Week One
Chapter 2 Business Planning for Entrepreneurs
Learning Objectives
· To understand the purpose of a business plan
· To understand the elements of a business plan
· To know the process of building a business plan
· To know how to develop the necessary financial information and statements
Case: TerraPower, Inc.
Bill Gates, Nathan Myhrvold (the former chief technology officer of Microsoft), and Lowell Wood (a renowned astrophysicist) were brainstorming about new ideas at an intellectual property incubator and licensor, Intellectual Ventures. The three knew that they needed to come up with an idea that would have significant potential by solving a large problem in the future and then developing a strategic plan and eventually a business plan to get there. While looking into the general area of energy, they focused on delivering massive amounts of emission-free energy that could occur in all kinds of weather conditions. This focus eventually led to concentrating on new designs to create and deliver nuclear energy that were technically feasible and developing the necessary plans for achieving this.
The group formed TerraPower, Inc. in Bellevue, Washington, and hired John Gilleland, founder of Archimedes Technology Group, a company that developed solutions for the disposal of nuclear waste, as CEO of the company. Since TerraPower did not require any public funding, the nuclear power startup could more easily develop an affordable endless supply of electricity through engineering an innovative traveling wave reactor (TWR) technology that would run on depleted uranium. Requiring a very small amount of enriched material to start, the wave reactor would slowly burn over decades the depleted uranium without refueling. This would provide better control of costs and reduce any opportunity for theft by terrorists.
The supply source of depleted uranium was enormous, with over 680,000 metric tons in just the United States. In addition, the coolant in the reactors would be liquid sodium, which is much softer water, just in case of an earthquake or another natural disaster such as happened in Japan in 2012.
As called for in the plan, the company had about 60 employees by March 2013 and has the objective of having a prototype ready for testing in 2022. This projected timeline is reasonable despite the technological and particularly the licensing problems associated with nuclear reactors.
The plan requires developing a brand-new supply chain for the components of the technology, a feat in itself. The distinctive fuel assemblies needed will require nontraditional materials and manufacturing techniques. Over 100 partner sources have been approached such as Massachusetts Institute of Technology, the University of Michigan, Kobe Steel, and Toshiba to develop the supply chain and conduct the necessary research.
As occurred in the development of TerraPower, Inc., a business plan is an important part of the new venture process, as it provides a road map for implementing the entrepreneurial strategy established. Strategy is defined in the strategic management literature as developing a plan for creating and operating a profitable new enterprise through the obtainment and development of internal and external resources in alignment with the environment (Dess & Miller, 1993; Mintzberg & Quinn, 1991; Pearce & Robinson, 1992; Thompson & Strickland, 1992). Strategy exists at various levels in a new venture, such as enterprise, corporate, business, functional, and subfunctional, so that implementation can occur throughout the firm.
A key aspect of developing a strategy at each level is establishing goals. Goals need to be difficult to achieve and represent a challenge for the new venture and yet realistic enough to be achieved with effort. Such is the case of the goal of TerraPower of having a prototype traveling wave reactor available in 2022.
To accomplish the goals established and implement the strategy, it is best to write a business plan before an entrepreneur goes very far in creating and starting a new venture. While the original plan developed will be modified and changed many times, remember, “If you do not know where you are going, any road will get you there.”
Chart 2.1 presents a schematic representation of the material covered in this chapter.
Chart 2.1 Schematic of Chapter 2
Purpose of Writing a Business Plan
Most entrepreneurs prepare a business plan for two reasons: to provide a road map for developing, managing, and operating the business and to raise outside equity or debt capital. While arguments can be made for and against writing a business plan, if financing is needed from an outside source, then a business plan needs to be written for this source to review.
Writing a business plan can be very difficult for entrepreneurs, as they are usually individuals characterized as doers, not planners. But it is not acceptable to hire someone to write the plan, as the task needs to be done personally. While outsiders (accountants, consultants, lawyers) can be used for input in terms of numbers and pieces of the plan, the final business plan needs to be developed and written by the entrepreneur and any initial top management team members when needed and appropriate. By doing this, the entrepreneur ensures that he or she is very familiar with all the details of the plan to be able to present it to outside sources of finance and make sound decisions that will affect the new venture. Every outside investor expects the entrepreneur to be knowledgeable about and totally involved in the proposed enterprise.
Developing the business plan takes energy, money, and time, with time being one of the most costly aspects. Since each business plan deals with an economy(s) and industry(s), a hidden cost of writing a business plan is a psychological one—understanding and knowing that anything can go wrong. This is particularly difficult for entrepreneurs who are overall optimistic and believe in themselves and their capabilities.
