MILESTONE #2: Business Planning
“ The only place where success comes before work is in the dictionary.”
— Vidal Sassoon
The second milestone is business planning, which – when done appropriately – will lead and direct your focus on the rest of the milestones. You will begin this milestone at the beginning and finish it last. In order to complete the business plan, you must simultaneously complete the other milestones.
The entire business planning process that we have laid out will hopefully highlight the major gaps in your own business that must be achieved to raise investment.
“If you fail to plan, you are planning to fail.”
– Benjamin Franklin
Every entrepreneur should begin planning their business by researching the competition, the industry, and the market. This is one of the most time consuming pieces of the business planning phase and corners should not be cut. The information you learn here becomes the foundation for many decisions you will make later on. We’ve provided an overview of this research process below, but you can learn more about it on our eBook: Business Plan Basics.
The Competitive Analysis assesses the differences between your business and your competition, while detecting and examining the factors that cause these differences. This section is broken down into direct and indirect competitors, and it is intended to give you insight for how to go head-to-head with these competitors in order to acquire customers. It is also used to show your advantages over your customers as well as how you are differentiated from them.
The Industry Analysis analyzes the conditions of your industry in its current moment. This includes the behavior and relations between competitors, suppliers, and consumers. It is vital to understand the different factors at work — political, economic, and environmental — within a given industry in order to create an effective strategic plan for any company. First, define what type of industry you are in, and then determine what sector of the industry you will operate within. Once you figure this out, you can determine the current and projected size of the industry and sector as well as start researching which factors can potentially impact your business, the other major players in the industry, and any relevant trends that will affect these industry players.
The Market Analysis is used to define and determine the potential appeal of numerous markets, and to understand those markets’ evolving opportunities and threats in relation to the strengths and weaknesses for a particular company. The focus of this section should be on the people you intend to sell your products/services to, known as your target market. This can include individual customers – known as business to customer (B2C) – or other businesses – known as business to business (B2B). In a way, the Market Analysis is the foundation of your business’ plan of attack.
The Product Description clearly explains what products or services your business will offer. The information provided in this section will become the basis of your Marketing Plan. It’s never safe to assume that your product/service will sell itself, so make sure to include a thorough description using specifics and detailed language. It should be written so that the reader can easily understand what the product is and what it does (features). It should also include a comparison of your product to other similar products on the market. This is your opportunity to clearly define the advantages your product has over any competitors, as well as to highlight any weaknesses that you would like to improve upon.
“An entrepreneur without funding is a musician without an instrument.”
– Robert A. Rice Jr.
You will need to create financial projections, which is where the remaining milestones come into play. Accurately projecting your financial statements is an extremely important part of your business plan. It gives insight on how your business will perform financially according to the current market assumptions and the business model you choose.
You will have to accomplish many of the other milestones in order to complete these accurately. For example, the first thing you need to do is create the revenue model, and you’re required to know your market size, marketing plan, and sales plan in order to do this (See how to create a revenue model blog post here for more information).
Then, when you’re putting together your sales projections, you will need to know your pricing strategy and cost of goods sold (COGS). This continues to occur in sections later on where you need to know your organizational chart and job descriptions so you can map out your 5 year personnel expenses.
You also need to create a 5 year month-to-month Balance Sheet, Income Statement – also referred to as the Profit and Loss (P&L) – and Cash Flow Statement. Other key metrics that should be included are startup expenses, marketing goals, unit sales and costs, and personnel expenses. You can learn more about this in our eBook Business Plan Basics.
Upon completion of the financials projections, you will be able to write the operations, management, sales, marketing, and financial summary sections of the business plan.
Take a look at our Sample Business Plan for a more thorough understanding of the various sections of the plan.
“If you’re not learning while you’re earning, you’re cheating yourself out of the better portion of your compensation.”
