August 25, 2014

How to build a 21st-century business plan

Q&A talks about the evolution of business plans with Timothy B. Folta, a UConn professor and Thomas John and Bette Wolff Family chair in strategic entrepreneurship.

Q: You hold the Thomas John and Bette Wolff Family chair in strategic entrepreneurship. Since 1998, the program has sponsored the Annual Wolff Business Plan Competition. You're new to UConn but from your many years of experience how have business plans evolved over the years? What are some of the biggest changes in the past 10 years?

A: One of the biggest changes has been an explicit emphasis on the "business model." A business model articulates the economic logic of the business — why and how the business creates value for all its stakeholders (customers, owners, suppliers, and society) — and quantifies how much value it will create. It is actually not so easy to create a business model where all parties benefit. In fact, the landscape is littered with businesses that might have created value for one stakeholder, but not for another. For example, during the "dot-com" era, it was common to get capital if a customer need was being met, even if there was not a clear understanding of a business's path to revenues and profits.

Since investors are now more attuned to business models than they were in the late 1990's, we should not expect them to make the same mistake. Entrepreneurs writing plans should focus explicitly on business models.

A second change to plans in recent years is emphasis on confirming assumptions explicated in the business model. The best plans do more to validate critical assumptions through primary research, such as speaking with customers or suppliers or other entrepreneurs. These steps not only "de-risk" the business, but also lend credibility to the entrepreneur.

Q: Some believe it is no longer necessary to write a business plan because it makes businesses less flexible when first starting out. What are your thoughts?

A: A business plan should be perceived as a living document, which means that it changes continually as the entrepreneur seeks to validate and readjust the business model. Entrepreneurs change their business models an average of six times prior to settling on one. The implication is that entrepreneurs are generally responsive to new information. They should not be a horse with blinders, pursuing an obstructed path just because it was described in their original plan. Rather, they should adapt their plans to reflect their latest thinking on why and how the business will succeed. Does this mean that they should never codify their original assumptions in a plan? Absolutely not! Doing so will provide a basis for feedback, which will expedite the learning process and speed a path toward success.

Q: What would you consider the top four things a good business plan should have when starting out?

A: First, the best business plans explicitly identify the key risks of the business — the factors on which the success of the business will hinge — and then clarify the steps they have taken to attend to these risks. A failure to mention key risks will not likely fool potential investors into thinking that there are none. It will, however, achieve a loss in credibility.

Second, it is important to clarify how the management team is right for the opportunity. Nearly all of the value of an early stage venture is based on the potential for growth, and whether this growth gets realized depends on an ability to execute the plan. Teams that lack a credible ability to execute, should address this weakness in their plan.

It is also paramount that the plan identifies (a) the customer "pain," (b) which type of customer is feeling the most pain, and (c) how the product or service attenuates the customer's pain. Plans targeting potential investors should also be explicit about how much money they need, how much equity their investment will give them, and for what the money will be used. Investors may be inhibited if they do not know what their investment will buy.

Q: What do entrepreneurs need to do when starting out when it comes to financing? Are they availing themselves of public-private financing or is that a diminishing pool to swim in?

A: Not all new ventures need external capital. However, a general rule is that the higher the potential of the venture, the quicker it must grow because of potential competition. Faster growth generally requires that the business not depend purely on cash from operations. Fortunately, there is an increasing amount of capital for early stage companies. This is partly because of the rapid development of angel investor groups, and partly because venture capitalists have shifted investment toward early stage ventures. In 2013, 91 percent of all angel investment and 35 percent of all venture capital was invested in seed and early stage ventures.

Q. What are some of the biggest mistakes companies make when first starting out?

A. Entrepreneurs are extraordinarily optimistic about their prospects for success. One study found that 95 percent of all entrepreneurs believed their business was likely to succeed even though they calculated the odds of similar businesses succeeding to be significantly lower. While optimism may help to convince customers, suppliers, or employees about the likely success of the business, it may also blind the entrepreneur to real threats. Accordingly, a key mistake of many entrepreneurs is to avoid serious and objective challenges to the key hypotheses they hold about their businesses. Objectivity is critical for this task, even if it is difficult for the entrepreneur to achieve.

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