Many would-be entrepreneurs go from idea to business plan too quickly with only minimal consideration of important developmental activities. The expectation is that funding will be forthcoming at good pre-money valuations for a good idea; however, that scenario rarely happens except perhaps for previously successful entrepreneurs with an established track record.
What is often missing, especially for first-time entrepreneurs, is detailed knowledge of the processes (steps) required to bring an idea to fruition though the development of a funded start-up. The purpose of defining processes is to provide for an effective and efficient sequencing of activities essential to the final goals of securing funding and achieving start-up.
An overview of the developmental processes for a start-up is provided in Figure 1. Each step is discussed below with step numbers corresponding to a same-numbered chapter in my new book.
Figure 1 Start-Up Developmental Processes
STEP 1—FIND AND RESEARCH AN IDEA AND PROTECT IT WITH IP
Simply wanting to be an entrepreneur can be an alluring notion, but it is best to not be too hasty lest an impropriate idea be used as a foundation for a business. Simply, not every idea can or should be turned into a business.
So, where does one start?
I have identified my process for ideation in the article titled “ENTREPRENEURS—Learn to Ideate and Innovate” found at http://linkd.in/1B5e7Tk.
Research and discovery are key concepts for developing entrepreneurial vision and innovation. The experience of this author is that many really good ideas have been discovered—but not all by any measure—and many great ideas only require the right entrepreneur to come along. More of my thoughts on vision and innovation are in the article titled “ENTREPRENEURS—Research & Discovery are Key Concepts of Innovation” found at http://linkd.in/17OiCef.
The process described in that article as well as the book can require an entrepreneur to talk with many people and simply talking with others can lead to complications; namely, an inadvertent disclosure of a nascent underdeveloped idea. Important thoughts on that issue are found in my article “ENTREPRENERUS--Discuss Your Ideas With Others Properly” found at http://linkd.in/1FY1rFM.
Elements of ideation and entrepreneurial vision are discussed in this first chapter of my book, and for a technology company, the result of these initial steps, presuming a solution to a significant problem is found, should be the filing of provisional patent applications. Also see my article titled “Invention and IP Development” found at http://linkd.in/1xMiSBm.
Entrepreneurs who neglect to properly secure their invention and associated intellectual properly will almost certainly be faced with a future competitor who has either taken the idea (with no legal risk) or filed patents in a related area that protects their business—typically to the disadvantage of the original holder of the idea. Want to know more about this possibility? Read my article titled “Who Owns Your Idea” found at http://linkd.in/1Lc5HVJ. If that isn’t enough, read about a true story from my own personal experiences in the article “Entrepreneurs, please, please, please secure your IP” found at http://tinyurl.com/k8z9now.
Why do I spend so much time talking about ideation and invention?
Because my experience is that many first-time entrepreneurs do not give sufficient thought to securing and protecting a robust idea—an idea that leads to a profitable business and justifies the investment of time, energy, and money an entrepreneur and his team has to put forward.
STEP 2—PERFORM FOUNDER DUE DILIGENCE
Once an idea is matured sufficiently to justify the development of provisional and regular patent applications then focus can shift to the important role of founder due diligence. I’m not talking about the due diligence that investors may devote to an entrepreneur’s business opportunity; rather, it is all about founders conducting at least a modest but important early effort to understand:
- Their fellow founders are suitable for the future startup company
- The value of the technology that underpins the business
- Whether the market is sufficiently large to support a new competitor
- Whether the envisioned products will be well-received from their target customers
- If there is a business model available that proves profitability in the future
My experience is that founders take very little time to perform an extremely important task—an objective evaluation of their opportunity before committing to a significant outlay of time, energy, and money.
A note about the all-important business model: Determination of an appropriate business model is critical if a business is to offer future profitability and hence a return on investment to investors. More on this subject is covered in the article “Startups—Get Your Business Model Right” found at http://tinyurl.com/m9v8k48. Important comments related to the bulleted list above are also covered in the article “Entrepreneurs, Don’t Fail – Ask & Answer These Questions First” found at http://linkd.in/1BYOKXZ.
The “gate” of founder due diligence provides a reasonable level of assurance to founders that the idea and inventions can be productized and sold into a market of reasonable size.
This due diligence also serves to sensitize founders to future due diligence to be conducted by prospective investors.
STEP 3—COMPLETE KEY AGREEMENTS AND INCORPORATE
Presuming that founders are comfortable with their early invention and discovery efforts (Steps 1 and 2, respectively), then forming a corporate entity for investment (Step 3) occurs next.
It is often very useful for founders to establish early-on a simple agreement called a founders agreement that identifies in some detail the proposed future distribution of founders’ equity, rights, etc. just so potential disagreements when the corporation is formally created disagreements are avoided.
Investors only invest in a company on the basis of owning a share (e.g., equity) in exchange for their investment. Thus, a corporate entity with different stock classes (common, preferred) has the legal ability to accept investment.