– Napoleon Hill
Once you complete your financials projections and your business plan you will find that you have an understanding of how much money you need and at what stage you need it. The next step is to develop your capital strategy, which includes asking yourself the following questions:
- What type of investment am I looking for? Debt or Equity?
- What type of investors am I seeking?
- What is the current valuation of my business?
- How much equity am I willing to give up?
- How can I find and approach investors? What do I say once I’m in a meeting?
- What legal documents will I need to close the deal? What are the terms of the deal?
Knowing the questions themselves is key at this stage. Find out many more details in the following eBooks, once you are ready with the answers.
AMOUNT TO RAISE
Knowing how much capital to raise is difficult to determine because there really is no right answer. It’s all dependent on what type of industry you are in, what your personal and financial goals are, what stage your company is at in development, what your capital strategy is, etc. With that said, your financial projections will answer this question to the best of your ability based on the assumptions that you make throughout the projections (revenue growth model, COGS, personnel plan, marketing plan, operating expenses, etc).
Similar to figuring out how much capital you need to raise, there is no right answer for determining the percentage of capital you raise through debt vs. equity. It all depends on what you are more comfortable with and the risks you are willing to take.
Because debt comes in the form of a loan, you are able to retain the equity share of the company, which doesn’t dilute your ownership. However, you must re-pay the loans with interest even if you go out of business (assuming the loan is a personal loan and not a business loan, which is usually the case for most entrepreneurs because these are the only type of loans you will have access to). Debt is a better choice for someone who is looking to stay with the company long term, as opposed to an early exit strategy.
Equity on the other hand is capital that doesn’t have to be paid back. However, it will dilute your shares and lessen the amount you earn upon exit.
TYPES OF INVESTORS
Family, Friends and Founders (FFF)
Roughly 50% of startups receive investments/ funding from friends and family members in the beginning of their venture. According the Global Entrepreneurship Monitor (Babson & London School of Business), $50 billion to $75 billion is invested annually in this manner. This is over double the amount of capital invested annually by angel investors or venture capitalists (approximately $20 billion).
FFF capital should be used to achieve the milestones that will attract seed funding from angel investors. Likewise, angel funding should be used to achieve the milestones that will attract Series A funding from venture capitalists. Normal amounts raised from FFF range from $25,000 to $50,000. See our Guide to Friends, Family, and Founders for more information.
Angels can also be thought of as private investors that provide financial backing for startup companies. By definition, Angels are accredited investors, meaning their net-worth (either alone or combined with their spouse) exceeds $750,000 at the time of investment, or they have an annual income that exceeds $200,000 ($300,000 if combined with spouse) for the two preceding years.
Angels aren’t professional investors working for an outside company. Rather, they invest their own money into the startups, which is why they invest at earlier stages and don’t provide as much funding as a venture capitalist. Normal amounts raised from angels range from $250,000 to $750,000. It is also common for multiple Angels to pool their money together, either informally or formally via an Angel Investment Group.
See our eBook Guide to Raising Capital from Angel Investors for more information.
Venture Capitalists (VCs) invest significantly more than FFF and Angel Investors, but they typically do it at a later stage when the company has a higher valuation. They can represent outside companies, groups of wealthy investors, investment banks, or other financial groups that pool investments or partnerships. The downside for entrepreneurs is that they usually require a higher level of inclusion in company decisions (if not majority control) and seek significant amounts of equity in the company. Normal amount raised from VCs range $3,000,000 to $10,000,000.
A family office or better known as single family office (SFO) are private companies that manage the investments of certain families that have accumulated wealth or trusts over many generations. Unlike angels and VCs, family offices don’t have the hands-on experience with starting a business so they may not be able to provide the valuable guidance that many startups desperately need.
A major benefit to Crowdfunding platforms is that they can bring in investors who normally wouldn’t have uncovered the company on their own. Until fairly recently, you could only act as an equity investor if you were accredited (which requires an income of at least $200,000 per year). However, because of the JOBS act, regular people are now allowed to invest with more flexibility.