Benefits of a Business Plan
Since a business plan details the entrepreneur's vision in writing and indicates the implementation strategy and the costs involved, it has several benefits:
1. Determining the amount and timing of resources needed. The business plan indicates the existing resources of the firm, the resources needed, and some potential suppliers of these resources. This allows the entrepreneur to determine how much money is needed at various times to obtain these resources and what approach to develop and use to obtain the money as well as any other resources. The money will be obtained from outside capital providers. Other resources needed are in the areas of supply, distribution, personnel, and support services.
2. Establishing the direction of the firm. Since the business plan is a comprehensive document, it treats all the major issues faced starting and growing the venture. This enables the entrepreneur to develop strategies and contingency plans to reduce the impact of any problems.
3. Guiding and evaluating. By setting goals and milestones for the new venture, the business plan lays out the intentions of the entrepreneur as well as his or her values. Accomplishments and results can be measured and any deviations from the plan corrected in a timely manner. These results should be reported to all interested stakeholders and to outside providers of financial resources on a regular basis, usually four times a year if not more frequently, such as every month in at least the first year.
4. Avoiding conflicts. By being put together by the entrepreneur and the management team and being reviewed and revised frequently, the business plan can be used to guide decisions and help avoid conflicts among the entrepreneur, management team, employees, outside vendors, and financial providers. The amount of energy and resources needed to launch and grow something new is enormous, with the risks being high; the new firm requires reinvestment and seems to always need more time and money. This requires significant sacrifice by the entrepreneur in terms of short-term income and people and family. There are often individuals hurt by the tough personal decisions that an entrepreneur needs to make.
Elements of the Business Plan
While there are some variations on what goes into a successful business plan, they all have the same essential elements (aspects). These can be grouped into three sections:
· Section 1: Introduction
· Title (Cover) Page
· Table of Contents
· Executive Summary
· Section 2: Body of the Business Plan
· Description of Business
· Description of Industry
· Technology Plan
· Marketing Plan
· Financial Plan
· Production (Outsourcing) Plan
· Organizational Plan
· Operational Plan
· Summary
· Section 3: Support (Backup) Material
· Exhibit A: Résumés of Principals
· Exhibit B: Market Statistics
· Exhibit C: Market Research Data
· Exhibit D: Competitive Brochures
· Exhibit E: Competitive Price Lists
· Exhibit F: Leases and Contracts
· Exhibit G: Supplier Price Lists
Each of these sections, as detailed in Table 2.1 , will be discussed in turn.
Section 1: Introduction
Section 1 contains the title (cover) page, table of contents, and executive summary. The title (cover) page is an important part of every business plan, as it has the following:
1. The company name, address, telephone, fax, e-mail address, and website.
2. Name and position of each member of the management team and the contact person.
3. The purpose of the plan, the amount of money needed, and funding increments
4. At the bottom of the title page: “This is confidential business plan number ____.” A low number should be put in for each business plan given out and when, and who received this numbered plan should be tracked for a 30-day/60-day/90-day period.
The first page after the title (cover) page is the table of contents. This follows the usual format and lists at least the major subsections in each section and the corresponding page number as well as each figure, table, and exhibit. Preferably each major subsection and smaller subsections should be labeled as 1.0, 1.1, 1.2, 2.0, 2.1, 2.3, and so on. The executive summary precedes the numbering and therefore either has no number or smaller letters or Roman numerals. The tables and figures should have a separate list, as should the exhibits (appendices).
The last item in Section 1, following the table of contents, is the all-important two-page executive summary. This is by far the most important document in the business plan, as it is often used as the screening section by investors who often decide not to read the entire plan. Many readers, including potential providers of capital, never read beyond the executive summary. One head of a very successful venture fund, who is now managing his eighth fund of over $850 million, indicated that he receives about 1,500 business plans a year, discards 1,400 based on the cover page or executive summary, and, of the remaining 100, will discard 80 after the first 1- to 2-hour examination. Of the remaining 20, about 4 to 6 will receive investment from his fund. So the executive summary needs to be very well written to invite further reading of the business plan.
The executive summary should have the name of the company and address at the top of the first page that appeared on the title (cover) page. It should begin with defining the nature and size of the problem existing. In the case of TerraPower, the problem is a large, critical one—the need for low-cost, clean electrical energy. The larger and more critical the problem, the more interest there will be on the part of investors and others.
