• Even if your startup idea has no direct competitors, you probably have some indirect competition.  That is, some other kind of product or service is competing for the same dollars.  For example, even though no one else sells chicken wings in a particular neighborhood, someone may indirectly compete with hamburger and other fast food.

• On the slim chance that you actually have no indirect competition, be mindful that buyers always have the choice of doing nothing.

• Note that investors prefer startups that leapfrog competitors in an established market, and so claiming “no competition” may suggest to them that that no demand exists for the product or service.

• Startups that take on larger sized competitors and succeed may find themselves an acquisition target of that competitor.  That could be an attractive exit strategy.

Now some clever people might reply that government agencies and monopolies have no competition.  Well, perhaps that is so in some instances, but rather few.  FedEx and UPS have shown the Post Office that they can compete quite well with a government agency.  There are few real monopolies any more, and those such as utility companies find themselves heavily regulated.  The point is that competition is not a bad thing at all.  In fact, it is an essential component of the capitalist system.

Competitors keep one another on their toes; forcing producers and suppliers to focus attention on consumer needs.  Every competitive analysis asks why the target market segment buys from company A or company B.  That answer to that question underlies every business success.  Competitors verify the existence of demand, help scope that demand and illustrate ways to satisfy it.  The question is not whether you have any competitors; it is whether you have learned what they can teach you about winning customers.

Nearly every professional manager knows that planning is crucial to business success.  Still, few people actually act on that knowledge.  In over 15 years of helping businesses plan their growth, it has become increasingly clear that only a small percentage of managers draft formal plans in order to create a disciplined strategic road map for success.  Instead, the motive that drives the production of most business plans is the need to raise capital, either bank loans or equity funding.  Everyone has heard some version of the old adage that “Failure to plan is a plan for failure” but few realize the actual consequences of deciding to “get by” without a carefully thought through, written business plan. The statistical evidence of that folly is overwhelming.

The Top Ten Reasons That Businesses Fail

No, this is not one of those David Lederman jokes; unfortunately it is deadly serious.  The business statistics surrounding business failure are widely published.  A Dunn and Bradstreet research report cites managerial incompetence as the cause of 96% of American business failures.  Many Internet sources have their own “Top 10″ reasons for business failure in the U.S. and although they differ somewhat in detail, the vast majority of relate directly to inadequate planning.[1] Here is the Small Business Administration’s rather typical Top 10 list:

1.  78% lack a rigorously-developed business plan keyed to the realities of their market, including sufficient research on the business before launching it.

2.  73% fail because the owner is wildly optimistic about projected sales, break-even point, and capital required.

3.  70% fail because the optimistic owner believes he/she can wing it on important issues with which he/she is ignorant, and ” can’t afford ” to hire the expertise to get it done right the first time.

4.  63% of new business owners simply don’t have the required business experience to make a success of the enterprise.

5.  82% lack cash-flow management skills. They don’t understand the importance of controlling cash flow.

6.  79% launch with a bright idea and little or no capital.

7.  77% don’t have a rationally-developed pricing model for their products or services.

8.  64% don’t have a clue as to how to aggressively promote their business, nor do they understand its importance.

9.  55% don’t understand their competition, or assume it can be safely ignored.

10.  47% rely too much on one customer/client.

Clearly, a rigorous project to write a comprehensive business would reveal most if not all of these top 10 problems in advance.  Especially if the project involved actively seeking criticism of the plan from experienced business people, investors, managers, academics and mentoring organizations such as SCORE and the Small Business Administration.

Don’t Bother Me with Facts

Few operating businesses write plans despite all the accumulated evidence that a written business plan – built on sound market and competitive research and including operational and financial plans – is crucial to business success.  Temple Porter once remarked to me that people only take business planning seriously when business pain forces them to do so.  Foresight simply does not motivate the vast majority of managers.

Mostly at the early stages of business development when businesses need capital and MUST write a business plan to attract investment, or when they require additional financing in later stages, will they grudgingly write one.  Generally, even in those situations entrepreneurs and managers sell their businesses short by producing a document designed more to “sell” outside investors on their idea than to actually plan for their own future success.  They seem to forget that the founders and owners are the people most invested in the business.  Outside investors stand to lose only some discretionary capital: Owners and founders risk years of work, dreams, foregone opportunities, the cost of loans they personally guaranteed, perhaps their business credibility and certainly their jobs.

