What Not To Say In a Business Plan

Guest Post by: Barry Moltz

The following is an excerpt from his e-book entitled, Growing Through Rants and Raves. Barry Moltz is also the writer of a book entitled You Have to Be a Little Crazy, which delivers irreverent, straight talk about the complex intersection of start-up business, financial health, physical well-being, spiritual wholeness and family life. This title and other publications by Barry can be viewed at his website, http://www.barrymoltz.com.

Sometimes I find that the company’s founder is so far ‘outside the box’ that they ‘stretch the envelope.’ As an angel investor, I review more than 500 business plans each year. Unfortunately, many are so riddled with economy lingo, business jargon and clichés, that they do not communicate any real business value. In my opinion, terminology, such as disintermediation, sweet spot, ASP, best of breed, and win-win should be outlawed for the next 100 years. For building a real business, these terms are meaningless. Another challenge when reviewing business plans is that the introductory sentences sometimes stretch for an entire paragraph as the entrepreneur looks for that all-encompassing way to describe their business. Forget it! There isn’t one. Many times I want to strangle the writer to simply tell me what they do in five words or less. Poor choice of words: This business makes mechanical gasoline fueled devices, used for transportation, more efficient by periodically sending them through an applied for patent machine to loosen the terra firma from these vehicles to make them more conducive at performing their task. Solid choice of words: We run a car wash. Another frequently used practice is to create a business plan using template software or by working from an existing plan. I do not recommend this practice and like to refer to William Sahlman in his Harvard Business case study “Some Thoughts on Business Plans.” This case study has continuously inspired me to see beyond clichés and catchphrases and better interpret misleading statements within business plans.

If the plan says: “Our numbers are conservative.” I read: “I know I better show a growing profitable company. This is my best-case scenario. Is it good enough?” Since all numbers are based on assumptions, projections in business plans are by their very nature a guess and are not conservative.

If the plan says: “We’ll give you a 100 percent internal rate of return on your money.” I read: “If everything goes perfectly right, the planets align, and we get lucky, you might get your money back. Actually, we have no idea if this idea will even work.” No one can predict what an investor’s return will be. Let them decide.

If the plan says: “We project a 10 percent margin.” I read: “We kept the same assumptions that the business plan software template came with and did not change a thing. Should we make any changes?” Ensure you have developed your financial projections from the ground up.

If the plan says: “We only need a 5 percent market share to make our conservative projections.” I read: “We were too lazy to figure out exactly how our business will ramp up.” Know what it will cost to acquire customers. Gaining 5 percent market share is not an easy task in a large market.

If the plan says: “Customers really need our product.” I read: ” We haven’t yet asked anyone to pay for it.” or “All our current customers are our relatives” or “We paid for an expensive survey and the people we interviewed said they needed our product.” The definition of a business is when people pay you money to solve their problems. This is the only way to prove people “need it.”

If the plan says: “We have no competition.” I read: Actually … I stop reading the plan. Always beware of entrepreneurs that claim they have no competitors. If they are right, it’s a problem and if they are wrong, it is also a problem. Every business has competitors or else there is a current solution to this customer need. If there are no competitors for what the entrepreneur wants to do, there is a good chance there also is no business. So what should an entrepreneur do? Write the plan in plain and proper English. Please understand that the reader comes to the plan with no knowledge of your business. No fancy words, clichés or graphs will make them want to invest. Understand every part of your plan and be able to defend it. Use your own passion to describe your plan. Make your plan your own.

The 11 things that matter in a business plan:

  • What problem exists that your business is trying to solve. Where is the pain?
  • What does it cost to solve that problem now? How deep and compelling is the pain?
  • What solutions does your business have that solve this problem?
  • What will the customer pay you to solve this problem? How solving this problem will make the company a lot of money.
  • What alliances can you leverage with other companies to help your company?
  • How big can this business get if given the right capital?
  • How much cash do you need to find a path to profitability?
  • How the skills of your management team, their domain knowledge, and track record of execution will make this happen.

Please remember, the business plan is basically an “argument” where you need to state the problem and pain, then provide your solution with supporting data and analogies.

Why not bank loans to EU startups?