This needs to be followed by your proposed solution to the problem. Again, for TerraPower, this is providing low-cost, clean electricity through a new traveling wave reactor (TWR) technology that runs on depleted uranium. In this section, all competitive ways to solve the problem should be discussed showing the uniqueness or the unique selling propositions of your solution. These would include nuclear, solar, cool, and geothermal energy for TerraPower.
Following the solution is the size of the market, trends for at least 3 to 5 years, and future growth rate. The market needs to be large enough and accessible to deliver the sales needed for the profits and returns expected by investors. The need for and increasing use of electricity makes for a very exciting perspective for TerraPower.
The entrepreneur and team who will deliver these sales and profits then need to be described. The education, accomplishments, and industry experience of each known member of the top management team need to be described. The individuals involved in TerraPower are very noteworthy and include CEO John Gilleland, founder of Archimedes Technology Group, and founding members Bill Gates (Microsoft), Nathan Myhrvold (Microsoft's former CTO), and Lowell Wood (a renowned astrophysicist).
The resulting sales and profits should be summarized over a 5-year period in the following format:
These numbers are taken directly from the pro forma income statement summary in the financial plan in Section 2. Note the exact calendar year is not used but rather year 1, 2, 3, 4, and 5, with 1 indicating the first year of company operations after the investment is received so that dates do not have to be changed based on the receipt of the investment.
The two-page executive summary closes with a statement of the resources needed, the increments of capital accepted, and contact information. An example two-page executive summary is indicated in Figure 2.1 .
Figure 2.1 Example Executive Summary
Section 2: Body of the Business Plan
Following the executive summary, which is the end of Section 1 of the business plan, Section 2 starts on a new page with its first part—1.0—Description of Business. In this section, the nature of the venture is described to provide an understanding of how the venture will operate and deliver the products/services to solve the problem identified. Information on the products/services should be in enough detail to be easily understood; this will be expanded on in two places in Section 3. If it is a technological product/service that employs a unique/new technology, it will be described with a summary copy of the patent as well as in the product section of the marketing plan (Section 4). Every product/service will be further discussed here regardless of its degree of technology. The mission statement of the company should be described as well as the business model—the entire picture of how the company does business—and if this business model significantly differs from the model of the way business is presently being done in the industry.
Section 2.0—Description of Industry—follows; this section discusses the characteristics and size of the industry, industry trends for the past 3 to 5 years, future outlook and growth rate, and a thorough analysis of competition presently filling the same need as the new idea. This is a large section with significant use of data from secondary sources. Sometimes there are so much data that only part appears in the body of the plan, with the rest appearing in an appendix at the end of Section 3. Graphs, charts, histograms, and other graphics should be used to thoroughly explain the industry, its growth projection, and the competitors. A graph showing the market growing is important based on the trends of this market to date. The market, the market segment, and target market for the first year will be further discussed in the first section of the marketing plan.
Following the description of the industry is Section 3.0—Technology Plan. Some business plans where there is not a technological advancement in the product/service being offered might not have a technology plan. For example, one author founded a rainbow decal and sticker company with no significantly new technology, so there was no technology plan in the business plan of the company. Whenever the product/service has a patent or patent pending or application, there will always be a technology plan as the patent adds value to the venture. A general rule is if you are having a hard time deciding whether to have a technology plan, then put one in, as it is better to have one than not in this circumstance. The technology plan describes the state of the technology presently available and how the new technology revolutionizes the way things are done. This was the case for the traveling wave reactor (TWR) technology running on depleted uranium of TerraPower, discussed in the opening of this chapter.
The marketing plan, the next section, begins with a discussion of the market segment and target market for the product/service. It defines, usually through using one or more segmentation techniques, the most appropriate overall market and target market and its size. Of the many available segmentation techniques (demographic, geographic, psychological, benefit, volume of use, and controllable market elements), the two most widely used ones, particularly for entrepreneurs and small- and medium-sized enterprises (SMEs), are demographic and geographic, as this is the way that much of the secondary data are published. SMEs are smaller enterprises defined by size category that varies by the industry the company is in; it is established by the government of the country. In the United States, the U.S. government allows SMEs in the construction industry to be larger than SMEs in consulting.
If the venture is BtoC (business to consumer), then the most important market data are the demographics of the selected geographic market. The most widely used demographic variables are age, income, and gender to determine the size of the market and a typical customer profile. For a BtoB (business to business) venture, then the business market needs to be identified using the classification (country) system of the country for the industrial (business) customer being served. The North American Industry Classification System (NAICS) code in the United States, the Standard Industrial Classification (SIC) code in Korea, and the SIC code in China each use a numbering system to classify each industry and specific products/services in that country. A sum of all the output of these numbers is the gross national product of the country. This procedure will provide the trends, size, and growth rate of the particular industry market, which can be used to develop the typical customer profile.