Every management team can recite a laundry list of plausible sounding reasons not to write a business plan for use a road map for growth.  “Time, resources and money” they will explain, “are better spent on running the business.”  Another familiar favorite is “We have a business plan but it’s not written down.” Yet no one can keep all the details of a real business plan in their head all at once.  So yes, even though 78% of businesses fail due to a “lack a rigorously-developed business plan keyed to the realities of their market” they all have plenty of reasons.  Only the other 22% have decent odds of survival, to say nothing of achieving prosperity.

Business Planning Best Practices

Every business needs to review its business plan annually.  That does not mean that they must right a new one every year, of course; in most cases that would overstate the need.  If a business has a written plan less than three years old, the executive team should review and discuss each strategy in light of the changing market place, available resources and external trends such as those in technology, regulation or demographics.  Management must place special emphasis on updating their competitive analysis and marketing strategies at least every year.  Still, operational plans and financial strategies warrant annual re-evaluation too.  Rather than write a full new plan, management can write an update and add it to the plan.  Update should include new factual findings, the reasons for making changes and specific new strategies and tactics.  When reviewed and approved by appropriate stakeholders, managers should communicate the plan, its central strategies and especially reasons for changes to the company’s employees.  When everyone knows and understands the overall plan, it is much easier to make individual day to day decisions and obtain “buy-in” and the sense of teamwork and shared mission that goes with it.

If your company or start-up venture does not have a business plan, write one immediately.  Spend the time to do it right and completely, with a full analysis of your business model, product or service, target market, value proposition, industry, competitors and financial plan.  If you decide to fly blind instead, in all likelihood you will eventually crash.  Look really hard at those statistics above.

Some years before, a woman had presented an idea for hand-embroidered sneakers as “tapping into the multi-billion dollar shoe market.”  When I questioned whether that figure was genuinely relevant, she noted that athletic shoes accounted for more that a quarter of the total market.  The sample pair that she had with her that day were red with floral embroidery.  In that meeting, we discussed whether investors might be more interested in the market for hand decorated red sneakers than for shoes generally. I came to call her hyped-up market size reference the “Red Sneakers” problem.  I wish that these were the only too examples that I knew about, but unfortunately, the Red Sneakers problem shows up in far too many business plans.

Red Sneakers market descriptions wave a red flag. It suggests that you are given to gross exaggeration, that you simply did not bother to do the necessary research and analysis to determine the size of the relevant market segment and/or that you do not know how to estimate the appropriate niche for your product.  Each of these reflects poorly on the plan and the writer.  The only market size estimate that makes any sense is one determined by the “100% of sales” rule.  How many dollars in revenue would the company produce if it made 100% of the sales in its market segment or niche?  Calculating that figure, even if it relies on a few (explicit) assumptions constitutes some evidence of sound business analysis; offering up overall industry figures is vacuous hype.

Of course, plans that then estimate their share of a Red Sneakers market are guilty of the further offense of “Chinese math.”

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• Taking substantial time away from other responsibilities to concentrate on growth, competitiveness, planning and writing
• Ability to “scope” correctly so that the plan contains neither too much or too little information
• Substantial and relevant research into markets, customers, competitors and industry dynamics
• Credible strategic thinking that sets the direction of major business activities
• Integrating strategies so that all the plan sections fit together logically
• Writing plan sections in clear, concise, grammatically correct language that is lively to read
• Writing with enthusiastiam without over-selling the product, market and business opportunity
• Anticipating challenges to your basic premises about the product, market and opportunity
• Levels of detail and process that typically lie outside an entrepreneur’s comfort zone
• Identifying all the crucial (and tough) strategic choices and making them wisely
• Systematically seeking criticism from skeptics to refine the plan and address perceived weakness
• Reevaluating strategies that others see as weak and deciding whether to change them or not
• Summarizing the most important aspects of the plan in a two-page-or-less executive summary

Difficult as these challenges may be, sound leadership requires that businesses face up to them.  There are good reasons that the old maxim still survives that says ”Failure to plan is a plan for failure.”  According to a U.S. Bank study, 78% of businesses fail because that do not have a well-developed business plan.  At the risk of quoting another ancient truism, “Each hour spent planning is worth two hours saved during implementation.”  Planning pays off better than most management activities and is the most reliable way to improve business performance.  Business gurus continue to recite these old saws because they are true.  Make a detailed plan, write it down, have the smartest people in and outside your organization read it, edit and correct it and then follow it!

