Jessica D. Herrin's first experience presenting a business plan to investors taught her many lessons, including a hard-knocks course in humility. During the dotcom boom, Herrin's plan for an online wedding gift registry called for selling products directly to consumers and also through retailers. Herrin, a business school student at the time, lacked wedding industry experience, so she didn't know retailers would never support a startup that competed with them. "When we presented the plan, people looked at us like we were crazy," Herrin recalls.
But the 34-year-old Burlingame, California, entrepreneur turned out to be crazy like a fox. She revamped the plan to employ a retailer-only distribution system and eventually got funding for her gift business. And before she even began to solicit investors for her latest business, a custom jewelry maker, she spent time with a retailer partner who showed her the industry ropes. As a result, Herrin was able to quickly raise the $350,000 in seed money Luxe Jewels needed to get off the ground in 2004. Today, Luxe has $1.2 million in sales, 10 employees and a CEO with a strong appreciation for the power of avoiding deal-breaking mistakes in a business plan.
Business plan experts, venture capitalists and entrepreneurs say Herrin's experience is common. Many business plans sport fatal errors that virtually guarantee a hostile reception from lenders or anyone else who views them. Unwary entrepreneurs plant red flags throughout their plans, from the executive summary to the financial statements, says Linda Pinson, a Tustin, California, business planner and author of Anatomy of a Business Plan. But the most common mistake, Pinson says, is a broad lack of internal consistency. An entrepreneur will, for instance, describe marketing costs one way in the section on marketing, then give another figure for marketing costs in the financial statement. "That's the kiss of death," Pinson says. "If [the business plan] doesn't work, how is the business going to work?"
Entrepreneurs can, however, make even flawed business plans work-if they are alert for business plan red flags and either remove them before presenting or correct them for a second go-round. Rhonda Kallman, 46, spent years fruitlessly asking angel investors to put $1 million into her Boston beer startup, New Century Brewing Co. Then Kallman realized she was thinking too small. She revamped her plan to request $3 million, on the theory that the larger amount would allow her to describe a faster-growing company with more upside. "The investors want to see huge upside potential," explains Kallman, a veteran entrepreneur who co-founded Boston Beer Co., maker of the Samuel Adams beers. A company founded on $1 million, she reasoned, was seen as a smaller opportunity than one requiring $3 million. Now, equipped with a $3 million plan to bring unique light beers and caffeinated beers to market, Kallman is more optimistic about her chances. "I'm showing them what my needs are," she says, "and how I plan on raising the appropriate amount of capital to execute my plan."
Elements of a Plan
If you're looking for red flags in your own startup's plan, start with the executive summary. The biggest problem with most summaries is that they're too big, says Stephen Dukker, a veteran entrepreneur and startup advisor in San Francisco. "If it takes more than two or three slides to communicate the overall picture of what your company is, you're going to either lose interest or you're going to confuse them."
Similar problems afflict the product and service sections of many plans. "People get too involved with the details," says Bart Greenberg, a Costa Mesa, California, attorney and startup advisor. "They forget investors aren't as interested in the product as they are in the market and how much money they are going to make." He suggests entrepreneurs devote more space to outlining the benefits to customers.
In the section describing the company itself, entrepreneurs often make the opposite mistake by skipping over essential facts, Greenberg says. He sees many plans that don't address the question of how the company will deal with regulators or other critical issues. "For example, if you're in the health-care industry, people want to know if you're private pay or [Medicare]," he says. "Because if you're Medicare, they know it's going to take six months longer to get paid."
Market Faux Pas
One of the best-known business plan red flags pops up in marketing sections that contain the "1 percent fallacy." This mistake involves describing a huge market, then saying, "If we can just get 1 percent of that . . . ." Plans with any variant of that error receive short shrift from the likes of Nat Goldhaber, managing director of Claremont Creek Ventures, a venture fund in Oakland, California. "Anyone who comes in and says the market is X, and we stand to get 10 percent or 20 percent, almost always gets thrown out," Goldhaber fumes. "I want to know why entrepreneurs believe they are able to capture a percentage of the marketplace. Tell me what you're going to do to capture that percentage."
Startups often misstep by scaling their marketing plans either too broadly or too narrowly. Pinson says going too broad is the most common error. "They have an unrealistic target market," she says. "They haven't narrowed their market down to the customers they will be able to reach."
But it can be an equally serious mistake to confine yourself to a niche that isn't big enough to interest investors, says Munjal Shah, 33, CEO and co-founder of 45-person Riya Inc., a San Mateo, California, visual image search startup. Though it's fine to start in a niche, Shah, who has raised $19 million in two rounds of financing for Riya, says investors want to see a way for you to parlay a toehold into a sizable chunk of a bigger market. "You have to have an idea that's really big," he says, "because high-risk investors need high return."
Whatever you do, don't underestimate the competition. Greenberg says entrepreneurs often downplay the power of existing competitors in a market, as well as what it will cost to unseat established brands.
Shah goes further, saying many startups deny the existence of any competition. "As soon as you say that, every person in the room turns off to you," he warns. "You may not have competitors, but you do have substitutions. Analyzing what that substitute is and whether it's good enough is where [entrepreneurs] fall down."