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The ABCs OF GROWTH COMPANIES

Jim Verdonik

SMASHWORDS EDITION

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PUBLISHED BY:

Enlightus on Smash words

The ABCs of growth companies

All rights reserved. No part of this book may be reproduced in any form or by any electronic or mechanical means including information storage and retrieval systems without permission in writing from the copyright owner, except by a reviewer who may quote brief passages in a review.

Smash words Edition License Notes

This eBook is licensed for your personal enjoyment only. This eBook may not be re-sold or given away to other people. If you would like to share this book with another person, please purchase an additional copy for each person you share it with. If you're reading this book and did not purchase it, or it was not purchased for your use only, then you should return to Smashwords.com and purchase your own copy. Thank you for respecting the author's work.

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ABOUT THE AUTHOR

Jim Verdonik, the founder of SecTec Publications, has advised successful and unsuccessful growth companies and investors for more than thirty years. His clients have ranged from very young companies to public companies across industries such as software, semiconductors, biotech, medical devices, computer games, venture capital investors and investment bankers.

He started his legal career as a securities lawyer with a large law firm in New York City. After moving to the Research Triangle area of North Carolina in 1985, he expanded his law practice to coaching clients on a wide range of business and legal matters. He is listed in Best Lawyers in America for corporate law.

Jim’s counseling and advice to clients is based on the premise that the extremely smart people who start and grow businesses are usually missing experience in some areas that are important to the success of their businesses. For example, because earning a Ph. D. in one area requires focus and dedication, most people who achieve great things in one area have experience holes in other areas. This creates a “swiss cheese” effect. Successful people fill in their experience holes. Unsuccessful people often refuse to acknowledge their experience holes. Jim’s primary mission is helping clients identify and fill in the experience holes in their “swiss cheese.”

Jim utilizes a combination of different types of current experience and past back ground to help clients identify and fill in their experience holes. Jim’s experience ranges from technical legal and business training to working in the frontline trenches to develop practical street smarts:

Eight years practicing corporate and securities law in a large New York City law firm
Over twenty-five years advising technology based companies, entrepreneurs and investors in the Research Triangle area of North Carolina
New York City Taxi driver
Teacher
Peace Corps Volunteer
Journalist and Writer

Jim has volunteered substantial personal time to help create a healthy infrastructure for successful growth companies. The Council for Entrepreneurial Development and the Raleigh Chamber of Commerce both awarded him "Service Provider of the Year" awards for his service to successful growth companies. These efforts to help early-stage companies to succeed include:

Organizing a university based incubator for early-stage technology companies.
Organizing an angel investor club.
Advising two governors about programs to foster economic development by assisting growth companies.
Serving on boards of directors for organizations that assist growth companies.
Writing a state law giving investors in early-stage growth companies a 25% tax credit.

Jim grew up in Brooklyn, New York. Jim now lives in the Research Triangle area of North Carolina with his wife, Pam, and daughter, J.J. He works in Ward and Smith, P.A.’s the Business, Securities and Technology Groups. www.WardandSmith.com

CONTACT INFORMATION:

JimV@elearnsuccess.com

jfv@wardandsmith.com

(919)277-9188

ABOUT SECTEC PUBLICATIONS

SecTec Publications is a publishing business founded by Jim Verdonik in year 2000 to produce and distribute business and legal information media products and services.

SecTec Publishing’s mission is communicating complex business and legal issues in easy to understand language and formats that people of average intelligence and education can understand and utilize to build successful businesses. Our business is based on the following principles:

Usable Information = Success

Unusable Information = Failure

The name SecTec is a combination of Securities and Technology, which encompass the primary areas of our founder (Jim Verdonik)’s expertise, which he acquired in over thirty years of advising public and private companies.

Securities incorporates multiple areas, such as capital raising, venture capital, private placements, public offerings, public company disclosure issues, stock options and other executive compensation matters, corporate governance and fiduciary issues and buying and selling companies.

Technology incorporates intellectual property, licensing, distribution and other channel partnering matters.

SecTec Publishing Platforms include

Web Sites
Books
Newspaper Columns

eLearning Web Sites:

www.elearncuccess.com incorporates an e-learning course that presents materials from other media products published by SecTec Publishing on an interactive user-friendly platform that is most conducive to learning useful business practices and strategies.

Our mission in life is your Success.

Books:

The ABCs of Growth Companies
[NOTE: INCLUDE REFERENCE TO EBOOK OUTLETS WHERE CAN PURCHASE]

Newspaper Column:

Jim Verdonik’s nationally syndicated newspaper column called “Growing Pains,” deals with business, and legal issues of interest to growing companies, their management and advisers. Since 1997, we have published over 150 articles through American Business Journals www.bizjournals.com in several dozen newspapers that reach over four million readers, including local business publications in the following cities and regions:

The key to our newspaper success is reducing complex business and legal issues to their basic fundamentals so that readers can better understand the environment in which they are operating their businesses. We have built the same principles into our e-learning products on www.elearningsuccess.com, which includes copies of these newspaper articles, and our eBooks.

INTRODUCTION

I wrote this book for my daughter, J J, to teach her the things I have learned in advising growth companies for more than thirty years to guide her as she starts her business career. The basic theme of this book is that success in business is based on understanding the people who play different roles in any business and building successful relationships with these people:

founders - management teams

their families - directors

investors - employees

customers - vendors

It's critical that each of these stakeholders understands their own roles and the needs and goals of the other stakeholders. Ultimately, your business will fail, if you don't manage these relationships successfully.