A truly successful crowdfunding campaign is one that has momentum and is being shared amongst many social channels. Another pro of crowdfunding is that it often established a degree of market traction when it comes to raising capital from more traditional sources. See our Crowdfunding 101 eBook for more information.
Many large corporations have investments groups that make strategic investments into early stage companies. Each group usually has clearly defined criteria in what, when, and how much they invest. You will have to do some good old fashioned research of companies that may be interested in investing in your startup.
ALTERNATIVE SOURCES OF CAPITAL
There are also a number of other alternative sources of capital including credit cards, inventory loans, etc. You can see dozens of these in the eBook Alternative sources of Capital.
Some say that valuing a company is more of an art than a science. Keep in mind that you may want to pitch the value at a higher amount to potential investors so that you can leave room for negotiations and settling on a number that your are still comfortable with. It’s also been said that a good rule of thumb is to value a company based on the sum of 2-3 years of net profits. This is a large topic and too big to be discussed in this beginners eBook.
OTHER INVESTOR DOCUMENTS
The Pitch Deck (also referred to as Investor Presentation, stack, or investor deck) is designed to accompany a formal presentation of your company to a group of investors to sell them on your business as an appealing, desirable opportunity to invest.
The goal is to present the business to potential investors in an effective format for receiving funding, while highlighting key points that they care about. At The Startup Garage, we create a set of approximately 10-15 slides that give a complete overview of your company, team, target market, competition and significant milestones, as well as your future plans and business funding needs that investors want to see. Take a look at our Sample Pitch Deck for a more thorough understanding of the various slides of the deck.
The executive summary can end up being the most important part of any business plan. It gives a brief overlook of where the company is, where it is heading, and why it will be successful. It is intended to highlight the strengths and potential growth of the business and it appears first in a normal business plan. The reader can easily see a mission statement, the competitive edge, sales growth, financial projections, the management team, and the exit strategy. Take a look at our Executive Summary for a more thorough understanding of what to include.
One Page Business Plan
The one page business plan is a great tool to quickly communicate your business concept when looking for funding. It is primarily used by high-growth startups as an efficient method for quickly communicating the business to their audience. They are typically expertly designed to show the viewer everything they need to know on a high level in an infographic-styled, easy to understand format. Take a look at our One Page Business Plan to better understanding what to include.
A new trend is creating a private password protected website to host basic information about the investment opportunity and the previous documents discussed. You will be able to share this website and login information with accredited investors without generally soliciting the investment opportunity. Below are a number of options for this. We recommend at the minimum post on both Gust and Angellist. Don’t publish until you are ready for fundraising. The chances that you will find you lead investor on one of these is slim. Using them to manage the process is valuable and you may be able to find some investors to close out a round after you found a lead investor elsewhere. More details can be found later in this ebook.
Fundingpost.com – The mission of Funding Post is to introduce Entrepreneurs to interested Venture Capitalists and Angel Investors. The site claims to showcase company profiles to over 7,900 Angel Investors & Venture Capitalists worldwide. Fundingpost costs $100 for the first 3 months, then $33 per month after that.
Gust.com – Gust aims to help angel groups and venture capital funds collaborate with promising startups. From February 2013-February 2014, 1800+ startups have been funded through the Gust website. The site includes a community of accredited investors from over 80 countries, insight and education into the fundraising process, as well as tools that help you build a complete profile that will convey your message to investors effectively. Gust is free.
Angellist.com – AngelList is a site dedicated to being a matchmaking service for early stage investors and entrepreneurs. It allows startups to find capital, and gives investors access to up-and-coming businesses, and links talents to startups looking to hire. Angellist is free.
Seedinvest.com – SeedInvest is a platform that gives equity-based accredited investors the ability to participate in crowdfunding. It was founded by professional investors involved in the passage of the 2012 Jobs Act. Two other major reasons that SeedInvest attracts investors are because it doesn’t charge them to use the site, and it makes the investment process relatively seamless requiring just a few clicks. Seedinvest costs $250 per month along with a 7.5% placement fee on funds raised as well as up to $3500 in due diligence, escrow, and legal fees.