1. What’s the business model? Where does the company fit in its industry, who will its customers be, and how will it generate its various revenue streams?
2. What customer or market problem does it address? How much old pain or new pleasure does it provide? Does it solve a critical problem or satisfy a strong desire?
3. How big is the market opportunity; big enough to cover the costs of acquiring customers and providing the product or service at a profit? Is it big enough to build a company around and to interest investors?
4. What’s the value proposition? How powerful is its competitive differentiation with respect to directly and indirectly competing ideas, technologies, products or services?
5. What are the competitive barriers? How defensible is it: will it rely on patents, trade secrets, trademarks, or just being first to market?
6. How strong is the management team’s knowledge, experience and commitment?
7. How does the current operating environment influence the timing for this kind of venture? Assess any relevant economic, demographic, technological and regulatory influences.

By the time entrepreneurs go looking for venture capital funding, they have already invested a great deal. They have spent years developing and refining the business concept, researching technologies, markets, customers, products, competitors and alternative business models. Inevitably, they have invested some of their own money and maybe asked family and friends to take some risks too. Moreover, they have spent months drafting, vetting and editing a business plan that proves – right there in black and write – that this business is a winner with enormous financial upside. When they finally gets an audience with a VC, they are in no mood to hear a “no thanks.”

On the other side of the table, the VC knows exactly how the entrepreneur feels; he has been here many times. Any investor with an ounce of empathy would find it had to say no thanks to someone who has worked so hard to hear a “yes.” As if empathy were not enough, there are plenty of other reasons for VCs to avoid saying “no;” some good, some bad, some true and some false.

Now most VCs are honest, fairminded business people who behave ethically.  Still, VCs often fail to voice their sound business reasons for saying ”no thanks.” For example, if the entrepreneur has failed to make a convincing case that the target market size is attractive, that the product or service is compelling enough to sustain competitive differentiation, that the business model will work or that the management team has relevant experience, then a “no thanks” makes sense. Still, it feels bad to say “no” and VCs know that entrepreneurs don’t like it. Many presenters become defensive, some will think the VC is stupid and/or out of touch. The entrepreneur might even tell her friends and networking colleagues that this particular VC is a jerk.

If a VC does say “no thanks” and the entrepreneur reacts calmly and rationally, she is still rather unlikely to simply take one “no” as a final answer: The VC may well be in for a long discussion of the merits of the business plan, whether they want to listen or not. Yet VCs are professional investors disciplined to think ahead, to keep their options open and to avoid alienating rare resources such as smart entrepreneurs, so they often perceive that their interest lies in simply saying little or nothing; at least not saying “no” directly.

For VCs, there is always the nagging possibility that this idea might turn out to be the next Google, Genzyme or Facebook. If they say “no thanks” now, they may fear that the entrepreneur will shut them out of later investment rounds. Even if the VC is convinced that this venture is a loser, he may worry that the entrepreneur may not come back when she does have a great idea. It may be selfish to avoid saying “no” directly and not telling the candid truth about why not, but then entrepreneurs are unlikely to ever find out that the reason the VC gave them for not investing was only an excuse. 

VCs may avoid saying “no” in some quite ambiguous ways that are tough for an entrepreneur to see through. For example, they may tell the entrepreneur that the firm has too many portfolio companies that need attention just now; “Try me again in six months.” That could be true or it could be just the right “maybe” to get the entrepreneur out of the office without making them angry or inviting a debate. “I just could not sell the idea to my partners” is another hard answer to figure out. “This looks interesting, but it’s not in our space” might be true as well (but makes one wonder why the VC had you in for a presentation in the first place). A little advance homework should shed light on what kinds of deals a particular VC firm prefers and largely avoid this reason.