I focused this book on growth companies, because of their importance to our economy and the fact that most growth companies, across many industries, face the same challenges, which revolve around how to obtain the resources to grow and how to manage that growth.

Although this book will be useful to people, who start and manage growth companies, ultimately everyone who works in, or deals with, growth companies needs to know what other people reasonably expect you to do and either satisfy or modify their expectations. Likewise, you need to know what you should reasonably expect other people to do in different situations, how to convince them to do it, how to reward them when they meet or exceed your expectations and what you should do when they don't. Your career will hit bumps, if you don't understand how to do this. Conversely, if you understand the objectives of others in your company, you are better prepared to give them what they need and to be rewarded for your contribution.

You also need a reference point to judge whether your current company that is going anywhere. If your employer doesn't grow, how will your career to grow? Growth creates opportunities for everyone. If your employer isn't doing the things it needs to grow, you should consider career alternatives. This book gives you a basis for judging your employer's progress, or lack of progress. Since many growth companies are planned to be sold (usually within five to ten years of starting), this book also serves as a reminder that you should be alert to signals that a sale is likely and determine what the sale means to your career. There are winners and losers in every sale. The winners are usually the people who know what's going on what it means to them. Don't bury your head in the sand.

I've tried to make this book relevant whatever the general state of the economy and to any business environment. In doing so, I've purposely refrained from using the words "globalization," "new economy," "old economy" and other trendy buzz words, which would tie the advice to specific times and circumstances.

People don't change nearly as fast as the buzz words change. Business is fundamentally about people and relationships between people. Evolution is a very slow process. So, this book focuses on the basic building blocks (like the alphabet) that you can apply to succeed in changing circumstances. The combination may change to spell new words, but the alphabet you use to communicate doesn't change, because human nature doesn't change.

I want to take this opportunity to thank my clients, my co-workers and my family for the experience and understanding they've provided me. They've all assisted me in writing this book. In advising growth companies for more than thirty years, I've seen some successful strategies, and many mistakes, of companies in a wide range of operations, including venture finance, strategic planning, partnering, launching new products and services, market penetration, cash flow management, personnel recruiting, compensation and retention, value realization and exit strategies. Like any good relationship, it's been a two-way street. My clients have taught me as much about starting and growing companies as I have taught them. They've taught me there's a pattern to growth. Understanding the sequence of events required to grow is an important planning tool. Each event is the basis for the next several events occurring. Growth builds on a foundation like a pyramid. That's why most overnight success stories don't really happen overnight. This book deals with all the major events in the life of a growth company.

The Major Events Timeline on the next page shows an example of how that sequence of events plays out in a software company as the company starts, raises money, develops and launches products and eventually exits. A slightly different set of events and timeline occurs for different industries, but looking at any industry provides a good template for organizing your own event timeline. If you are starting a company, a timeline like this is a good planning tool.

If you are seeking employment with a growth company, use this timeline to evaluate your prospective employer. Careers are determined as much by the dead end jobs you turn down or quit as by the positions you accept. If you are already employed, use this timeline to determine your company's future and how you fit into that future. Are you joining or in a company that is about to take off on a growth spurt or about to be sold or closed down? .Your career depends on knowing the difference.

I wrote this book to help my daughter navigate her way through the business world. If it helps you as well, so much the better.

MAJOR EVENTS TIMELINE

The following table contains a list of major events most young software companies

are likely to encounter over a five to ten year period.

CHAPTER

A is for ANGEL INVESTORS

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"She's an Angel."

"My Guardian Angel must be looking out for me today."

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Did you ever?

. . . sit in a restaurant or a bar and overhear words like these wafting across the room:

business plan . . .

burn rate . . .

monetization strategy . . .

pre-money valuation . . .

leverage . . .

exit strategy

You are listening to the mating call of two species; growth companies and venture capital investors.

If you want to participate in this activity in either role, you need to know some basic things.

FINDING, WINING AND DINING ANGEL INVESTORS

Angel investors are wealthy individuals who invest in young companies. Roughly 20% of wealthy people have invested in young companies, but fewer than 5% do so on a regular basis.

There are lots of wealthy people. Why are so few of them angel investors? You can't have capitalism without capitalists playing a role at every level of company development. Angel investors are capitalism's infantry. They get the tough job of slogging through the mud and take a lot of casualties, while the Generals (VCs, bankers, CEOs, etc) take all the credit. Very few people become rich as a result of being angel investors. They usually have made their money doing other things and are reinvesting some of that money. In the process, they take on much higher risks than other capitalists and often lose their entire investment. The key to dealing with angel investors is understanding their problems and working with them to minimize their risks.

Your job is to find the repeat angel investors. Repeat investors know the ropes and are generally easier to deal with than people you have to educate about this type of investment.

How do you find repeat angel investors? In many cities the repeat investors know one another and often co-invest with one another. Therefore, if you locate one repeat angel investor, that investor can often lead you to other angel investors.

Other good leads to repeat angel investors include company founders, accountants and attorneys, who have done investment transactions with such investors.