Onevest.com – Onevest is a startup investing tool that connects early stage startups with accredited investors. Founders are able to find funding and build a team all on the site. Onevest is free or you can pay a fundraising success fee and they will manage your campaign.
IDENTIFYING POTENTIAL INVESTORS
Networking is a crucial part for finding investors. There is no such thing as too much networking, so don’t hesitate to get out there and meet potential investors or individuals that can introduce you to potential investors. Your only focus shouldn’t be about selling your business, because cultivating personal relationships with potential investors and the other people you meet while networking will pay off in the future. Part of effectively building professional relationships includes always being positive and polite, and dressing to impress. You only have one opportunity to make your first impression. Additionally, you’ll want to ask questions and make yourself a resource for others as this is good common practice in the startup community and will increase your chances of people thinking of you when opportunities become available.
Unfortunately, you will face rejection from many potential investors. It doesn’t imply that your business opportunity isn’t legitimate; it just means that for whatever reason your business wasn’t the right fit for them. If someone turns down investing in your company, always ask if the person can refer an angel that would be interested. If you can manage this, you can also ask why they weren’t interested and use that to perfect your pitch.
You may also want to consider asking your bank if they have any connections to angels. It’s in the bank’s best interest to assist your company towards financial success, so it is very possible that they willing to share contacts within their network of investors with you.
You can also search for investment groups through Internet forums. If you reside close to a major city, you can likely find a local investment forum nearby. Investment forums are similar to angel groups in that many investors attend for the opportunity to invest in promising new companies. At these forums you may encounter advisors, customers, and other strategic partners along with the angels. It’s possible that they also host workshops for investor education, which could be beneficial for you to attend in order to get into the mindset of an investor and see what they are looking to learn.
Once you find an investor that you want to partner with, you must approach them in a way that optimizes your potential to receive funding. Consider how you got the angel’s contact information to guide your first move. Did you already meet them at a networking event? In that case, you already have a sense for the way they wish to be contacted. Are they a referral from someone else you met? Ask that person who referred you for more information on the angel’s personality. Regardless of your means of communication, make sure you tailor your first communications to them.
*A good rule of thumb is to ask for 45 minutes of the angel’s time. They can extend or shorten the window if they think necessary.
Your elevator pitch is supposed to explain the value of your startup in the amount of time you spend on a normal elevator ride (not including the Empire State Building). You must come up with a clear way to communicate everything an investor would want to know to be interested in your business. Shoot for a 60-second pitch and try it out on some friends. It’s a handy tool to have available when you want to take maximum advantage of a brief moment to talk with someone who has resources that may help you.
This is a more formal pitch usually pre scheduled with the investor and can be located in a formal business setting or a more informal lunch or tea setting. This pitch is usually accomplished with the CEO presenting the pitch deck and then followed by Q&A with the investor. These meetings usually last from 30 to 90 minutes.
There are a number of Quick Pitch events and they usually last anywhere from 1 minute to 15 minutes. You will want to share the key information just more succinctly.
There are a number of other pitching opportunities each with their own rules and guidelines. Once you have your main pitch down you can adjust down to the time allowed.
This is a comprehensive, thorough background check of investment opportunities, which allows angels the ability to assess the opportunities for a maximal return on investment (ROI). By working together as an angel group to conduct due diligence, angels with expertise in areas such as finance, law, or marketing can research and validate business planning documents as well as the other strategies presented by a startup.
When it comes to the part of the deal with your investor where a valuation must be determined, make sure you are prepared. Most likely the valuation will fall far below what you consider to be the value of your company, but there are many factors that contribute to an objective valuation. A valuation can assess your company’s liquidity, cash flow, and the value of similar companies. You also have to consider the value that the investor brings to the table, especially if they are well-connected, have a lot of experience and advice, and if they provide an opportunity to receive additional funding down the road.