One egocentric, insensitive and potentially dangerous way that some VCs may avoid saying “no” is to send the entrepreneur on an impossible mission. “Get your sales up to $2 million before the next partners meeting and I’d say you have a shot” is one example. Another might be, “If you get Warren Buffet or Bill Gates to invest, we’ll come along” or “sign up a few high profile reference accounts like Boeing, Microsoft and Intel and we will reconsider.” These are extreme examples, of course, but you get the idea. By setting a high bar and/or a short timeframe, the VC can not only avoid saying “no” but also leave the entrepreneur believing that it was their own fault that they missed out on funding.  A thoughtless VC may may set a lower bar, or repeatedly send the entrepreneur off to put together just a little more information.  That behavior is sure to start a meaningless quest.

That is not to say that every suggestion that a VC might be more interested if the start-up achieved a certain milestone or had more information is either false or unreasonable. Yet sending start-ups on an endless quest leaves open the selfish possibility that if someone else funds them, the VC could still get in on the next round. Of course, if the entrepreneur does meet the challenge, the VC can always set up another impossible quest, or revert to “My partners are not crazy about it” or some other excuse. Again, most VCs strive to be fair and completely straightforward, but some do not.

So what’s the harm when VCs don’t say “no,” even when they mean “no?” Entrepreneurs are optimists by nature and they need to be. So the lack of a “no” sounds like “maybe” to them, or least an affirmation that there is nothing fundamentally wrong with their plan. Yet in fact, the mere lack of a “no” from a VC says nothing of the kind and it can create serious problems, especially for inexperienced entrepreneurs. Their idea may be a stinker, and plainly so to a professional investor: More commonly it may just be too risky to fund, or not have the potential for the $100 million to $500 million in fifth year revenues that attracts venture money. VCs reject many plans because the management team lacks relevant experience, but any one of a dozen other good reasons may apply.

So a discussion with a VC that ends in only a “not now” may actually teach an entrepreneur nothing of value, perhaps even mislead and encourage them to continue to seek funds and obfuscate that the management needs to make substantial changes in the business model, strategy and/or management. An entrepreneur may well leave the VC’s office, not only without a clue, but essentially lulled into believing that it was only his timing that was off or some other reason that seemed false but benign to the VC.

To avoid a long wasteful quest, entrepreneurs need to hold VCs to a higher standard. They must state clearly at the outset of their conversation that they welcome constructive criticism, that they want the whole truth, no matter how difficult, that they do not need coddling and won’t take a “no” personally and that they will not insist on a long debate. It may help to remind the VC that entrepreneurs hear “no” all the time. Point out that the VC’s experience and insights could really be helpful, but only if his assessment is frank and straightforward. No one wants to hear “no thanks” but the reasons underlying a decision not to invest are inherently valuable. Hearing only happy talk that avoids the actual issues can inadvertently fuel a fruitless quest that wastes the resources of entrepreneurs and investors alike.

Revenue Projections

Entrepreneurs fret most over their revenue projections and often with good reason. Many suppose that prospective investors want to see “hockey stick” sales growth that takes off sharply from near zero and then rockets into the stratosphere. Get real folks! Investors know that any spreadsheet application can convert unrealistic projections, even total fantasies, into “black and white. You need a sound forecast that projects sales that walk the line between growth that is sufficiently attractive to merit capital investment and reasonable enough to maintain credibility with investors.  Never use “Chinese math” that could ruin your credibility. Bear in mind that smart managers and investors know that growing too fast can lead to operational chaos and failure.

One sensible path to realistic sales forecasts is to base them on headcount growth. It is reasonable to assume that most well-run companies can achieve around $250,000 in gross revenue per employee. Sure, a handful of historically notable Internet ventures have hugely exceeded these norms for productivity, but modeling your growth after eBay strains credulity. If you have reliable industry data from a trade association or competitive intelligence that says otherwise, you may consider building a forecast on those figures. The point is that no matter what level of productivity you project, growth in revenue is nearly always proportional to growth in headcount. It is obvious that operating problems will result if you hire people too fast. You need to train them adequately in technical processes, policies and procedures and inculcate them with important company values. Further, you may find that certain operations do not scale well and instead start blowing fuses above a certain transaction volume. These concerns and others underlie the need to “control growth” and tailor it to the operating realities of a particular business.