Also, for a fee, informal investment bankers called placement agents or finders can assist you to find angel investors. Be aware, however, that some investors don't want to have their investments used to pay fees to placement agents or finders. Also, some agents or finders may be overaggressive in selling securities. Make sure any agent or finder you use complies with securities laws. Carefully check the backgrounds of any agents or finders you use. Their past or current misdeeds can kill your company.

Most angel investors fall within the following categories:

Lone wolves - individuals who invest by themselves, either sporadically or as a business.
Dinner club groups - groups of investors who mix business and socializing with one another.
Organized angel groups - these are very similar to professional venture capital funds, except the managers usually are not compensated like in professional venture funds and angel groups usually invest smaller amounts.
Internet based angel networks - individuals in the network share information but usually make investment decisions as individuals.

One of the benefits of dealing with an organized angel group is the group of investors is more likely to give you the experience, contacts and financial strength you need than is any single investor. On the other hand, if no single investor in the group has a large investment in your company, there may not be anyone with sufficient motivation to provide much real assistance.

A basic characteristic of angel investors is some degree of wealth. What constitutes wealth in this context? Generally, net assets in excess of $1 million. However, not every wealthy person is an angel investor. Many wealthy people don't have the time for this type of investment. Others view this type of investing as too risky compared to investment alternatives. Angel investing is not for the weak of heart.

When you meet someone whose wealth would qualify them to be an angel investor, you have to decide whether to invest your time pursuing this individual.

Ask questions:

Has the person previously invested in a company like yours?
Did the person make money in the prior investments?
Have friends or family of the potential investor made this type of investment?
Does the person have business experience in the same industry?

If all four answers are "no", you're probably wasting your time.

Two or three yes answers, don't guaranty you'll get money, but it’s a good sign, because you won't have to spend much time educating the investors. Also, investors are likely to be more confident they can make an informed investment decision, if they know your industry. Lack of confidence in their own ability to identify good investments is the biggest impediment to doing angel deals. Invest your time with knowledgeable self-confident investors.

You will often meet people who seem genuinely interested in investing in your company, but you never quite seem to be able to close the deal. One of the most common reasons for this problem is the investor's spouse. Never underestimate the spouse's influence. In many cases, you have to sell both the investor and the spouse. Risk tolerance is the key issue. If the spouse has a low tolerance for risk, it may be impossible to close the deal.

It's highly unlikely an investor will tell you his or her spouse won't allow this investment. No one wants to admit they have to ask permission. You have to read between the lines. When dealing with angel investors who perpetually remain on the fence, either move on to other targets or make one last attempt by making your pitch to both the investor and the spouse.

Age also matters. Some older investors have lower risk tolerance, because they have shorter time frames for recovering from a bad investment. Retired investors also may have more time to kill with you. Beware. They may be seeing you as a form of entertainment. Busy risk - tolerant people, who are good at making quick decisions and, who know something about your industry, are your primary targets.

Usually, you won't achieve your goals by finding one angel investor. Most deals require anywhere from several to a dozen. This makes raising angel money a lengthy and time consuming process. To raise $500,000 of angel money, plan for a six to twelve month effort. Remember this before you quit your day job. On the other hand, some investors will be reluctant to risk their money until you make the personal commitment evidenced by quitting your day job. Timing is critical.

If you continue at your day job while you work on your business plan, new products or technology, consult with a lawyer about what to do to make sure your employer doesn't own the new idea or product you develop.

HOW TO CHOOSE THE RIGHT ANGEL INVESTOR

Well, you've been trying to raise money for over a year. You've been told your company isn't suitable for venture capital and your VISA capital is maxed out. However, your company has achieved several value milestones and, after chasing all over town for money, you find potential angel investors are no longer laughing at you. In fact, someone is starting to reach for his checkbook to make an investment.

This is a new situation for you. What do you do? Should you ask the bartender for a napkin, write up a stock certificate on the napkin and take the money before the investor sobers up? Or, should you get to know your potential new partner better before accepting an investment?

Like other relationships with strangers starting out under similar circumstances, you may be getting more than you bargained for. Unfortunately, with investors there are no successful one night stands. Investors are there the next morning, and the morning after . . . and they bring with them whatever problems life has given them. Divorcing yourself from an investor is messy at best, and in the worst cases can lead to the death of a good company.

Look before you leap. To choose the right investors, identify your goals and analyze how each investor will assist or impede reaching your goals. Of course, very few potential investors will satisfy all your needs. It's difficult to raise capital. You have to be flexible, but don't take money from anyone who is likely to impede achieving your goals. Consider some of the following issues:

