s a large document that incorporates an executive summary of what the product/service is, the marketing differential of the company and pro forma financials. That last one is a fancy way of describing profit and losses, cash flow, balance sheet, proceeds and use from any capital raise (this means where you get money from investors) product costs, and usually a marketing plan also is included.
Invariably the first round of projections is wildly optimistic and has skipped major expenses that will effect the cash flow, profitability and ultimately the success of the company. Usually a new entrepreneur under estimates the costs of running a company and over estimates the amount of revenue to be received. This is completely understandable because no one wants to start a new venture with a negative outlook. However, there is a world of difference between negative and realistic. I review business plans regularly. Some of the smartest people in business have sent me plans that are fatally flawed.
I just reviewed a five-year projection for a wanna-be publisher. The marketing niche is underserved, the concept is excellent and the resumes of the management team are impressive but not comprehensive. There are glaring holes in the management and this will prevent a savvy investor from entrusting them with money. The projections show that the company will be doing $1.5 million in revenues in its first 12 months and have a net profit of $600,00, all for the low, low, capital investment of $300,000. If only it were this easy to turn a profit. The projections do not include advertising expenses, marketing expenses and a whole host of other items. They are top heavy on management salaries and stupidly naïve on offices expenses. For example, they budgeted only $1,000 a month for telephones. Lastly, they did not include a basic breakdown of the way the revenues were to be generated from all the different revenue streams.
Why does this matter? Well, the business plan is essentially a roadmap that details how a company is going to operate. It’s a budget that allows a business owner to know when they are over spending, or under charging. It also is a key document when you are trying to raise capital. A glaring error like under estimating telephone costs screams that the entrepreneur is either out of touch with business or overly optimistic.
Banks don’t like to lend money to someone unless it can be demonstrated that the money will be paid back. One of the ways that this is done is the business plan.
One of the purposes of the business plan also is to spark interest in investors — particularly when a new entrepreneur has gone through all the friends and family who are willing to lend a few thousand for start up. The business plan is like the company calling card to angel investors and venture capitalists.
Without a properly written and well drafted set of financial projections, a new entrepreneur cannot get beyond the e-mail address of most investors. The reason for this is an investor in a business sees the relationship as one of long-term permanence. When you sell a piece of your company, no matter how small, you have that investor for life.
The bottom line is that when building a business, proper planning for success can reap large rewards and is time well spent. If you are starting a new company you need to meet with someone who is experienced in drafting and reviewing business plans. It’s time and money well spent, because an experienced consultant can tell you after an hour or two if your idea will fly or not. This is a lot cheaper than starting a business and then not being able to maintain it. (David Pisarra is a partner in the Santa Monica law firm of Pisarra & Grist. He (310) 664-9969 or by e-mail at).
Originally published in the Santa Monica Daily Press print edition on March 9, 2004. Read the original PDF.