Once you have arrived at a credible growth rate you can apply reasonable and familiar financial ratios to work out the other three sections of the profit and loss statement; cost of goods sold, operating expenses and net income. By following typical P&L ratios you can build credible projections and reasonable goals, adjusting them as you gather experience and learn sound reasons to vary from familiar norms.

Cost of Goods Sold

For most manufacturing operations, the cost of goods sold (COGS) runs between 25% and 40%. Products with strong intellectual property protection such as patented drugs will command premium prices and so achieve lower COGS, of course, but most manufactured products will fall within this range. Software COGS typically runs around 15%. Treating a social networking site as though it was a software company probably makes sense, at least initially. The direct costs associated with services comprise salaries, materials and expenses that may vary broadly. Window washing obviously costs a good deal less than engaging a Bain consultant for an hour’s work. So no COGS ratio applies to service businesses generally; some competitive intelligence gathering may be needed to estimate COGS.

Expenses

Some operating expenses may also vary considerably by industry though some typical ratios are useful for start-ups. Setting general and administrative (G&A) expenses at 10% and research and development (R&D) at 15% are reasonable for most businesses. Typical sales and marketing (S&M) expenses run somewhere around 25% for products and 40% for software.

To estimate salaries, allocate departmental headcount according to these categorical expense projections. These rough estimates work because overall productivity is calculated as a company-wide average. Next, look at on-line job boards for a reality check on competitive salaries for administrative assistants, sales people, managers, scientists, road warriors and other positions your company will need to fill as it grows, and don’t forget to load them for benefits, taxes and insurance. Add travel expenses equal to the salaries of road warriors and sales staff that travel nationally. Headcount also drives rent; allocate 200sq.ft/person and multiply the cost of office space in your start-up location.

Net Income

You have probably already noticed that these typical ratios don’t leave room for huge profit margins. The lesson is simple; most businesses have rather modest margins. The few exceptions with larger margins include professional services firms and product manufacturers with intellectual property that creates monopoly power.

Top Down Estimating vs. Bottom Up Calculating

There is an old business adage that says “Everything costs more and takes longer than you think.” It’s still around because it is true and it applies with special force to new ventures. Forecasting the four major income statement categories from the top down, without trying to fill in all the low-level detail avoids common projection errors. Building estimates from the bottom up is a trap for novices because it will necessarily underestimate some expenses and leave out others entirely. It must fail because only trivial costs are subject to accurate prediction while many of the most crucial expense details are simply not knowable at start-up. Office supplies, telephone expenses, rent and utilities may be predictable, but these pale in relevance compared to COGS and S&M expenses.

Using rough, typical ratios tends to work because it reflects reality. Managements control their expenses by choosing between various ways of solving problems based on actual operating priorities. For example, initial performance may convince managers to hire additional sales staff and stop going to as many trade shows. Trying to predict that level of detail before the business operates is futile and investors know it. Sure, you can and should adjust the ratios where you have a reliable basis that makes sense for a particular business model, but generally don’t waste time on hypothetical spreadsheet details that you cannot possibly get right.

Instead, start with reasonable productivity, divide up revenue according to typical ratios for the rest of the P&L sections, calculate overall and departmental headcount and fully loaded salaries. Be sure that you have a sound, ration basis for COGS and S&M estimates. Those ratios often vary and are generally the largest budgets. Some trial and error will help make your specific numbers look most reasonable in year five; after operations run routinely.

No Hockeysticks

It is not necessary or even desirable to paint unrealistically optimistic pictures of revenue growth. Work backwards from a complete year five projection to your present financial situation. Note that growth is generally slow in the early years and does not usually accelerate logarithmically. Smooth the curve to show modest and increasing growth rates, i.e., forecast manageable growth. Only after you believe that your forecast reflects achievable revenue performance based on reasonable and express assumptions should you show it to investors.