Other Financing Goals. If you know you will need $10,000,000 in two years from professional venture capital investors, don't raise $500,000 now from 100 individuals. Many venture capital investors don't want to invest in companies with a large number of individual investors. Venture investors are more likely to accept a company with a dozen individual investors than a much larger group. Having a large number of investors also raises legal, logistical and expense issues. Initially, you may have to spend more money to comply with securities laws. Over time, you have to keep more people informed about what's happening with your company and listen to all their opinions or complaints. When they invest their money, they all have the right to complain. Also, angel investors sometimes invest on emotion at valuations professional investors would never pay. If you later raise money from professional investors at a lower valuation, the "down round" may create a dissatisfied angel investor group, which can cause you problems, because they own part of your business.
Financial Strength. Will the investor be able to assist your company in future rounds of financing? This issue concerns both the investor's financial resources and willingness to use them. Both should be discussed with the investor. Has the investor made follow-on investments in other companies? If your investors fail to participate in later investment rounds, they will suffer dilution and you may be forced to raise capital for a low valuation.
Investor Participation. Do you want an active partner or a silent partner? Many companies benefit from advice and contacts provided by their investors. It may be wise to sell stock at a lower price to someone who can help your company, even if you could obtain a higher price from others. Identify the areas of expertise and contacts where the existing management team is weakest. Seek out investors who are strong in these areas. Find out how much participation the investor plans to have in your business. There is no general "right" level of participation. You and your investor just need to agree on how much participation is desirable.
Ethics and Reputation. If you lie down with dogs, expect to get fleas. Investors with significant legal, financial or ethical problems may pose serious problems for your company. They may create legal impediments to raising capital under federal and state securities laws. Other investors, lenders, customers and suppliers may hesitate to deal your company. At best, some may question your judgment. In the worst case, some may assume you are guilty by association.
Competitors. One of the biggest threats to a company is that a competitor will use an investment to obtain information or use its investment position to block your company's development or steal your trade secrets. You should, therefore, be certain your investor is not a spy for a competitor.
Compatibility. If you and an investor have different goals, management styles or personalities, continuing disputes may demoralize you and your employees or otherwise make your life miserable. Identify potential problems by discussing your business in depth and soliciting the investor's views. Ask the investor about his business. Talk to people who work for, or otherwise know, the investor. Contacting the management of companies in which the investor has made prior investments is particularly useful.
Exit Strategy. Discuss in detail how your investors will exit and make a profit, including the expected timeframe and return on investment (ROI). Investors expecting to exit in three years can become "grouchy" after five years. Also, if you sell stock to someone who could potentially buy your whole company, they may be in position to later block sale of the whole company to another buyer, thereby lowering the sale price.

Checking out an investor won't scare off a serious investor. If anything, the investor should be pleased you are thorough. After all, he's trusting you with his money.

STRUCTURING THE DEAL

Here are some tips for moving a deal forward from the time the investors psychologically "buy-in" to your pitch until closing.

Be prepared to put a price and other deal terms on the table. Many angel investors don't have an established set of deal terms like professional venture capital investors do. Circulate a term sheet. Don't wait for the investor to send you a term sheet.
When someone says they are interested in investing, ask them to sign a one page form letter indicating they want to invest in your company. A moral commitment is very useful to moving forward to close a deal. Many people won't back out of a moral commitment, even though it's not legally binding. Such letters are also useful in giving other angels the courage to invest. Often, no one wants to go first, but if you have other investors committed in writing they will jump on the train as it leaves the station.
Operate on the principal that investors always have the right to back out until the deal actually closes. It's foolish to try to legally bind people to invest. Their personal circumstances may change. If you force them to close anyway, they are likely to cause you trouble as a shareholder. Remember, shareholders have the right to attend and speak at meetings, demand to inspect corporate records and bring law suits to challenge decisions by the CEO and the Board of Directors. Unhappy investors can drive you crazy.
Angel deals have a wide range of structures and terms, unlike investments by professional venture capital investors, which tend to follow a fixed model. In some angel deals, the investor makes a loan to the company. In other deals the investor purchases common stock, preferred stock or a warrant. Angel investors sometimes guarantee bank loans instead of paying cash for your company's stock. The key to doing a successful angel deal is to keep the terms simple so investors understand the deal. Keeping the deal simple will also reduce legal expenses, which is important in all small deals.
Some angel investors are motivated by tax considerations. For example, they may want to be able to deduct your company's losses from their taxable income. In that case, they may want to invest in a Subchapter S company or a limited liability company. This may not be consistent with your long term goals, if you want to later raise a large amount of venture capital. Professional venture capital investors rarely invest in tax pass through entities.
Valuations in angel deals tend to vary widely from one investor to another compared to professional venture capital investors, who often reach very similar valuations. One angel investor may give you a valuation that's substantially higher or lower than other angel investors or venture capital investors. Both venture capital and angel valuations have subjective factors, but the subjective factors in valuation mean more to some angel investors than to others. If you don't like the valuation given by one angel, you may get a substantially better deal from another angel. Although everyone wants to get the best price, beware. Unrealistically high valuations in seed capital rounds from angels can cause problems in raising larger amounts of capital in future rounds. Professional venture investors may give you a lower valuation in later rounds. When you have to raise money at a lower valuation, your angel investors may be upset. Also remember that a low valuation results in relatively little dilution to you, if you are raising only a small amount of money. Therefore, dilution is only one of many factors to consider in an angel investment.
Angel investors often are one shot investors. They often are reluctant to invest in later rounds. This is dangerous for both the investor and your company. The risks include your company going out of business for lack of capital and investors suffering substantial dilution. To protect their investment, angels should have the financial ability to invest at least three times their initial investment over a period of several years. Discuss this issue with angel investors. This will limit the number of people who are good angel investor candidates, but it's important for both you and your investors to understand the risks each of you are running.
Disclose the risks of investing in your company more explicitly when dealing with angel investors than with a professional investor. If possible, make your disclosures in writing. People have short memories, especially if the company falls on hard times. Written disclosures can be made in informal letters or emails. They need not be in a formal legal document, but save the letters and emails to remind investors about your disclosures.
Raise enough money to allow your company to achieve a milestone that increases your company's value. Many companies get in trouble, because the small amounts of money raised is barely enough to keep the doors open. The investment money is spent before the company can make progress in achieving its business plan. As a result, it's still difficult to raise capital and you may lose money for your investors, if you don't raise enough capital. Discipline yourself to set a capital goal that allows you to increase value, reduce risk and makes it easier to raise more money. Don't take investments until you have raised enough to achieve that goal. It's tough to discipline yourself to delay taking money when you need it desperately, but it will avoid later trouble. A mechanism for doing this is for investors to deposit money into an escrow account, which you can't touch until an agreed amount is deposited. Also, smart angel investors will want to know what milestones you can achieve with their money to protect themselves against dilution. Be prepared to tell them as part of your sales pitch.
Finally, in trying to put together a group of investors, different investors may have incompatible goals or want terms that are incompatible. Getting the investors to agree on one deal may be a problem. This is probably the most frustrating situation for a founder. You are willing to do any one of the proposed deals, but the investors can't agree. Meanwhile, you get no money. Be prepared to play the role of arbitrator.

