258 Planning and Forecasting de cide to form an entity to construct and own the hotel building, separate from the entity that manages the ongoing hotel business. This plan would convert a rather confusing real estate/operating venture into a pure real estate investment opportunity for potential investors. The real estate entity would receive enough revenue from the management entity to cover its cash flow and would generate tax losses through depreciation, interest, and real estate taxes. These short-term losses would eventually yield long-term capital gains when the hotel is sold, so this entity would attract investors look- ing for short-term losses and long-term capital appreciation. For the short-term losses to be attractive, however, they must be usable by the investors on their personal returns and not trapped at the business entity level. All these factors point inevitably to the use of either the limited partner- ship, LLC, or subchapter S corporation for the hotel building entity. All three entities allow the tax losses to pass through to the owners for use on their per- sonal returns. Among these three choices, the limited partnership and LLC allow more flexibility in allocating losses to the investors, and away from Bruce, Erika, and Michael (who most likely do not need them), and they pro- vide higher limits on the amounts of losses each investor may use. In past years, our entrepreneurs would thus face the unenviable choice between losing the tax advantages of the limited partnership to preserve the limited liability offered by the subchapter S corporation or preserving the tax advantages (and the ability to attract investors) by either accepting personal li- ability as general partners or attempting to adequately capitalize a corporate general partner. This choice is no longer necessary with the advent of the LLC, which solves the problem by offering the tax advantages of the limited partner- ship and the liability protection of the subchapter S corporation. However, the passive loss limitations will still impact upon the usefulness of the losses for the members who do not have significant passive income, making this project (as is the case with most real estate investments in today’s climate) more difficult to sell. This leaves the entity which will operate the hotel business itself. The presence of our three principals immediately eliminates the sole proprietorship as a possibility. Because all the investment capital has already been raised for the real estate entity, there does not seem to be a need for further investors, thus eliminating the limited partnership as a possibility. The partnership seems inapplicable, since it is unlikely that any of the principals would wish to expose himself or herself to unlimited liability in such a consumer-oriented business. Thus, the corporation and LLC with their limited liability, continuity, and transferability, seem to be the obvious choices for this potentially growing and successful business. As with Phil, it becomes necessary to decide whether to make the subchapter S election or choose an LLC to achieve tax pass- through. This decision will be made on the basis of the parties’ projections. Are there likely to be serious losses in the short-term, which might be usable on their personal tax returns? Will there be a need for significant capital expendi- tures, thus indicating a need for the low-end corporate tax rates? Will the Choosing a Business Form 259 company offer a variety of employee benefits, which our principals would wish to exclude from their taxable income? Is the company likely to generate more profit than can be distributed in the form of “reasonable” compensation, thus calling for the elimination of the corporate-level tax. If these factors seem to favor a tax pass-through entity, the principals will likely analyze the choice be- tween subchapter S and LLC in a manner similar to Phil. In addition, they may find the LLC’s lack of eligibility rules attractive in the short run should they ever consider the possibility of corporate or foreign investors, or creative divi- sions of equity. CONCLUSION These and the many other factors described in this chapter deserve careful consideration by the thousands of entrepreneurs forming businesses every month. After the basic decision to start a new business itself, the choice of the appropriate form for the business may well be the most significant decision facing the entrepreneur in the short run. FOR FURTHER READING Bischoff, William, Choosing the Right Business Entity (New York: Harcourt Brace, 1997). Burstiner, Irving, The Small Business Handbook: A Comprehensive Guide to Starting and Running Your Own Business (New Jersey: Fireside, 1997). Diamond, Michael R., How to Incorporate (New York: John Wiley, 1996). Pressment, Stanley, Choice of Business Entity Answer Book (Gaithersburg, MD: