Whilst a professional business plan is no guarantee of success, it certainly goes a long way towards displaying the relative knowledge and experience of the business owner. Ultimately, an entrepreneur may have an innovative and disruptive idea, but without the relevant business acumen, they are unlikely to succeed.
Then there are startups that are simply non-starters, businesses with a chequered financial past, and startups too new to the market to be of interest to a capital investor seeking an expedient return.
How do you sift through the multitude of business jargon to find the eligible startup that is right for you? When reading a business plan, consider these the 10 most essential elements to search for in the plan. The presence or lack thereof will guide you to ventures with the lowest risk factors and the highest potential Return on Investment (ROI).
Unit Economics
First, it may be necessary to provide an explanation of the term unit economics. This is essentially a method of evaluating the revenues and costs associated with a business plan, assigned on a per unit level. Such elements include the production cost per unit, shipping and logistics costs, the price the end customer pays, and how much different distribution channels pay per unit (if applicable).
Whether reading the business plan of an entrepreneur you are considering investing in, or one that offers information for a potential client-investor relationship, the unit economics are the most basic information required in order to make a sound investment. This is because the data gives you insight into the profitability of a business, allowing you to make predictions about the break-even point of a business and how this measures up against the opportunity cost.
Market Segment
Also known as the target audience, this dimension will tell you as much about the understanding of the business owner as it will the validity of their business plan. Market segmentation is the cornerstone of any business, as the wise entrepreneur knows they cannot be all things to all people.
With a keen eye, look at how the product is positioned: Has the market been segmented specifically enough? Are the target segment needs met by the functionality of the product? Is this segment capable of generating profit and can you reach them efficiently in terms of cost?
By understanding the businesses segmentation and targeting, you can gain insight into the potential limitations of the business, as well as further opportunities for growth. This is especially important when handling first-time entrepreneurs who may have limited experience in business. A good business plan will have a defined market segment it is targeting, as well as quantitative data on the segment size and the cost of reaching the segment.
Competition
To provide absolute clarity on this point: every business has competition of some form. No matter how innovative or disruptive the idea, no matter how new the market or industry, no startup runs a monopoly. It is true however that this competition may take many forms other than a direct competitor, be it a substitute product or newer entrants to the market.
A business plan that does not mention competitors indicates one of two things:
- The business model or the market, in general, is unprofitable or otherwise untenable.
- The business owner has no idea who the competition is.
The first option is an obvious non-starter for an investor. The second shows a serious lack of business acumen on the part of the entrepreneur – though this is not necessarily desirable, the experienced investor may be willing to offer significant guidance in this case, depending on their individual belief in the product.
Every business should be aware of its competitors and a solid business plan will include not only their relative positioning and product offering but also financial and statistical data. Knowing your competitors is crucial to staying ahead of them, and one of the benefits of investing in small businesses like startups is the flexibility that allows them to adapt to their competition.
Cash Flow
While profit and loss statements and revenue projections are interesting for the casual observer, they can often be used to disguise fundamental flaws in the operations of the business. This particularly relates to a business’ cash flow, and remember, as the investor it’s you that’s going to be financing these daily operations.
A wise investor does not expect a business to turn a profit starting on day 1, but an eventual return on investment (ROI) is the ultimate objective. This is where you, as a well-informed investor, should perform a bit of detective work. Remember, entrepreneurs wish to present their businesses in the most attractive light in hopes of generating the most capital, but if a business plan fails to mention cash flows, this is a red flag that needs to be addressed before making any substantial investment.
Realistic Expenses
With an emphasis on the word ‘realistic’. Again, in the effort to appear like an attractive investment opportunity, inexperienced entrepreneurs have a tendency to inflate estimates, and this extends to projected expenses.
A good business plan should include estimates for all business expenses, or indirect costs (those not directly related to the production). If an entrepreneur is forecasting momentous growth, this is unlikely to come to fruition operating out of their home office whilst remaining a one-man show. For a business to grow, so to must their expenses, and to ignore this in a business plan shows naivety on the part of the business owner.