A panel discussion of prominent Boston VCs held on Boston’s Beacon Hill answer with a qualified “no.” The distinguished panel included Jonathon Seelig of Globespan Capital Partners, David Aronoff of Flybridge Capital Partners, and Larry Bohn of General Catalyst Partners with several other prominent venture capitalists and angel investors attending and participating in the discussion. They painted a somewhat more nuanced picture of the 2009 outlook. Here are some of the points I took away.

• CalPERS notwithstanding, the vast majority of venture limited partners (LPs) – the primary source of VC investment money – will continue step up to their contract commitments to fund future rounds. CalPERS is a special case with vast market power.
• Over the last decade, despite historically high levels of VC investment, returns have lagged. Most LPs, like the rest of us, are heavily invested in depressed equities and sitting on the venture sidelines for now.
• Whether a particular VC firm has capital to invest in A-rounds depends in large measure on when they raised their last fund from LPs. The situation varies considerably from firm to firm; some have substantial amounts remaining to invest, others have cancelled new fund-raising for now.
• Several VCs agreed that they are more likely to cut off funds to their under-performing portfolio companies, to avoid “putting good money after bad” than to stop investing in new opportunities entirely.
• Tight money means lower valuations, stricter scrutiny of risk and more smaller deals in the $1 million to $3 million range – with syndication of even these deals.
• The VCs in attendance continue to seek cleantech opportunities (though the precise definition remains elusive) as well as selected life sciences and communications ventures.

For Boston entrepreneurs, the message is mixed. Substantial venture capital remains available for initial funding of start-ups, though conditions are less than ideal. Start-ups must compete for initial funding and expect somewhat lower valuations and tougher terms. Competition for ongoing funding in later “go-to-market” rounds may be sharper too. The best startups with well-researched business plans, experienced managements and promising prospects still have a fighting chjance in 2009.  If you are one of those, look for VC funding with genuine value-added funding, such as connections to key customers, suppliers, advisors and experienced executive staffing. You may well need that help. Good hunting.

But the real issue is content. Business plan software treats all chapters and sections as equal; market size here, target customers there; competition over here. It has all the right buckets. Unfortunately, buckets of arbitrarily parsed information don’t do a great job of story-telling. A business plan needs to get right to the point of this specific business and then back it up with solid evidence and details. Many good ideas never obtain funding or attract other needed resources because they fail to communicate the plan in a way that is clear, effective and impressive. Starting with a generic format cannot help. Each business idea has unique priorities that must drive the presentation of the plan’s content, not some generic, one-size-fits-all format. Too many entrepreneurs learn this lesson the hard way.

Perhaps the most compelling reason to learn to look at your own venture as an investor would is that you will always be its major investor. Outside financial investors will invest discretionary capital that they can afford to lose. You will end up investing years of your life, enthusiasm, energy and credibility. Your friends, business colleagues, family and many others will either watch you succeed or fail.  You will probably spend a good deal of your own money and make many material and other sacrifices.  If the venture stumbles along for three to five years, it is likely that you will be the first one in and the last one out. No one has more invested in your start-up than you do. The years, money, self-esteem, sleepless nights, personal reputation and spirit that you put at risk is a huge investment.

The first step in the process is to stop focusing on the great new product or service that you dreamed up and shift to laser sharpness on whether and exactly how a company built around such a product would make money. Learn to question your assumptions and seek proof as professional investors surely will. Have you adequately laid out the business case?  Have you accurately estimated the market or have you made the Red Sneakers mistake or used Chinese Math?  Will people actually want what you sell enough to spend the amount you need to yield a profit? How much must they spend for a competing product? Do you have solid figures to back up the cost of making the product, acquiring customers and closing sales?  Great ideas are a dime a dozen. Businesses succeed by executing well on sound business strategies. Can you demonstrate that your management team has the vision, skills and relevant experience to do that?

These are hard questions indeed, but you need to ask and answer them to protect your investment.  If you fail to ask them now, it is very likely that you will wish later that you had paid them more attention. Moreover, if you think these things through carefull before an outside investor asks about them, you will not only be prepared, but you will see the importance and relevance of the questions much more clearly.