A term sheet outlines the details of the investment you and the angel agree on. Some of the things you should include on a term sheet are:
- Type of financing: debt or equity?
- If you choose debt, will it be convertible? Secured or unsecured?
- If you choose equity, will the stock be common or preferred?
- The amount of financing
- Will the angel be active or silent after funding has been received?
What happens if the company faces a liquidity event during the course of the investment? Who is paid and when?
Although there are many more here are some common terms that you will need to know:
A term used in Venture Capital that defines who gets paid how much when there is a liquidation event such as a sale of the company. Standard is a 1x which means the investor gets paid back exactly what they invested (1x) their investment first and then gets part of the profits from the sale. This reduces the risk for investors from not getting the original investment back. Investors are usually repaid before founders and other stock holders.
A security derivate Issued by the company usually as an incentive to the investor. It is the right to purchase securities from the company at a specific price by a certain date. If the value of the company goes up above this price investors can purchase extra shares at a discounted price and make money.
Pre & Post Money Valuation
Pre Money Value is the value of the company before the investment. If you have a pre money value of $2 million and get 1 million in investment your post money value is $3 million.
Par value, authorized and issued shares
Par value is a simple but confusing attribute related to corporate stock. The value of the stock has very little to do with this par value. Rather, the par value relates to the number of shares of stock which are authorized to be issued in a company. For example, a corporation may “authorize” 1 million shares of common stock and 1 million shares of preferred stock for $0.0001 per share. Authorized shares, are the shares the company has “on-the- shelf” to issue to the shareholders. “Issued” shares are the shares which are actually purchased by the shareholders and which constitute and represent the capital stock of the company.
The stock cannot be sold for less than its par value. The price of issued shares is based on the value of the company divided by the number of issued shares of stock. For example, if ABC company is valued at $1 million and the company issues 200,000 shares of preferred stock for one dollar per share, and 800,000 shares of common stock for $0.0001 per share, then the post-investment (“post-money”) valuation of the company would be $5 million, making the preferred shareholders, owners of 20% of the company’s equity.
Stock and Units
The ownership interest that is provided to and investor for investing cash in a business is an equity investment. In a corporation, the investor will typically receive “Stock” in exchange for their investment. In an LLC, the investor will typically receive a percentage interest, or a “Unit” in exchange for their investment. In an LP the investor will typically receive a “Limited Partnership Unit” for their investment.
A company can issue new or “preferred” stock as another way to raise capital. Its owners will receive their dividends prior to common stock owners are paid after the company settles loan interest payments.
Once a company is financially stable, they can issue common stock (also known as “ordinary shares”), usually with the help of an investment bank. Common shareholders are allowed to vote for the Board of Directors. However, when it comes to distributing profits they rank behind preferred stock owners or anybody who issues bonds/loans.
Stock options can be used to incentivize talented senior management during the recruitment stage. If you create an Option Pool you can also set up an employee program that issues stock or bonuses based on performance in order to increase productivity and efficiency (this also could be used as an alternative to normal means of compensation). The value of the shares increase in alignment with investors’ expectations of earnings.
CLOSING THE DEAL
Closing the deal will be done when all of the business terms are in place, the legal documents are in place, and the investor is ready to write the check.
In order to maintain a good relationship with the angels you meet throughout the process of seeking financing, make sure to keep in touch with them after your conversations. For anyone who you have a meeting with, send them a handwritten thank you card. If they end up not funding you, you can keep them posted on your company’s progress. You never know, they may change their mind and provide you with funding in the future!
For an angel who does invest in your company, keep them updated on everything about your progress, for the better or the worse. Share your successes and milestones with them, but be honest about problems you are struggling with. They might be able to help you get through the rut. Be sure to thank your angel frequently for supporting your company and making your passion possible.