Aspen, 1998). Shenkman, Martin M., Starting a Limited Liability Company (New York: John Wiley, 1996). INTERNET LINKS www.tannedfeet.com /choice_of_entity.htm Entrepreneurs’ Help Page www.smallbiz.findlaw.com /book/su_structures/articles/01.html Findlaw Small Business Center www.lexspace.com/html Lexspace-Business Entity /formation.html Formation 260 9 THE BUSINESS PLAN Andrew Zacharakis The sole purpose of a business plan is to explore and answer questions—crit- ical questions starting with whether the business idea is a viable opportunity. During the dot-com boom of the late 1990’s, many entrepreneurs and ven- ture capitalists questioned the importance of the business plan. Typical of this hyperstartup phase are stories like James Walker. He generated financ- ing on a 10-day-old company based on “a bunch of bullet points on a piece of paper.” He added, “It has to happen quick” in the hypercompetitive wireless- Internet-technology world. “There’s a revolution every year and a half now,” Mr. Walker said. 1 Media stories abounded of the whiz kid college dropout who received venture capital, zoomed to IPO (initial public offering), and cashed out a mul- timillionaire in 18 months or less. The mythology of the dot-com entrepreneur was that he didn’t have a business plan, only a couple of PowerPoint slides. That was all it took to identify the opportunity, secure venture backing, and go public. Why spend the 200 hours or so that a solid business plan often takes? The NASDAQ crash of March 2000 and the subsequent death of many dot-com high flyers provides the clearest answer. Many of these businesses didn’t have the potential to make profits—not then, not now, and not anytime in the fu- ture. The easy money and quick returns of the late nineties have disappeared, and what we are left with is the fact that good opportunities need good execu- tion in order to succeed and a rigorous business plan process can assist in the pursuit of entrepreneurial gold. There is a common misperception that a business plan is primarily used for raising capital. Although a good business plan assists in raising capital, the The Business Plan 261 primary purpose of the process is to help the entrepreneur gain deep under- standing of the opportunity he or she is envisioning. A business plan tests the feasibility of an idea. Is it truly an opportunity? Many a would-be entrepreneur has doggedly pursued ideas that are not opportunities; the time invested in a business plan would save thousands of dollars and hours spent on such wild goose chases. For example, if a person makes $100,000 a year, spending 200 hours on a business plan equates to a $10,000 investment in time spent ($50/hour times 200 hours). However, the costs of launching a flawed business concept can quickly accelerate into the millions. Most entrepreneurial ventures raise enough money to survive two years even if the business ultimately fails. Assuming that the only expense is the time value of the lead entrepreneur, a two-year invest- ment equates to $200,000, not to mention the lost opportunity cost and the like- lihood that other employees were hired and paid and that other expenses were incurred. So do yourself a favor and spend the time and money up front. The business plan process can not only prevent entrepreneurs from pur- suing a bad opportunity but also help them reshape their original visions into better opportunities. As we will explore in the remainder of this chapter, the business plan process involves raising a number of critical questions and then seeking answers. Part of that question-answering process involves talking to target customers and gauging what is their “pain.” These conversations with customers as well as other trusted advisors can assist in better targeting the features and needs that customers most want in a good or service. This prestartup work saves untold effort and money otherwise spent trying to re- shape the product after the launch has occurred. This is not to say that new ventures don’t adjust their offering based upon customer feedback, but the business plan process can anticipate some of these adjustments in advance of the initial launch. Perhaps the greatest benefit of the business plan is that it allows the en- trepreneur to articulate the business opportunity to various stakeholders in the most effective manner. The plan provides the background to enable the entrepreneur to communicate the upside potential and attract equity invest- ment, and the validation needed to convince potential employees to leave their current jobs for the uncertain future of a new venture. It is also the instru- ment that can secure a strategic partner, key customer, or key supplier. In short, the business plan provides the entrepreneur the deep understanding he needs to answer the critical questions that various stakeholders will ask, even if the