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What Does a Venture Capitalist Look for in a Business Plan?
Since venture capitalists are high risk investors, their expected returns are high. Venture capitalist firms review hundreds of business plans and zero in on some of them. Individual venture capitalists or VC firms raise equity funding for new business start-ups or existing businesses. They can either take a minority stake or a larger shareholding. Management bandwidth, customer base, corporate governance structure, investment structure and exit plan are some of the factors that VCs look for in a business.
Writing a professional business plan
A business plan should convince the venture capitalist and give them confidence in the management team’s skills and experience to achieve the business objectives within a defined time frame. An effective high profit business plan should cover the following essentials:
– Executive summary
The most important part of any business plan is the executive summary and is often written last. This is the initial communication between the author of the report and the Vice-Chancellor. It summarizes a long report or proposal or group of related reports in such a way that VCs can quickly familiarize themselves with the larger content without having to read it all. It should be short and to the point with proper recommendations, justification and conclusion.
The executive summary recommends addressing the following questions:
• Do you have a unique partnership?
• Do you already have customers and traction?
• Do you have a patent or technology?
• Is your marketing plan unique in a certain way?
If the product or service is technology-oriented, it should be clearly explained with a proper product description, its competitive comparison, unique selling proposition, technology used and future innovations to help the VC understand the whole concept. The stages and development of products or services should also be mentioned (seed stage, early stage, expansion stage).
– Market analysis
Analysis of market potential separates the pure investor from the true entrepreneur. Many times good products are not successfully commercialized because their inventors do not understand the market or do not assemble the necessary management teams to take advantage of the opportunity.
This section of the business plan will be carefully scrutinized; Market analysis should therefore be as specific as possible, focusing on reliable, verifiable data. Market research should include an in-depth analysis of the company’s industry and potential customers. Industry data should include growth rate, market size, recent technological advancements, government regulations and future trends. Customer research should include the number of potential customers, purchase rates per customer and profile of the decision maker. This research drives sales forecasting and pricing strategy, which is related to all other strategies in marketing, sales and distribution. A realistic SWOT also attracts venture capitalists. Finally, comment on the percentage of the target market the company plans to capture.
– Marketing plan
The primary purpose of the marketing section of the business plan is to convince the venture capitalist that the market can be developed and penetrated.
The strategy used to determine the price of a product or service provides insight to the investor to evaluate the strategic plan. Explain the key factors of pricing decision, i.e., image, competitive issues, gross margin and discount structure for each distribution channel. Pricing strategy should also consider the future
Product Releases and Future Products.
For a service provider, distribution channels are not as important as advertising tools but the manufacturer’s business plan should clearly identify the distribution channels through which the product will reach the end user. Delivery options for a manufacturer may include:
• direct sales, such as mail order, direct contact by salespeople and telemarketing;
• Original Equipment Manufacturer (OEM), product integration into other manufacturers’ products;
• distributors or wholesalers; or retailers.
Each of these channels has its own advantages and disadvantages and financial implications, so they should be explained and explained in the business plan. Specify if more than one channel is used and it should be consistent.
Plans for product sales brochures, potential advertising plans, Internet strategies, 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 promotional activities selected and those not selected.
The business plan should also discuss the level of competition and competitors. If the company is first-to-market, the entrepreneur must explain how the market need is currently being met and how the new product will compete with the existing solution.
A VC will look to see how and why the company will win the competition. Try to anticipate a competitive response to the product. If possible, include direct product comparisons based on price, quality, warranties, product updates, features, delivery strategies, and other means of comparison. Document the sources used in the analysis.
– Business operations
The location and size of the facility should be discussed in the operations section of the business plan. Factors such as availability of labour, availability of materials, proximity of distribution channels and tax considerations should be mentioned. Describe equipment and facilities. If the company requires international distribution, state whether the operations facility will provide adequate support. If work is being outsourced to subcontractors, eliminating the need to expand facilities, state that as well. Investors will look for inconsistencies in the business plan.
Venture capitalists will also ask questions like: If sales forecasts predict 25 percent growth per year, does the current site allow for expansion? Are there suppliers who can provide the necessary materials? Is there an educated workforce in the area? Sales forecasts will determine the size of the operation and thereby the funds needed now and in the future. Include sources and uses of financing in the business plan and ensure that assumptions are realistic.
– Management team
Venture capitalists invest in people—people who have run or are likely to run successful operations. The team must have experience and talent in key disciplines: technical development, marketing, sales, production and finance.
Most start-up companies have a few founders with diverse backgrounds in the management team. In this case there is a gap in team skills and knowledge, it is necessary to mention how this gap can be filled. Include a board of directors or list of advisors: key industry or technology experts who provide guidance and credibility. This is another area where vacancies can be filled through referrals from well-networked investors.
– Financial forecasting
A realistic financial forecast is important to attract investors and retain their interest in future financing. Good financial forecasting integrates the performance goals outlined in the plan into the financial objectives so that return on investment, profitability and cash flow milestones can be clearly stated. Investors use these forecasts to determine whether (a) the company offers sufficient growth potential to provide the return on investment the investor is seeking, and (b) the forecasts are realistic enough to give the company a reasonable chance of achieving it.
The financial statements that investors are most concerned with are the balance sheet, cash-flow statement, and income expense statement for a period of three to five years. The VC will help in creating the process adopted for the development of the business, operations and overheads and the development of personnel and staff. It is also imperative that estimates include a footnote section that explains the key assumptions used to develop revenue and expense items.
A financial plan depends on important assumptions, which may be daily basis (credit days, charity, average stock turnover days) or annual basis (depreciation etc.) or any other unit of measurement which needs to be carefully stated.
Product development costs should be closely linked to product introduction schedules elsewhere in the plan. These costs are typically higher in the early years and decrease as product line extensions are less expensive to develop. A detailed set of cost (operations and overheads, staffing and personnel) assumptions should take into account headcount, space, selling and administrative costs, and major promotions.
The balance sheet should agree with the income and cash flow statements. The cash flow statement must relate to the balance sheet and income statement and match the timing of the funding requirements outlined in the plan.
– Amount and use of necessary financing and exit opportunities
State how much financing your business needs and from what sources (ie management, venture capital, banks, etc.) and explain the purpose for which it will be applied. Consider how venture capital investors will exit the investment and earn a return. Possible exit strategies for investors may include floating the company on a stock exchange or selling the company to a trade buyer.
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