The formalities of the corporation also include election of an initial board of directors, board meetings, corporate rules, bylaws, initial board actions (regarding stock distribution), indemnification, employment agreements, and a myriad of legal matters for which both the actual decisions of the founders as well as the formal legal requirements of each state must be properly handled. As always, the guidance of a corporate attorney is essential.
STEP 4—CREATE THE IP PORTFOLIO
Entrepreneurs and founders who have completed the first three steps above can take a deep breath (but, for only a moment) and begin the ardent work of creating significant early value for the corporation by continuing with their research and development activities and the purposeful effort of developing a portfolio of IP. Often called a “patent fortress,” the concept is simple enough; build an IP portfolio that protects in a substantial way the future revenue and profitability of the business by excluding others from your protected territory. If you are a technology-based company, even in only small ways, this is a critical factor that investors consider when making their investment decisions. As most technology business will have very little revenue during its early stages pre-money valuation will be based on promise of future revenue based on the technology and expected future patents.
Many important details of how to build the patent fortress are discussed in Chapter 4 of the book.
STEP 5—BUILD THE MARKETING & SALES PLAN
Entrepreneurs may be tempted to start writing the business plan as a first item of business once the technological and competitive basis of the company is determined and provisional patent applications accomplished. The business plan, of course, is the key document needed to open up discussions with potential investors. Its completion would seem to presage the securitization of investment needed to start the business. However, the business plan needs to be supported with defensible projections of revenue, sales, and net profit. Projections of revenue and sales are derived from a detailed analysis of the target markets and the strategies and tactics needed to secure revenue and sales. Net profit is determined from an analysis of all relevant financial factors and reported in the financial plan (see Step 6).
The weakest part of any business plan will be the projection of sales revenue. Investors, for good reasons, dissect sales numbers and also carefully study the rationale behind the projections. The inability of the entrepreneur to adequately explain or validate how sales will be accomplished gives investors the opportunity to discount proposed valuations. More about the details of projecting sales can be found in the article “Valuation of Early-Stage Companies – Part II – Substantiation of Sales” found at http://linkd.in/1EqicWf.
The entrepreneur is usually ill prepared to defend the business plan in the absence of a good, if not excellent, marketing-and-sales strategy and MSP.
STEP 6—BUILD THE FINANCIAL PLAN
If you are fortunate enough to have a financially minded person on your team, then the hurdle of developing sound financial data will be more easily surmounted. If, like most early entrepreneurial teams, you are missing your future CFO, then you may be faced with developing financial information and projections without that person’s expert guidance. In any event, a sound set of financial statements will serve your business well and make investors much more amenable to making an investment.
Chapter 6 of the book is devoted to helping an entrepreneur formulate a robust and respectable financial plan and supporting pro forma statements that support the business plan. The financial plan consists of a delineation of all the company’s revenues, expenses, and resultant profits for past, current, and future periods of time. Pro forma financial statements refer to a set of financial tables, figures, and data that is prepared in advance of a potential transaction such as an investment. Pro forma financial statements for a start-up are intended to model the company’s projected financial results after the investment transaction is completed for the current stage of company development.
A useful and effective set of integrated financial statements (forms) that I have developed and successfully used for over 25 years can be found at http://www.amazon.com/gp/product/B00K2KPSI2. The spreadsheets allow an entrepreneur to specify, over a 4 year period, the details of expected revenue, sales, operating expenses, etc. and automatically prepare income statement, balance sheet, and cash flow statements. The spreadsheets use a bottoms-up approach and enables the entrepreneur to quickly model the business and make appropriate adjustments to determine profitability. The set of spreadsheets includes one devoted to valuation. The spreadsheets are integrated meaning that they automatically update in accordance with changes to underlying driving cell values. With the integrated set of spreadsheets entrepreneurs can easily create an initial set of financial statements within a day.
STEP 7—CONDUCT OPPORTUNITY VALUATION
Prior to engaging in negotiations with interested investors, founders and their executive management team need to have developed a keen understanding of how a new venture is valued and what is a reasonable value for them to expect for their new venture. Chapter 7 explains how to value your opportunity.
Chapter 7 of the book explains valuation from both the entrepreneur’s and the investor’s perspectives starting with an explanation of net present value, terminal value, discount rates used by investors, and the use of an entrepreneurial scorecard to help the entrepreneur have a realistic notion of the value of their business prior to entering discussions with prospective investors.
The process that an entrepreneur needs to use is also reviewed in a series of articles:
- Valuing Early-Stage Companies – Part I – Introduction http://bit.ly/1MBlw6t
- Valuing Early-Stage Companies – Part II – Sales Projections http://bit.ly/1JrWWWC
- Valuing Early-Stage Companies – Part III – Net Present Value http://bit.ly/1ApPdB8
- Valuing Early-Stage Companies – Part IV – Entrepreneurial Scorecard http://bit.ly/1FgFspK
- Valuing Early-Stage Companies – Part V – Negotiation http://bit.ly/17KC4s1
As Figure 1 shows, there are two iterative phases involving first a projection of revenue (sales) and secondly a projection of profitability. In practice, if a proposed model (strategy and tactics) for marketing and sales does not achieve a desired (even though speculative) level of profit then the entrepreneur should revisit the MSP with the goal being to increase sales revenue; thereafter, re-estimating profit via the financial projections and FP. Clearly, these two iterative steps have to be accomplished in an intellectually honest fashion rather than simply changing the numbers in the spreadsheets involving sales and profit projections. Once an entrepreneurial team is satisfied that the sales and financial projections are valid; that is, logical and able to withstand 3rd-party scrutiny, then the opportunity is valued and it becomes appropriate to prepare the business plan (Step 8 below).