POSITIONING FOR FUTURE DEALS

Angel valuations and deal structures often cause later damage to companies.

Angel investors often are willing to purchase common stock, whereas professional venture capital investors usually insist on convertible preferred stock or convertible debt. Since preferred stock or convertible debt usually comes with rights that are adverse to the founders of the company, you may want to sell common stock to angel investors.

Before you do, however, consider that when the angel investors see the terms of the later venture capital deal they may feel you have taken advantage of their lack of investment experience. As they are now your shareholders, they can make it more difficult for you to run your company. Also, some founders start more than one company in their lives. Treating your angel investors right is a good way to position yourself to raise money from them for future ventures. Sometimes it's wise to give angel investors better rights than they request to establish a good long-term relationship.

Another reason not to sell common stock to angel investors is the sale will establish a market value for your company's common stock for tax and accounting purposes. This can limit your ability to recruit a strong management team and good employees.

Many small companies attract their team by granting restricted stock or stock options. If you grant stock to employees, they will have to pay taxes on the amount by which the market value of the stock exceeds the amount the employee pays. If options are granted, the options must have an exercise price equal to the market value of the stock, but the option grant is usually not a taxable event for the employee. Options with a low exercise price are more attractive and useful in recruiting. Stock and option grants also affect your financial statements. The tax and accounting rules change over time. You need professional advice about how to deal with the issues to minimize adverse consequences.

If you don't sell common stock, but instead you sell securities with other rights, then your deal won't establish a firm market value for the common stock. This gives you greater flexibility in rewarding employees with lower stock or option prices. Therefore, you want to consider the impact of your capital raising transaction on your equity compensation policies.

Another problem with trying to sell common stock, or any security with a fixed price, is it forces you and the investors to agree on the company's value.

Valuing very early stage companies is a very subjective process. You and your angel investors may not be able to agree. Long negotiations about value only delay your company getting the money you need to grow.

One deal structure for addressing all these problems with seed investments is to delay valuation by selling debt securities convertible into the type of security sold in the first professional investment round. The debt is converted into stock at the price of the next round. This delays all valuation issues and avoids pricing the common stock for stock option purposes. To reward the angel investors for investing earlier than the first large venture round, the angel investors also receive a warrant allowing them to buy more shares at a fixed price. Later investors don't receive this warrant, because their risk is lower than the earlier investors.

CHAPTER

B IS FOR BUSINESS PLAN

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"Let's see your Plan."

"I'm working on the Plan."

"They're behind Plan."

"We're meeting Plan."

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People constantly talk about business plans. Business plans are important, but beware. Don't become so preoccupied refining your Plan, you never get around to building your company.

KNOW WHEN TO STOP

One common pitfall is some people think the Plan has to answer all questions about the business. In fact, most companies change their Plans many times as the business evolves. New issues and questions almost always arise and companies simply have to adjust their Plans. Even very successful companies almost never develop precisely according to the original Plan. If that's true, then one of the most important things about doing a business plan is to know when to stop planning and start implementing.

Approach a business plan like a scientist approaches formulating and testing a hypothesis. Formulate your hypothesis based on your observations of reality. Implementation is the key to getting the facts required to adapt the Plan to reality. Trying to write the perfect Plan before you begin implementation is like writing a treatise on the theory of evolution without ever leaving your bedroom. Charles Darwin had to get out of his study and experience the Galapagos Islands to succeed. You need to test your business plan against reality like scientists test and refine a hypothesis. Therefore, a business plan is like all living things, it needs to change over time.

PURPOSES

Business plans serve many purposes, including:

Serving as a general guide for the team.
Getting team members excited about the company.
Setting milestones to help management and the Board of Directors determine whether the company is succeeding.
Allocating resources.
Raising money.

Unfortunately, the last purpose often overwhelms all the others, especially in a company's early stages of development.

Resist the temptation to let capital raising drive your business plan. Remember, you're making a big investment in your business in time, effort and money. The best business plans describe what the founders would do, if they could fund the company themselves. The biggest question is: Does your business plan justify your own investment? You assume that it does at you and your family's peril.