stakeholders don’t actually read the written plan. Completing a well- founded business plan gives the entrepreneur credibility in the eyes of various stakeholders. TYPES OF PLANS A business plan can take a number of forms depending on its purpose. The pri- mary difference between business plan types is length. If outside capital is 262 Planning and Forecasting needed, a business plan geared towards equity investors or debt providers typ- ically is 25 to 40 pages long. Professional equity investors such as venture capi- talists and professional debt providers such as bankers will not read the entire plan from front to back. Recognizing this fact, the entrepreneur needs to pro- duce the plan in a format that facilitates spot reading. We will investigate the major sections that comprise business plans throughout this chapter. My gen- eral rule of thumb is that less is more. For instance, I’ve seen a number of plans receive venture funding that were closer to 25 pages than 40 pages. A second type of business plan, the operational plan, is primarily for the entrepreneur and his team to guide the development, launch, and initial growth of the venture. There really is no length specification for this type of plan; however, it is common for these plans to exceed 80 pages. The basic organiza- tion format between the two types of plans is the same, however the level of detail tends to be much greater in an operational plan. This effort is where the entrepreneur really gains the deep understanding important in discerning how to build and run the business. The last type of plan is called a dehydrated business plan. This type is considerably shorter than the previous two, typically no more than 10 pages. Its purpose is to provide an initial conception of the business. As such, it can be used to test initial reaction to the entrepreneur’s idea and can be shared with his confidants to obtain feedback before he invests significant time and effort on a longer business plan. FROM GLIMMER TO ACTION: THE PROCESS Perhaps the hardest part of writing any business plan is getting started. Com- piling the data, shaping it into an articulate story, and producing the finished product can be a daunting task. The best way to attack a business plan, there- fore, is in steps. First, write a four-to-five-page summary of your current vi- sion. This provides a roadmap for you and others to follow as you complete the rest of the plan. Second, start attacking major sections of the plan. Although all of the sections interact and influence every other section, it is often easiest for entrepreneurs to write the product/service description first. This is usually the most concrete component of the entrepreneur’s vision. Keep in mind, however, that writing a business plan isn’t purely a sequential process. You will be filling in different parts of the plan simultaneously or in whatever order makes the most sense in your mind. Finally, after completing a first draft of all the major sections, come back and rewrite a shorter, more concise executive summary (one to two pages). Not too surprisingly, the executive summary will be quite different from the original summary because of all the learning and reshaping that the business plan process facilitates. Common wisdom is that the business plan is a living document. Although your first draft will be polished, most business plans are obsolete the day they come off the presses. That means that entrepreneurs are continuously updating The Business Plan 263 and revising their business plan. Again, the importance of the business plan isn’t the final product but the learning that is gleaned from going through the process. The business plan is the story line of your vision. It articulates what you see in your mind and crystallizes that vision for you and your team. It also provides a history, a photo album, if you will, of the birth, growth, and matu- rity of your business. Each major revision should be kept and filed and occa- sionally looked back upon for the lessons you have learned. I find writing a business plan, although daunting, exciting and creative, especially if I am working on it with a founding team. Whether it is over a glass of wine, beer, or coffee, talking about your business concept with your founding team is invigo- rating, and the business plan is a critical outcome of these discussions. So now let us dig in and examine how to write effective business plans. THE STORY MODEL One of the major goals for business plans is to attract and convince various stakeholders of the potential of your business. You have to keep in mind, there- fore, how these stakeholders will interpret your plan. The guiding principal is that you are writing a story. All good stories have a plot line, a unifying thread that ties the characters and events together. If you think about the most suc- cessful businesses in