Guest post by Rafael González-Gallarza and Álex Pujol, partners at Garrigues Corporate Department

One way to boost the digital economy in the EU would be to help banks making loans to new businesses. To do this, the institutions themselves need to know about venture debt and other possible products, and the European and national authorities need to support a stable legal framework adapted to the business environment including the area of bank finance.

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What is a management rights letter and why is my investor asking for it?

Guest post by DLA Piper

What are they?

A letter agreement between a company and an investing venture capital fund which provides the fund with certain “management rights” that allow it to substantially participate in, or substantially influence the conduct of, the management of the portfolio company.

Why are they important?

A management rights letter is critical for any venture capital fund that is seeking to rely upon the venture capital operating company (VCOC) exemption in order to avoid its assets from being subject to the Employee Retirement Income Security Act of 1974 (ERISA) and the onerous requirements that would be imposed thereunder (which would include managers of the fund becoming personal fiduciaries under ERISA with respect to any private pension plans that invest in the fund and becoming subject to a set of strict prohibited transaction rules and conflict of interest and self-dealing issues as a result of the fund manager’s receipt of performance fees in the form of its carried interest).

As background, private pension plans constitute a meaningful percentage of the investors in venture capital funds. The assets of such pension plans are subject to ERISA. When a venture capital fund takes in investors who are themselves subject to ERISA, the fund will want to avoid the assets of the fund from also becoming subject to ERISA. There are two exemptions that a venture capital fund can seek to rely upon in order to avoid such an outcome:

1. The Not Significant Participation Exemption (ie, the 25 percent test)

  • If less than 25 percent of each class of equity interests of the venture capital fund (and a fund typically only has one class of equity interest) is held by investors who are subject to ERISA, then the assets of the fund will not be subject to ERISA.
  • In determining whether the 25 percent threshold has been surpassed, investments by public pension plans and non-US pension plans are not counted towards the threshold.

2. The VCOC Exemption

  •  If the venture capital fund qualifies as a VCOC, then the assets of the fund will not be subject to ERISA.
  • In order to qualify as a VCOC:
    • at least 50 percent of the fund’s assets must be invested in operating companies in which the fund has direct contractual management rights (which is where the management rights letter comes into play) and
    • the fund must exercise such management rights with respect to at least one operating company that it holds an investment in
  • The 50 percent requirement must be met on the date the venture capital fund makes its first investment.
  • The securing of a management rights letter by a venture capital fund is critical in that it is the means through which the fund has direct contractual management rights in its underlying portfolio companies.

What should they contain?

A management rights letter should secure as many of the following rights as possible for the investing venture capital fund:

  • The right to appoint one or more directors to the board of the portfolio company
  • The right to regularly informally consult with and advise the management team of the portfolio company
  • The right to receive quarterly and annual financial statements of the portfolio company, including the annual auditor’s report
  • The right to examine the books and records of the portfolio company
  • The right to receive copies of all documents, reports, financial data and other information that the fund may reasonably request and
  • The right to appoint a person to serve as the corporate officer of the portfolio company

Potential traps

  • Rights that a venture capital fund secures and shares with other investors do not count as management rights for purposes of meeting the VCOC exemption (ie, the rights must be individual to the fund). Thus parallel funds or related co-investment funds should each obtain separate management rights letters.
  • Portfolio company investments, which are made by a venture capital fund indirectly through a special purpose vehicle, which is not wholly owned by such fund can be an issue in situations where the special purpose vehicle only holds a minority position in the underlying portfolio company. In that scenario, the special purpose vehicle will not be treated as an operating company for purposes of the VCOC exemption due to the fact that it is not primarily engaged, directly or through a majority owned subsidiary, in the production or sale of a product or service other than the investment of capital.
  • If a venture capital fund seeking to rely on the VCOC exemption makes an investment which does not qualify as an investment in an operating company prior to making its first investment in an operating company, then such fund can never qualify as a VCOC.

Takeaway

A management rights letter is a key aspect for venture capital funds when investing in companies, as it enables funds to raise capital without subjecting the activities of the fund to the various restrictions imposed under ERISA. Requests for management rights letters are fairly common in today’s market and do not impose significant burdens on the companies from whom such letters are sought.