When the self-funding plan is complete, you know what you want to do and should do. After you determine that, you have a base line from which to judge whether it's worth making the changes necessary to raise money. In some cases, the things you will need to do to raise money may be at odds with what you really want to do. It's important to identify these issues early.

PROCESS

A business plan should reflect the vision of the founders. Never hire someone to write the Plan. Although you may benefit by asking other people questions about particular areas before you write the Plan, the founders should go off into the wilderness alone to do the first draft of the Plan.

After the founders are finished, other team members should give their input.

Only after the team is finished with the Plan should you open the Plan up to comment by professional advisers.

Professional advisors are good for (i) asking questions you assume everyone knows the answers to, but don't, (ii) helping you to position the Plan so it's understandable by people not already immersed in your business, (iii) helping you to anticipate and answer questions investors will ask and (iv) comparing your Plan to other plans they have seen.

PRELIMINARY WORK

Before you write a single word of your business plan, organize what you know about your business into the following categories:

What you know you know
What you know you don't know

Then start asking questions about each piece of information in both categories. With a little analysis, some items will shift categories as you find that you didn't really know some of the things you thought you knew and that you now know some things you didn't know before.

Now add the two most important categories with the biggest risks to your business. This is where you get blindsided.

What you don't know that you don't know.
What you think you know, but don't really know.

Investors who have been burned before on earlier investments will be most concerned about what you don't know you don't know and what you think you know, but don't really know are what keeps you awake at night. You should be concerned too. As you refine and execute your business plan, continually test information to determine which of these categories apply. If you are doing the right things, expect information to change categories as you learn more about your customers and market.

CONTENT

People often overcomplicate business plans. The business plan merely tells the company's story. As any reporter can tell you, the best way to tell a story is to answer the following questions:

Who?

What?

When?

Where?

Why?

How?

You should have the basis of a good first draft of a business plan, if you answer these questions. It's not sufficient to ask and answer their questions once. As you drill down into different parts of your business you have to ask and answer these questions about each aspect of your operation. It's like an onion. Each layer leads to another inner layer with its own questions and answers. After that, it's usually a matter of deciding (i) in how much detail to answer the questions and (ii) in what order the questions should be answered. You can look at the business plans of other companies as a guide for these issues. The best approach often varies by the experience preferences of your potential investors.

BUSINESS PLAN OUTLINE

Executive Summary

The executive summary is the most important part of your business plan. If the summary isn't compelling, most investors won't waste time reading the rest of your plan. Here are the types of things you need to put into the summary, but don't blindly follow this or any other checklist in creating your summary. Remember, your summary must be compelling. Since no two businesses are the same, what is compelling will naturally differ. Often, compelling means explaining why your business differs from the rest of the herd.

Concept - What distinguishes your company from others in the pack?
Target Market or Opportunity - Who will buy your product? How many buyers are there? How much money do they spend? How large is the market? How quickly is the market growing? Why is it growing?
Strategy - Why will you win? What is your Competitive Advantage and how will you use it against competitors?
Compelling Product, Service or Technology - What does it do and why is it important to customers? Is the product "disruptive?" Will it change competitive dynamics in the market? Why? How long will you have this advantage?
Revenue Streams - For what products or services will customers pay? Will there be recurring revenue from the same customers or one-time sales? Most investors like recurring revenue models. If your revenue is primarily recurring revenue, highlight that to investors in your Executive Summary and all your presentations. Recurring revenue is usually associated with monthly or annual subscriptions that customers are highly likely to renew, because your product of service has become an integral part of your customers' businesses. Investors like and value recurring revenue more than other types of revenue, because it builds a platform of existing revenue onto which each new sale is added to grow the business. Its difficult to be a high growth company if most of your sales each year just replace sales from the prior year. The other benefit is that it makes your revenue more predictable, which means you its easier to make sure your expenses don't unexpectedly exceed your revenue. Investors also like recurring revenue, because buyers place a higher value on recurring revenue when you sell your company, which increases investor ROI. If most of your revenue isn't recurring revenue, you should either change your business model or lower your expectations about how much money you can raise and at what valuations.
Management Team - Focus on the CEO and a limited number of other key people. Identify the part of their experience most important to your company's success, not their entire biographies. If team members have worked together before, point it out. Prior experience of team members with one another reduces the risk they can't work together. Have they built successful companies before?
Capital Needs - How much money will you need? When will you need it? The amount you need to raise should match the size of your market opportunity. Timing and purposes should be tied to specific milestones that increase the value of your company. Tying the timing of future investment rounds to value milestones tells investors it's reasonable to believe later rounds will be priced higher than the current round. This is critical to achieving the valuation you want, because it reassures investors about the extent of future dilution.

Business Plan Outline

Address risks and challenges in the order investors are most likely to be concerned. Tell how you will deal with the biggest risks.
Present clear solutions to minimize risk. If it doesn't work out like you expect, is there a back up plan?

Examples of the types of Risks and Challenges you should address include:

Product - What is it and why will people buy it?
Competition - Who are they and what might competitors do that could affect you? Are there barriers to entry into your market by competitors?
Market Risk - Is the market developed yet? What parts of the market will you seek to penetrate first and why?
Technology Development - What does it take to successfully develop the product? What is off-the-shelf and what is cutting edge science? How long will it take?
Manufacturing Costs - How will you be price competitive?
Sales - How long is the sales cycle? Who makes the decision to buy within the customer's company? Do they control the purchasing budget? Who will sell for you?
Pricing - What factors affect how much are people willing to pay for your product?
Management Risk - Which team members are on board and which ones will need to be recruited? Which ones are experienced hands?