America, they all have well-publicized plot lines, more appropriately called taglines. When you hear these taglines, you immediately connect them to the business. For example, when you hear “absolutely, posi- tively has to be there overnight,” you probably connect that tagline to Federal Express and package delivery. Similarly, “Just do it” is intricately linked to Nike and the image of athletic proficiency (see Exhibit 9.1). A tagline is a sen- tence or fragment of a sentence that summarizes the pure essence of your busi- ness. It is the plot line that every sentence, paragraph, page, diagram, and other part of your business plan should correlate to. One useful tip that I share with every entrepreneur I work with is to put that tagline in a footer that runs on the bottom of every page. Most word-processing packages, such as Microsoft Word, enable you to insert a footer that you can see as you type. As you are writing, if the section doesn’t build on, explain, or otherwise directly relate to the tagline, it most likely isn’t a necessary component to the business plan. Rigorous adher- ence to the tagline facilitates writing a concise business plan. EXHIBIT 9.1 Taglines. Nike Just do it! Federal Express Absolutely, positively has to be there overnight. McDonalds We love to see you smile. Cisco Systems Discover all that's possible on the Internet. Microsoft Where do you want to go today. 264 Planning and Forecasting The key to beginning the story model is capturing the reader’s attention. The tagline is the foundation, but in writing the plan you want to create a num- ber of visual catch points. Too many business plans are dense, text-laden mani- festos. Only the most diligent reader will wade through all that text to find the nuggets of value. Help the reader by highlighting different key points through- out the plan. How do you create these catch points? Some effective techniques include extensive use of headings and subheadings, strategically placed bullet- point lists, diagrams, charts, and the use of sidebars. 2 The point is to make the document not only content rich but visually attractive. Now, let’s take a look at the major sections of the plan (see Exhibit 9.2). Keep in mind that although there are some different variations, most plans have these components. It is important to keep your plan as close to this format as possible because many stakeholders are used to the format and it facilitates EXHIBIT 9.2 Business plan outline. I. Cover II. Title Page III. Executive Summary a. Hook—potential size of opportunity b. Business Concept—company and products c. Industry Overview d. Target Market e. Competitive Advantage f. Business Model g. Team h. Offering IV. Industry, Customer, and Competitor Analysis a. Industry i. Overview—Market Demand, Market Size and Structure, and Margin Analysis ii. Trends iii. Market Space or Segment you will compete in b. Customer Analysis c. Competitor Analysis V. Company and Product Description a. Company Description b. Product Description c. Competitive Advantage d. Entry Strategy e. Growth Strategy VI. Marketing Plan a. Target Market Strategy b. Product /Service Strategy c. Pricing Strategy d. Distribution Strategy e. Advertising and Promotion Strategy f. Sales Strategy g. Sales and Marketing Forecasts VII. Operations Plan a. Operations Strategy b. Scope of Operations c. Ongoing Operations VIII. Development Plan a. Development Strategy b. Development Timeline IX. Team a. Team Bios and Roles b. Advisory Boards, Board of Directors, Strategic Partners, External Members c. Compensation and Ownership X. Critical Risks a. Market Interest and Growth Potential b. Competitor Actions and Retaliation c. Time and Cost of Development d. Operating Expenses e. Availability and Timing of Financing f. Other Risks XI. Offering XII. Financial Plan a. Description of Financial Assumptions b. Income Statement c. Cash Flow Statement d. Balance Sheet XIII. Appendices The Business Plan 265 spot reading. So if you are seeking venture capital, for instance, you want to fa- cilitate quick perusal because venture capitalists often spend, research shows, as little as five minutes on a plan before rejecting it or putting it aside for later study. If a venture capitalist becomes frustrated with an unfamiliar format, he will more likely reject it than try to pull out the pertinent information. THE BUSINESS PLAN We will progress through the sections in the order that they typically appear, but keep in mind that you can work on the sections in any order that you wish. The Cover The plan’s cover should include the following information: company name, tagline, contact person and address, phone, fax, e-mail address, date, dis- claimer, and copy number. Most of the information is self-explanatory, but I should point out a few things (see Exhibit 9.3). First, the contact person for a new venture should be the