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Capitalization Tables Demystified

Guest post by Kevin Learned and Denise Dunlap, Boise Angel Alliance

Originally post on Angel Insights Blog, The Angel Capital Association

Terms like “warrants, waterfalls and preferences” can be confusing and intimidating when attempting to understand a capitalization table (aka cap table); it is no wonder we are often asked for a simple way to understand them! This article will give a brief overview of why cap tables are important and introduce a simple model to use early in the due diligence process.

As fund administrators and instructors for the Angel Capital Association (ACA)’s educational programs,  Loon Creek founders Kevin and Denise sometimes develop tools to help investors understand the concepts presented in the courses they teach. Many years ago Kevin developed a simple spreadsheet to model basic cap tables for use by our local angels as part of their regular due diligence process. He introduced this model during his presentation at a recent national webinar for the ACA discussing the basics of cap tables. You can download a copy of that cap table model as well as access the webinar archive from our Resources page.  

For those who would like a brief primer, a capitalization table is a document that lists all of the owners of equity and potential equity, the shares they own and the percentage ownership those shares represent.  Typically, the cap table is organized by type of security and/or by investment round.

We believe it is important for angel investors to understand cap tables.  It is part of our regular diligence process to first construct our own summary cap table before we decide to invest.  

Here’s what a rudimentary cap table can help you answer:

  • Founders’ ownership. What percentage of the company do the founders own now and will be likely to own at exit?  As investors, we want to be sure the founders have adequate incentive to continue to work very hard right through the exit.
  • Stock options. How many shares are set aside for the stock option pool, and is the pool set up before or after we make our investment (pre or post money)?  We know the company will not be able to pay market salaries in its early years and that a stock option pool will be needed to attract quality staff.  If the pool is set up before we invest, then the dilution associated with the stock option pool goes against the previous investors; if the pool is set up after our investment, then we are diluted as well at the time we make our investment.
  • Valuation. What is the impact of the agreed upon pre-money valuation?  This allows us to see what percentage of the company we will own now as well as projecting that through to exit to see if a) an exit at the required valuation is achievable, b) the likely exit will be sufficiently rewarding.
  • Subsequent rounds. What is the impact of subsequent investment rounds in terms of dilution, share price, and required exit valuation?
  • Exits. At various exit amounts what will our return likely be?

We have also found this simple model to be a helpful tool when working with entrepreneurs who are new to the process – often cap tables are confusing to them as well! In our experience, many entrepreneurs rely on a third party such as an attorney to maintain the schedule for them and only understand it at a high level.

Admittedly cap tables can become very complicated when they take into account convertible notes, warrants, preferences, waterfalls and other terms and instruments that may impact our return.  But we argue that if the simple cap table doesn’t show you that it is possible for this investment to make stellar returns, then you need go no further with negotiations or due diligence.

The ACA has a wonderful advanced course on cap tables that teaches the audience to deal with the myriad of possible return-reducing conditions.  Information on this and other ACA courses is available from their website.  

Opportunity and Risk Reduction: The Startup Two-Step

Guest post by Paul A. Jones, Of Counsel, Michael Best & Friedrich LLP

Most entrepreneurs really enjoy talking about the prodigious opportunity at the end of their startup’s rainbow. The reward side of the high-risk/reward equation. And that’s good, to a point. The point at which the prospective investor buys into the reality of the opportunity and the entrepreneur’s team for capturing it. Unfortunately, it’s not a point at which most prospective investors are willing to write a check.

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Silicon Valley Venture Capital Survey – Fourth Quarter 2017

 

By Cynthia Clarfield Hess, Mark A. Leahy and Khang Tran

View the full report.

Background
This report analyzes the terms of 190 venture financings closed in the fourth quarter of 2017 by companies headquartered in Silicon Valley.

Overview of Results
Valuation Results Remain Strong
Valuation results continued to be strong in Q4 2017, but the percentage price increases declined moderately compared to the prior quarter, following three consecutive quarters of increases.

Internet/Digital Media Scores Highest Valuation Results
The internet/digital media industry recorded the strongest valuation results in Q4 2017 compared to the other industries, with an average price increase of 179% and a median price increase of 51%, both up from the prior quarter.

Valuation Results Down for Series D Financings
Series D financings recorded the weakest valuation results in Q4 2017 compared to the other financing rounds, with the highest percentage of down rounds and the lowest average and median price increases of all the financing rounds.

 

FULL REPORT

 

View the original post by Fenwick & West LLP