Projections

Big Picture - Yearly projections show the value-building picture.
Micro Picture - Monthly projections show when financing is needed compared to milestone achievement.
Length - Eighteen months for monthly projections and quarterly projections for three years, beyond that it's anyone's guess.
Assumptions - What are your assumptions and why are the assumptions reasonable? In particular, focus on what part of your revenue is recurring revenue and the extent to which your expenses grow as your revenue grows.
Variances - What happens if your assumptions are wrong?

COMMON BUSINESS PLAN MISTAKES

Never say "We have no competition." Everyone has a competitor. Investors just assume you don't know enough about your market to know who your competitors are. This means they think you are flying blind. The key to most battles is knowing your enemy. You have to know and understand your competition to win. What you really mean is that we are doing something our competitors aren't doing now. If you say you have no competitors, you will miss the opportunity to tell investors why your strategy or product is better than your competitors.
Don't make up things or skip over areas in which you are weak. Address issues head on. If you lack information about some issue say in the plan that you intend to do further work in that area. That tells investors you know what you don't know, which is a lot less risky than not knowing what you don't know.
Avoid using glowing general words like "unique," "best," "revolutionary." You usually can't verify these words are correct. Just as important, you want investors to reach these conclusions themselves after reading your plan.
Clearly distinguish timing. Don't give the impression all features of your product are ready, if all you have is a simple prototype. Clearly distinguish between:

What you have already accomplished
What you are doing now
What you plan to do in the future
When you plan to do it and what resources you will need to do it

Don't assume customers will buy your product immediately. Selling takes time and money. Revenues don't ramp as quickly as you think. Showing substantial revenue soon after product launches is usually unrealistic. Likewise, ramping up sales quickly is difficult and usually expensive. Large quarterly sales increases are usually unrealistic, especially if your sales are not primarily recurring revenue or if you lack a substantial marketing and sales budget.
Don't underestimate the amount of capital you will need. It always costs more than you expect.
Don’t assume that initial success means continued successes. Competitors will react to your initial success. You will have to adjust to their reactions. Show your investors you know that by discussing likely reactions and how you intend to deal with them into your Plan.

CONFIDENTIAL INFORMATION

Don't put valuable confidential information into your business plan. Most investors refuse to sign confidentiality agreements. Even if someone signs a confidentiality agreement, proving they used your information can be very difficult and expensive. Your best defense is not to circulate valuable confidential information. Focus your plan on what you intend to do and provide less information about how you are going to do it. This is yet another reason to send the executive summary of your business plan to investors before you send your full plan. After you initially spark investor interest and develop a relationship, you can begin to disclose more detail. Investors are more likely to sign confidentiality agreements at the end of their due diligence process than when they first receive a business plan. The confidentiality agreement at this later point would be a condition to reviewing a limited amount of trade secret information-your company's crown jewels.

POSITIONING FOR INVESTORS

After you have the basic Plan, it's time to think about positioning the Plan to make it understandable by different audiences. This is most important when the Plan is to be sent to investors. Investors generally:

are sent many business plans.
lack sufficient time to evaluate thoroughly all the plans they receive.
may not understand the jargon of your industry.
are not under any pressure to invest, you have to make them WANT to invest.

In writing your Plan, remember this secret. Many successful business people are not avid readers. As people rise in importance in the business world, they often only read summaries of documents reduced to bullet points by other lower paid staff. Some very successful people never liked reading and they have avoided it since they left school. Their days in the business world are filled with meetings and telephone conversations. Computer graphics and television have accelerated the trend away from complex written communications. The world is dumping down even as education levels increase.

When I was a young lawyer in a large Park Avenue law firm in New York, one of the firm's best clients was a venture capital investor. He wouldn't read any paragraph I wrote, if it was longer than three sentences and wouldn't answer a written question in a memo, if it couldn't be answered "yes" or "no." This was how he budgeted his time and forced others to boil issues down to the basics. If you can't describe your business simply, many people will assume you don't really understand your business. Often, they will be right.

The Securities and Exchange Commission requires public securities disclosure documents to be understandable by anyone who reads at the 5th grade reading level. What does the SEC know about the reading levels of investors that you don't? Imagine what happens to business plans with dense pages of text written by a Ph.D. in genetics using the same language used with academic colleagues.

To maximize the likelihood investors will read your plan and contact you to discuss it further, you should write a Plan that:

has an executive summary readable in five minutes (3 to 5 pages).
is understandable by anyone.
distinguishes your plan from others in the same space.
anticipates the big picture questions investors are likely to have.
corrects common misconceptions about your industry or market.
demonstrates you know the risks and you have a strategy to minimize the risks.
shows the investor it's financial goals can be achieved, if the Plan is implemented successfully (even perfect implementation of a small market opportunity may not result in sufficient financial returns).
demonstrates there are fall back scenarios for a decent financial return, if implementation is not perfect.

