Last Updated Jun 1, 2011 9:14 PM EDT
By Tim Berry
Each spring, I review 50 or so business plans for various business planning contests. These plans are developed for startup companies that are seeking thousands, and sometimes millions of dollars in angel investment or venture capital. By the time I see them, they've been weeded out from the less worthy submissions and selected as finalists or semi-finalists.
And, each year, I'm reminded that even the "best" business plans can have serious flaws. Some project profits far beyond reality. Others bury key details far down in the document.
Reading these business plans inspired me to create a list of the top mistakes that I identified. I've outlined them below with some tips for how to avoid making them.
1. Projecting outrageous profits. More than half of the business plans I read this year projected profits way beyond the normal 10 percent to 15 percent that most other businesses see. High profitability projections indicate that the business owner is underestimating costs and expenses. They also suggest that the owner is choosing profits over growth. The best startups generally invest whatever money is left over from costs and expenses into marketing for higher growth.
To avoid doing this, find some standard financial reports for an industry like yours and figure out what real companies generate in profits. Then go back and rethink your estimates. Is your gross margin higher than average? Can you justify that? Are your marketing expenses lower than average?
2. Incomplete financial projections. Every business plan should include a realistic cash flow projection and a breakdown of starting costs. It's good to use charts to do this but also make the details available somewhere in the document, even in an appendix. Show how much investment you need and what you'll do with the money. Just projecting sales and profits isn't enough.
If you plan on selling your products to businesses, you'll need to show that you understand the cash flow implications of waiting to get paid. If you want to build products or websites, show that you understand the cash flow implications of building things or buying things before you sell them.
3. Top-down forecasting. I hope to never see another business plan promising to get a small percentage of a large market. Yes, 1 percent of $43 billion is $4.3 million but, no, you're not going to sell that much.
Instead, go granular. Start with specific assumptions and work upward to the sales forecast. Build your sales forecast up from the unit economics and on detailed assumptions that you can illustrate.
4. Inflating the market. No one is going to believe you when you say, for example, that your musician tutorial website is going to appeal to 50 million people. When talking about total market value, you need to be realistic, skeptical and make assumptions to bring those huge market numbers down.
Consider the market projection based on words -- a story -- instead of using numbers. Talk about what market you will disrupt and let the readers use their imaginations about how big it is.
5. Too "big picture." Business plans often deal only in global strategies, showing only the big picture. A business plan needs to illustrate the economics of a single unit -- from production, to channels, to end user. Show what you get, what it costs you and what the buyer pays. Also show how you're going to scale up, how you're going to build a direct sales force, how you're going to build web traffic and how long your sales cycle will take.
6. Unrealistic about selling channels. Not understanding how retail channels work is a big mistake. Don't assume that retailers will want to buy your product directly from you. Most often, they want to go through a distributor. If you plan on selling through channels and to take home more than 50 percent of what the end consumer pays, then you don't know your channels.
Know your margins, including administrative costs and co-promotion dollars for distributors and retail stores that carry products like yours. Once you've got that down, you'll need to remember to allocate enough working capital to support your business while you wait for distributors to pay your invoices.
7. Buried treasure. Communicate your key points quickly. Some key points that investors look for include market, sales projections, your management team, scalability and defensibility.
Also remember to communicate your points clearly and in plain language. Prove your technology by quoting experts and showing your degrees and qualifications. Then show sales, channels, markets, strategy and your team.
Tim Berry is the president of Palo Alto Software Inc., based in Eugene, Ore., which produces the industry's leading business planning software, Business Plan Pro, as well as other popular planning applications for businesses. He is also the author of The Plan-As-You-Go Business Plan, published by Entrepreneur Press.
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Flickr photo courtesy of rmkoske, CC 2.0