What Does a Venture Capitalist Look for in a Business Plan?
The business plan should convince the venture capitalist and give confidence to them about the expertise and experience of the management team in achieving the business objectives within a defined timeline.
As venture capitalists are high risk investors a higher rate of return is what they expect. Venture capitalist firms review hundreds of business plans and zero in on just a few of them. Individual venture capitalists or VC firms extend equity funding to new business start-ups or an existing business. They can either take a minority stake or a major shareholding. Some of the factors that VC’s look for in a business are management bandwidth, customer base, corporate governance structure, investment structure and the exit plan.
Writing a professional Business Plan
The business plan should convince the venture capitalist and give confidence to them about the expertise and experience of the management team in achieving the business objectives within a defined timeline. An effective high rewarding business plan should cover up the following essentials:
– Executive Summary
The most important part of any business plan is the executive summary and is often best written last. It is an initial interaction between the writers of the report and the VC. It summarizes a longer report or proposal or a group of related reports in such a way that VC can rapidly become acquainted with a large body of material without having to read it all. It must be short and to the point with proper recommendations, justifications and a conclusion.
It is recommended to address the following questions in an executive summary:
- Do you have a unique partnership?
- Do you already have customers and traction?
- Do you have patents or technology?
- Is your marketing plan special in a certain way?
If the product or service is technology oriented it has to be explained clearly with proper product description, its competitive comparison, unique selling proposition, technology to be used and future innovations in order to help the VC understand the whole concept. Stages and development of the products or services should also be mentioned (seed stage, early stage, expansion stage).
– Market Analysis
The analysis of market potential separates the pure investors from a real entrepreneur. Many a time good products are not successfully commercialized because their inventors don’t understand the market or they not assemble the management team necessary to capitalize on the opportunity.
This section of the business plan will be scrutinized carefully; market analysis should therefore be as specific as possible, focusing on believable, verifiable data. Market Research should contain a thorough analysis of the company’s industry and potential customers. Industry Data should include growth rates, size of the market, recent technical advances, government regulations and future trends. Customer Research should include the number of potential customers, the purchase rate per customer, and a profile of the decision-maker. This research drives the sales forecast and pricing strategy, which relates to all other strategies in marketing, sales and distribution. A realistic SWOT also attracts venture capitalist. Finally, comment on the percentage of the target market the company plans to capture.
– Marketing Plan
The primary purpose of the marketing section of a business plan is to convince the venture capitalist that the market can be developed and penetrated.
Pricing
The strategy used to price a product or service provides an investor with insight for evaluating the strategic plan. Explain the key components of the pricing decision, i.e., image, competitive issues, gross margins, and the discount structure for each distribution channel. Pricing strategy should also involve consideration of future product releases and future products.
Distribution Channels
For a service provider, the distribution channels are not as important as are the means of promotion but for a manufacturer’s business plan should clearly identify the distribution channels that will get the product to the end user. Distribution options for a manufacturer may include:
- Direct Sales, such as mail order, direct contact through salespeople, and telemarketing;
- Original Equipment Manufacturers (OEM), integration of the product into other manufacturers’ products;
- Distributors or Wholesalers; or Retailers.
Each of these channels has its own advantages and disadvantages and the financial impact, so they should be explained and clarified in the business plan. Mention if more than one channel is being used and it should be compatible.
Promotion
Plans for product sales sheets, potential advertising plans, internet strategy, trade show schedules, and any other promotional materials should be included in the marketing promotion section of the business plan. It is also important to explain the thought process of the selected promotional activities and also for those not selected.
Competition
A business plan should also discuss about the competition level and the competitors. If the company is first-to-market, the entrepreneur must explain how the market’s need is currently being met and how the new product will compete against the existing solution.
A VC will be looking to see how and why the firm will beat the competition. Attempt to anticipate competitive response to the product. Include, if possible, a direct product comparison based on price, quality, warranties, product updates, features, distribution strategies, and other means of comparison. Document the sources used in the analysis.
– Business Operations
The operations section of the business plan should discuss the location and size of the facility. Factors such as the availability of labor, accessibility of materials, proximity to distribution channels, and tax considerations should be mentioned. Describe the equipment and the facilities. If the company needs international distribution, mention whether the operations facility will provide adequate support. If work will be outsourced to subcontractors, eliminating the need to expand facilities, state that, too. The investor will be looking to see if there are inconsistencies in the business plan.
The venture capitalist will also ask such questions as: If sales projections predict a growth rate of 25 percent per year, does the current site allow for expansion? Are there suppliers who can provide the materials required? Is there an educated labor force in the area? The sales projections will determine the size of the operation and thereby the funds required both now and in the future. Include the sources and uses of financing in the business plan, and be certain that the assumptions are realistic.
– Management Team
Venture capitalist invests in people-people who have run or who are likely to run successful operations. The team should have experience and talents in the key disciplines: technological development, marketing, sales, manufacturing, and finance.
In most of the start-up companies the management team consists of few founders with varied background. In this case there is gap in the team skills and knowledge, it is important to mention how this gap can be filled. Include a list of the board of directors or advisors: key outside industry or technology experts who lend guidance and credibility. This is another area where empty positions may be filled from suggestions of a well-net-worked investor.
– Financial Projections
In order to attract investors and retain their interest in future financing a realistic financial forecast is important. Good financial forecasts integrate the performance goals outlined in the plan into financial goals so that return on investment, profitability and cash-flow milestones can be clearly stated. Investors use these forecasts to determine if (a) the company offers enough growth potential to deliver the type of return on investment that the investor is seeking, and (b) the projections are realistic enough to give the company a reasonable chance of attaining them.
Financial Statements which the investors are concerned about are the balance sheet, cash-flow statement and income expenditure statement for a period of three to five years. It would help the VC to make out the process adopted for the development of the business, operations and overheads and staffing and personnel. It is also imperative that the forecasts include a footnote section that explains the major assumptions used to develop revenue and expense items.
The financial plan depends on important assumptions, which can be daily basis (debtor days, charity, average stock turnover days) or annual basis (depreciation, etc) or any other unit of measurement which is needed to be stated carefully.
Product development expenses should be closely tied to product introduction timetables elsewhere in the plan. These expenses are typically higher in the early years and taper off because product line extensions are less costly to develop. A detailed set of expense (operations & overheads, staffing & personnel) assumptions should take into consideration headcount, space, selling and administrative costs and major promotions.
The balance sheet should agree with the income and cash flows statement. The cash-flows statement must correlate to the balance sheet and income statement and should match the timing of the funding requirements stated in the plan.
– Amount and use of finance required and exit opportunities
State how much finance is required by your business and from what sources (i.e. Management, venture capital, banks and others) and explain the purpose for which it will be applied. Consider how the venture capital investors will exit the investment and make a return. Possible exit strategies for the investors may include floating the company on a stock exchange or selling the company to a trade buyer.
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