PLAN FORMATS

To get your message across, create your Plan in a variety of formats. You need to do a little homework before you send your plan. Send the best format for each potential reader. What one person finds compelling, may turn off another person. Matching the format to the reader will depend upon a number of factors, including your prior experience with how the person best assimilates information, how much the person already knows about your company or its industry, how much time the person is likely to devote to reading the plan and whether the person is a potential investor or someone who may introduce you to an investor.

For example, it's probably overkill to give the guy you are sitting next to on an airplane a copy of your full plan. Odds are, he won't read it. He may, however, read a three page summary and pass the summary to someone who may have an interest.

You should be prepared for whatever game you track down, if you have the following arrows in your quiver:

Complete Business Plan
Executive Summary
One-Page Fact Sheet
Presentation Graphics
Presentation Graphics with Presentation Text

Have each of these in both digital form and hard copy so that you are able to distribute them either in person or by email.

Try to meet with potential investors before you send a business plan. Investors tend to invest in people. If you impress the investor, your plan will get more attention. Ask someone who knows the investor to set up a meeting. If that fails, either call to set up an appointment at their office or find out what conferences or other public meetings they are likely to attend and ambush them. Don't monopolize the investor's time. Your initial meeting need not be very long for you to succeed. Your sole objective is to make a positive impression to convince the investor to read your business plan. If you sense an investor isn't interested, ask what you would have to accomplish to interest him. Then ask if the investor would be willing to take another look after you accomplish the investor's milestones. In the alternative, a brief meeting may be enough to enable you to determine that further pursuit of this investor is pointless. You may be so far apart that you can never get into the investor's sweet spot. If so, move on. You can't argue your way to an investment. Crossing an investor off your list is progress. Remember it never hurts to ask if an investor knows other people who might be interested. The problem may be a simple mismatch between your company and that particular investor's criteria or timing. Investors after know others who are a better match. Some investors may be reluctant to give you the names of other investors, because of privacy issues. If the investor is willing to forward your business plan to his contacts, you may actually be better positioned than if you contact them yourself.

ORAL PITCHES

After you write your business plan, be prepared to personally sell your Plan to investors, lenders and others. Prepare pitches of several different lengths and levels of formality. Remember, your pitch is about SELLING. It's not an educational seminar.

Elevator Pitches. Be prepared to summarize your plan in one minute without graphics. This is called the elevator pitch, because you should be prepared to sell to any audience in the short period of time it takes an elevator to reach its destination. The purpose of the elevator pitch is to interest someone to read your business plan or to introduce you to an investor or send your business plan to an investor.
Conference Pitches. At venture capital conferences companies present their business plans to an audiences of hundreds of venture investors. These conferences are held in different cities across the country almost every month of the year. Presenters are generally allotted between five and fifteen minutes. Good graphics that capture the critical points of your plan are a must for these formal pitches. The purpose is to interest investors to read your business plan. You don't need to be on the official program to benefit from these conferences. Buy a ticket and work the halls delivering your elevator pitch to potential investors. Many investors spend more time talking in the halls than they do listening to the formal presentations.
Private Meetings with Investors. If a venture capital investor likes your business plan, you will probably be asked to meet with one or more representatives of the investor. Ask how much time your pitch should be compared to time for questions. Ask the investor for feedback about your written plan. What issues are most troubling? What areas need clarification? Tailor your pitch to the time constraints and comments from the investor. If an investor has three investments in other companies in your industry, you don't need to spend five minutes giving industry background. That five minutes is better spent telling the investor why your company is different from the companies he already knows. Some meetings with investors occur before they have read your business plan. In that case, your goal is to convince them to read your plan. If the meeting occurs after the investor has reviewed your plan, your goal is to have them do a deeper analysis of your plan or to ask a more senior person in their organization to read it, or to start to do preliminary due diligence.
Partnering Presentations. If you are seeking a strategic alliance with a large corporation, your presentations will probably range from informal one-on-one meetings to formal presentations to personnel from several departments. The key difference between meetings with corporate partners, compared to meetings with venture investors, is the investor's goals. Venture investors are concerned only about the rate of return on investment (ROI) they can achieve from investing in your company. Direct financial return on the investment is usually a secondary concern to strategic partner investors. In a meeting with a strategic partner, your highest priority should usually be to explain clearly how your company can help the partner's business. To do that, you have to know a lot about your partner. Do in-depth research about your partner before your meeting. Partner presentations are often more detailed and technical than those made to investors, because the audience is more likely to already know the industry and its jargon. General education isn't required. You need to get to the point quickly or you will lose your audience. Beware. Your potential partner may also be a potential competitor. Carefully prepare your presentation to give enough information to stimulate interest in your company without giving away trade secrets. It's a delicate balance. Finally, be aware of internal politics. Investing in your company might mean fewer resources for one department in your strategic partner. You want to obtain information before and at each meeting that enables you to demonstrate how each interested group within your strategic partner can benefit from partnering with your company. Telling the head of R&D that his department can be eliminated or substantially reduced won't win you a friend. You need to know your audience.

Whatever the form or purpose of the presentation, here are a few tips to remember:

Rehearse Your Pitch. After you finish rehearsing, do it again and again and again. You should be able to do it in your sleep by the time you finish rehearsing.
Time It. It's usually longer than you think.
Outsiders. Rehearse your pitch to an audience of people who are not part of the management team. They will see things needing clarification better than team members. If your audience includes people who have seen many companies make presentations, their comments are likely to be even better.

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