A professional business plan will go into greater detail, with each department having its own expenses. For example, the marketing department will have a breakdown of estimated expenses separate from the HR department, and a planned contingency fund should be included as an insurance policy. As an investor, you should educate yourself about the realistic costs associated with the business, and cross-check them with those stated in the business plan.
Experienced Management Team
As an investor, you must seek assurances that a business is able to scale up proportionally to the investment requested. When addressing the validity of the stated business projections, the team behind the business must be considered.
A reliable team will be necessary in order to achieve projected growth. A professional business plan will include the credentials, skills and experience the team holds as evidence of its capability. A revolutionary business concept without a capable workforce is a venture that is doomed to failure.
As an investor, you want consistency in decision making within the management team and as such a proven track record of the management team is critical. This fact is compounded by the fact that hiring staff without objectivity is one of the most common mistakes made by startup CEO’s. Citations of the consistent performance of the management team establish trust in the business and any potential investment.
Look for Milestones
The business plan of a driven entrepreneur should highlight milestones achieved. What business goals have been met, and in what time frame will give an indication of the current position and potential growth of the business, but also the ambitiousness of its owner, both of which are of import when considering an investment.
Analyzing the past performance of the business signals the direction it is likely to go in the future. These observations may also uncover potential opportunities and risks for the business that had previously been imperceptible.
Compare previous sales figures with those projected sales in the business plan. Do these figures validate the plan and imply authenticity in the business and its capabilities? An entrepreneur may include letters from customers promising future business or letters of recommendation from previous customers regarding their performance and these should be considered before making an investment.
Check for Other Investors
The measure of how much a business has grown can also be measured by the level of investment it has already garnered. Having significant financial backing is crucial for success, and startup CEO’s know this. Therefore, if you are looking to invest in a more mature startup, it would be unlikely to find one that had no previous investors.
Have other investors already bought equity in the business? Has the business received any seed funding? These are indicators of the validity of the business and imply that it is (at least considered to be) a lower risk investment. Be aware; the business plan should contain sufficient information about all the investors, including contact details. If you suspect that the entrepreneur is not being transparent, contact their previous investors for confirmation.
In every business plan, you need to be checking where the business’ current capital is coming from. In some cases, the venture may be self-funded by the entrepreneur, and this should be seen as a positive sign. It implies they are committed to the business. Calculate the percentage of investment share in these cases for greater insight.
Easy Exit Strategy
When investing in a small business or startup, it is important to acknowledge the associated risks. Up to 90% of startups fail, and as an investor, it is, your responsibility to ensure that your personal risk is minimized. After all, it’s your money that will evaporate when the business folds. For this reason, the inclusion of an effective exit strategy in a plan is positive for investors.
An exit strategy that allows the investor to withdraw whenever they deem it necessary? Does the exit strategy include a way to recoup potential losses? A thoughtful exit strategy indicates a level of maturity in the business and its management team.
Competitive Advantage
A lucrative investment business is one that is able to scale up, generating sustainable profits over time. A business plan should indicate the competitive advantage and Unique Selling Point (USP), whether that be a product, idea or human resources. A competitive advantage will generate sales and affords a business higher profit margins. It is essential to research this feature to ensure that the entrepreneurs’ claims are accurate. In the case of a product or service being the competitive advantage, this will require a demonstration of its functionality.
Final Thoughts
As an investor, analyzing the business plan carefully allows you to make an informed decision regarding the venture. Remember that what is not included is just as important as what is. The stated 10 factors are a critical starting point in determining the viability of the investment, but more extensive research may be required. There is a slew of startups desperate for capital investment, and it may take time to find the right one for you.
Author bio:
Andy is a UK native, living and studying in Copenhagen since 2017. Having lived as an expat most of his adult life, Andy has an interest in geopolitics and intercultural communications. He is currently studying a Bachelors degree in Marketing and International Sales and works as a content creator at Valuer, a company connecting resource strong corporates and enterprises with agile startups.