STEP 8—BUILD THE BUSINESS PLAN
The BP must be a persuasive document. It will be the first written document read by an investor, and it must, from the very first word, keep the reader/investor interested and absorbed with the messages you craft. Achieving that goal is not easy, but it will be easier if the points of Chapter 8 are followed.
The marketing and sales plan (MSP) and the financial plan (FP) should be well along in development before starting the business plan (BP). It is critical that the MSP strategies and tactics be thought out and supports the company’s business goals and objectives. The revenue projections need to be established and validated by constructing the financial plan. An initial entrepreneurial valuation (Chapter 7) should have been performed. Assuming that valuation and sales projections are deemed appropriate by the CEO and CFO, it then makes sense to start writing the BP. While the BP is being written, further refinements and iterations of the MSP and FPs can occur.
Chapter 8 leads the entrepreneur through the process of brainstorming, preparation of the table of contents, and the structural and writing requirements of the BP.
STEP 9—PREPARE FOR INVESTMENTS AND INVESTORS
Most entrepreneurial ventures will eventually need to secure professional investment, unless the new venture is fortunate to have created significant sales and profit or does not have the desire to grow more rapidly. Completion of the initial versions of the BP, MSP, and FPs is a significant accomplishment and opens up the entrepreneurial team for discussions with investors.
Important issues that entrepreneurs must understand include: milestones and investment staging, founder dilution and control, investor due diligence, documents needed to support the securitization of investor interest, communications and negotiations with investors, and term sheets and legal agreements are discussed in Chapter 9.
STEP 10—EXPLORE YOUR INVESTOR NETWORK
In Chapter 10, the various types of investors and their investment potentials are reviewed, starting first with founders. Family and friends, who would be expected to invest less and also be less skilled in evaluation and how to approach them, are also discussed. At the other extreme are venture capital organizations, which are very professional and experienced in both business and financial matters and can put together larger investments. In between, other forms of securing funds are considered such as from federal grants for research (e.g., the Small Business Innovation Research Program), crowdfunding, professional angels, and corporations.
How once goes about approaching and interacting with each type of investor is explored so that entrepreneurs can find the best options for themselves and their opportunities.
STEP 11—START EARLY-STAGE COMPANY OPERATIONS
Once a company is funded, the founders embark on achieving their next-stage goals as defined in their business plan. This “execution phase,” as it is often called, represents the first major transition of the company from one that has principally been involved with planning to one that actually begins to design and manufacture products that satisfy customers.
In Chapter 11 important issues related to vision, leadership and followership, organization, executive management, team building, mission statement, building an organization for customer satisfaction, interdepartmental interactions, early-stage business processes, and initial operations and execution are discussed.
A first-time entrepreneur (95 percent of those who try) has to work harder. There is much to be learned, and if an apparently good or great idea is behind the entrepreneurial motivation, the pressure to proceed is very strong—indeed, overwhelming—because of the urgency to bring the product to market. But patience is a virtue, as they say, if only to avoid the pitfalls that come the way of a first-time entrepreneur.
The chapters of this book have been written in a very specific order, intended to allow an entrepreneur the opportunity to evaluate each step carefully and at minimum cost before making the larger commitments of time, energy, and money required of a subsequent chapter. It takes discipline, and often patience, to execute every step rigorously, and while some things may overlap to a degree, the steps represent an evolutionary and process-oriented way to build toward the development of a successful start-up launch.
This book orders the entrepreneurial process, and an entrepreneur with the discipline to follow the book has, in the opinion of the author, the ability to beat the odds.
***Rocky Richard Arnold provides strategic corporate and capital acquisition advice to early-stage companies founded by entrepreneurs wishing to successfully commercialize high-value-creation opportunities, ideas, and/or technologies. More information about Rocky can be found at www.rockyrichardarnold.com. His book, The Smart Entrepreneur: The book investors don’t want you to read, is available as paperback or Kindle ebook for purchase on Amazon at http://tinyurl.com/pv248qq. Financial software for use by startups can be purchased on Amazon at http://www.amazon.com/gp/product/B00K2KPSI2. He posts articles about entrepreneurship on his blog at http://thesmartentrepreneur.blogspot.com. Connect with Rocky on Twitter @Rocky_R_Arnold; Facebook at www.facebook.com/rocky.r.arnold; Google+ at www.google.com/+RockyArnold01.