president or some other founding team member. I have seen some business plans that failed to have the contact person’s name and phone on the cover. Imagine the frustration of an excited potential in- vestor who can’t find out how to contact the entrepreneur to gain more infor- mation; such plans usually end up in the rejected pile. Second, business plans should have a disclaimer along these lines: This business plan has been submitted on a confidential basis solely to selected, highly qualified investors. The recipient should not reproduce this plan nor dis- tribute it to others without permission. Please return this copy if you do not wish to invest in the company. Controlling distribution is particularly important when seeking investment capital, especially to comply with Regulation A of the Securities and Exchange Commission, which specifies that you must solicit qualified investors (high net-worth and income individuals). The cover should also have a line specifying the copy number. You will often see on the bottom right portion of the cover a line that says something like “Copy 1 of 5 copies.” Entrepreneurs should keep a log of who has copies so that they can control for unexpected distribution. Finally, the cover should be eye-catching. If you have a product or proto- type, a picture of it can draw the reader in. Likewise, a catchy tagline draws at- tention and encourages the reader to look further. Table of Contents Continuing the theme of making the document easy to read, a detailed table of contents is critical. It should list major sections, subsections, exhibits, and appen- dices. The table provides the reader a roadmap to your plan (see Exhibit 9.4). 266 Planning and Forecasting Note that the table of contents is customized to the specific business so that it doesn’t perfectly correlate to the business plan outline presented in Exhibit 9.2. Nonetheless, a look at Exhibit 9.4 shows that the company’s business plan in- cludes most of the elements highlighted in the business outline and that the order of information is basically the same as well. EXHIBIT 9.3 Cover of PurePlay Golf business plan. Bringing Information to the Golfer’s Palm www.PurePlayGolf.com Prepared by: Amy Ball, Michael Bear, Christy Long, Geoff Mall, and Hilary Tabor Contact: Geoff Mall, gmall@PurePlayGolf.com PurePlayGolf.com Reynolds Center, Suite 1 Babson Park, MA 02457 (781) 555-5252 (781) 555-5253 (fax) Draft: December 6, 2000 The information in this Business Plan is highly confidential and is provided to you conditioned on your agreement not to disclose or use this information for any purpose other then contemplating an investment in PurePlay Golf. Do not copy, fax, reproduce, or distribute without permission. Copy 5 of 5. The Business Plan 267 Executive Summary (1–3 pages) This section is the most important part of the business plan. If you don’t cap- ture readers’ attention in the executive summary, it is unlikely that they will read any other parts of the plan. Therefore, you want to hit them with the most compelling aspects of your business opportunity right up front. EXHIBIT 9.4 Sample table of contents. 1.0 Executive Summary 3 2.0 Market Analysis 6 2.1 Entertainment Industry 6 2.2 Accessing Music Online 7 2.3 Telematics Industry 8 2.5 Market Research 11 3.0 Competition 13 3.1 Direct Competition 13 3.2 Indirect Competition 15 4.0 Company Description and Services 16 4.1 The Personal Radio Station 16 4.2 Listener’s Choice 16 4.3 The Personal Music Collection 17 4.4 Recurring Royalties 17 4.5 Listener Consumption Data 17 5.0 Strategic Partners 20 5.1 Device Partners 20 5.2 Content Partners 21 5.3 Service Providers and Other 22 6.0 Development Strategy 23 6.1 Engineering Activities 23 6.2 Business Development Activities 24 7.0 Marketing and Sales Activities 25 8.0 Operations 27 8.1 VMC Core of Engineers 27 8.2 VMC Live Services 27 8.3 VMC Customer Service 27 9.0 Management Team 28 9.1 Founding Team 28 9.2 Advisors 29 10.0 Critical Risk Factors 30 11.0 Financials 31 11.1 Economics of the Business 31 11.2 VMC Consumer Assumptions 32 11.3 Service Assumptions 32 11.4 Personal Radio Station Assumptions 32 11.5 Listener’s Choice Assumptions 33 11.7 Break-Even/Positive Cash Flow 34 11.8 Sources and Uses Schedule 35 11.9 Headcount Schedule 35 . 17 4.4 Recurring Royalties 17 4.5 Listener Consumption Data 17 5.0 Strategic Partners 20 5.1 Device Partners 20 5.2 Content Partners 21 5.3 Service Providers and Other 22 6.0 Development Strategy. does not seem to be a need for further investors, thus eliminating the limited partnership as a possibility. The partnership seems inapplicable, since it is unlikely that any of the principals. section is the most important part of the business plan. If you don’t cap- ture readers’ attention in the executive summary, it is unlikely that they will read any other parts of the plan. Therefore,