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.

The Entrepreneur’s Shares: A Balanced Approach To Founder’s Equity

Guest post by Daniel I. DeWolf, Evan M. Bienstock, Samuel Effron, and Ilan Goldbard – Mintz, Levin, Cohn, Ferris, Glovsky and Popeo, P.C.

When accepting money from outside investors, entrepreneurs are generally asked to give up some degree of control over their start-up, exchanging equity in their company for cash. In an effort to minimize the control they relinquish, upon formation of their company entrepreneurs can grant themselves equity that comes with special rights. These rights, such as special voting privileges or guaranteed board seats, allow founders to maintain control of their company in spite of a dwindling ownership percentage. They may also include special rights that make it possible for a founder to cash out some of his equity prior to an IPO or other exit event.

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Confronting a Down Round

Guest Post by:  Dror Futter, Partner – McCarter & English LLP

The last few years have witnessed Unicorns become common and down rounds become scarce. Now the venture market is returning to a more normal state, which means more down rounds and fewer Unicorns.

If your venture is confronting a down round, you should not wear it as a badge of shame. In normal times, few ventures make an uninterrupted march up and to the right on the valuation curve. More importantly, if you are doing a down round, it still means you were able to raise capital. Although a down round will dilute your economics, no venture has ever died from excess dilution, the same cannot be said for lack of funds.

What is a “Down Round”

Simply stated, a “down round” is a round in which the pre-money valuation of a company is below the post-money valuation of its last round. As result, shares in the company purchased in a down round will be less expensive than those bought in the last round. Down rounds are never fun. To existing shareholders, it means the value of their investment has dropped and they will absorb additional dilution to raise the same amount of money. To venture investors, who report their illiquid holdings to their limited partners based on “mark-to-market” principles, it almost inevitably means a write-down of the carrying value of the investment. As a result, reported fund returns drop.

Down rounds are most common when a new investor enters the scene or most existing investors are not funding their pro rata. In addition to a lower valuation, funding terms of a down round are usually more investor friendly. Often shares sold in a down round will have a senior liquidation preference (i.e. they will sit above prior classes of shares in terms of priority for getting a return at exit), a participating preferred return (i.e. investor gets its investment back and sometimes a multiple of its investment back and then participates with common), dividends that are accruing and at a higher rate, and class-specific veto rights on multiple corporate decisions.

Why Do Down Rounds Occur?

There are several reasons why your company may be subject to a down round, including:

  • Your company failed to reach the financial and operational goals it set for itself the last time it raised money;
  • You did a particularly good job of selling your company at the last round and received financing at a favorable valuation. The down round may just be reversion to a more conservative valuation; or
  • Overall valuations have dropped in your sector or market-wide.

A down round, therefore, is not always a sign of a struggling company. However, even if your down round result from broad market forces, you will subject to the valuation drop, and likely many of the same unfavorable deal terms, as a struggling company.

What Can You Do to Prepare?

There are a few things a company can do that will help its down round proceed more smoothly.

1. Review the Corporate Charter and financing documents from prior rounds. Make sure you understand the rights of existing shareholders in a down round and have identified any relevant supermajority voting requirements and pay-to-play obligations. Also, identify all pre-emptive rights that existing shareholders have and the timetables they have to exercise. Down rounds are often Eleventh Hour fire drills and you do not want to be stymied by a multi-day notice period for pre-emptive rights.

2. If your shareholders have anti-dilution rights, make sure you have assembled a spreadsheet that will allow you to determine the impact of financings at various price points on the existing cap table. This will be essential information for the new investors as they determine the new pre-money valuation of the company. In some cases, new investors may require existing investors to waive their anti-dilution right as a condition of funding.

3. Down rounds are risky events for a company’s Board of Directors. This is especially true for a Board that does not have independent directors to provide an unbiased view on the fairness of the reduced share price in a down round. Shareholders who do not participate in the new financing and are significantly diluted may bring an action against the Board. To reduce this risk, the Board should shop financings to multiple investors and should document these efforts in writing. Also, the Board should conduct market research to fully understand market terms. If possible, the Board should seek to obtain the approval of non-participating shareholders and at a minimum, such shareholder should routinely be updated on attempts to find financing and findings on current market terms. The Board should also consider doing a “Rights Offering” where each existing shareholder is offered the opportunity to purchase its pro-rata piece the financing at the down round price, even those shareholders who do not have the benefit of a contractual pre-emptive right. Finally, a down round is a good time to make sure that D&O insurance is in place and includes adequate coverage.

4. Develop a communications plan for employees. Despite your best efforts, this is the type of information that often can get out there. Decide how you will position the down round to your employees. Since the dilution of a down round will also impact their options, consider whether some star performers should get option refreshes (i.e. a supplemental option grant to reduce the economic impact of the dilution).

One Final Word

Success lifts many boats. As a result, when a company is doing well and experiencing a string of “up rounds,” it is easy to gloss over different interests among shareholders and directors. A down round can create two or more classes of investors with very different economics. In the wake of a down round, it is important to be sensitive to this change, factor it into decision making, and develop a communications plan that addresses the potentially divergent interests of these shareholders.


Dror Futter, Partner, dfutter@mccarter.com

Dror Futter is a partner of the firm who brings more than 20 years of high tech and intellectual property legal and business experience to McCarter and its clients. Dror joined the firm as part of McCarter’s combination with SorinRand. Prior to joining SorinRand in February 2013, Dror was General Counsel to Vidyo, Inc., one of the nation’s top 50 venture-backed companies, where, among other things, he negotiated and documented sales agreements for both direct and indirect channels, purchase agreements, software licenses, service agreements, and strategic agreements in the US, Asia and Europe. Previously, he was a partner and General Counsel of renowned venture capital fund New Venture Partners LLC. While there, he helped to form funds, and advised multiple start-ups and corporate spin-offs in the information technology and telecommunications industries, as well as serving as the venture fund’s legal counsel. He also advised portfolio companies with respect to commercial, mergers and acquisitions, employment, Internet/ecommerce and intellectual property law matters.

Biography

McCarter & English LLP

McCarter & English, LLP is a firm of approximately 400 lawyers with offices in Boston, Hartford, Stamford, New York, Newark, East Brunswick, Philadelphia, Wilmington and Washington, DC. In continuous business for more than 170 years, we are among the oldest and largest law firms in America.

Material in this work is for general educational purposes only, and should not be construed as legal advice or legal opinion on any specific facts or circumstances, and reflects personal views of the authors and not necessarily those of their firm or any of its clients. For legal advice, please consult your personal lawyer or other appropriate professional. Reproduced with permission from McCarter & English LLP. This work reflects the law at the time of writing in September 2016.

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.

For more information on this subject and other Venture Capital and Private Equity matters, please visit VC Experts.

 

Looking Under the Hood

Joseph W. Bartlett, jbartlett@reitlerlaw.com, Counsel, Reitler Kailas & Rosenblatt LLC

It’s useful to explore some of the conversations which experienced venture capitalists trade with one another, often deriding the claims which come across the venture fund’s transom.

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How to Bubble-Proof Your Venture

Guest Post by Dror Futter, Esq. – McCarter & English, LLP

The venture community is buzzing with talk about bubbles.  Even if we are not on the verge of a 2000-style collapse, multiple signs of contraction in the venture space make it clear that entrepreneurs need to start planning their response.  Based on past downturns, it is impossible to overstate the importance of having cash in the bank and a flexible cost structure to weather the storm.

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