Following the delineation of the target market, a marketing plan needs to be developed to successfully reach and sell to that target market. The marketing plan has four major areas—product/service, price, distribution, and promotion—as indicated in Table 2.2 . The product/service part describes the characteristics and quality of the offering, the assortment of items to be offered, the guarantee, any servicing provided if needed, and the packaging. The latter can be very important for entrepreneurs and SMEs in the BtoC market as it can be a major area of distinctiveness as well as a sales tool in the distribution center(s) used.
The second variable, price, is closely related to the product/service, particularly the quality level. The price, the most badly executed of the marketing areas by entrepreneurs and SMEs, needs to reflect the competitive prices, the costs, and the consumer reaction to the price. If a distribution system is used, then there will be a chain of markups on the cost, as indicated in Chart 2.2 .
The distribution area has two major aspects: distribution channels and physical distribution, which together is called supply chain management. The distribution channels include entities handling the product, such as retailers, wholesalers, and representatives. The physical distribution, or logistics, is becoming an increasingly important area and includes transportation, storage (warehousing), and inventory.
The final area of the marketing plan is the promotion area, which is composed of advertising, personal selling, publicity, sales promotion, and social media. The latter three are particularly important for entrepreneurs and SMEs as they can be used to produce multiple exposures cost-effectively. Social media, including the website of the new venture, are a particularly useful area. A marketing budget needs to be prepared for the first year indicating where the money will be specifically allocated to promote the company and achieve the initial sales of the first year. This first-year sales figure concludes the marketing part of the business plan and is a good start for the next section—the financial plan.
The financial plan, the next part of Section 2, focuses on a discussion of the created statements indicated in Table 2.3 . These will be discussed later in this chapter following the discussion of the business plan.
Following the financial plan is the production or outsourcing plan, which indicates how the offering will be developed and produced. Some service ventures will not have this part in their business plan as they are not producing or outsourcing anything. Each individual cost needs to be specified so that an understanding is provided of the actual costs involved in the final offering and how much this can be reduced through economies of scale. All suppliers or outsourcing firms should be described in detail.
Chart 2.2 Channel Members and the Price
Following the production (outsourcing) plan is a short section—the operational plan. This describes in detail how the company will operate, including the flow of goods and orders. An important aspect discussed here is the exit strategy by which investors will get their equity and a return on equity, hopefully in a 5- to 7-year period of time from the initial investment. There are basically three ways to provide this exit and return desired: (1) retained earnings of the venture, (2) selling to another financial institution or firm, or (3) going public and being a publicly traded company. The most likely exit avenue is selling to another firm and, if this is mentioned, then three to four likely exit firms in the industry area need to be identified and discussed. Section 2 concludes with a brief summary that completes this section of the business plan.
Section 3: Support (Backup) Material
Section 3 contains all the backup material to support areas in Section 2. This includes secondary support data, any research data, contracts or leases, the patent document, and most notably the résumés of the entrepreneur and members of the management team. Nothing new should be introduced in this section.
Financial Information
The financial information contained in the financial plan consists primarily of the 11 financial statements indicated in Table 2.3 . All but one of these are actual statements of any operating company. While having the same content, the difference in these statements is that they are forecasted—pro forma—statements that at the end of the time period will become actual statements. The one new statement is the first one—the sources and uses of funds statement—which describes how much money is needed (uses) and where it will come from (sources). The uses part often includes money for renovations, inventory, working capital, and/or reserve for contingencies. Each use statement will include working capital—the money needed until the venture positively cash flows, the point in time when the revenues from operations exceed the cost of operations. Sources of money will always include the entrepreneur and usually friends and family. The other sources of finance include banks, private investors, venture capitalists, and/or grants, which are described in Chapter 9 .
Business Plan Development and Update
The business plan is a very important document both for providing direction for the new venture and for raising financial resources. It is important that it be well written and edited. The best way for an entrepreneur to proceed is to develop and write everything in draft format and then go back and rewrite. Keep in mind during this process the audience for your plan and arrange the material in a way, such as the one suggested in this chapter, that makes items flow smoothly from start to finish. Clear and concise writing is needed, and all numbers need to be consistent. If possible, have a friend or colleague critique the final business plan. If needed, you can always pay a professional writer at the end to make sure the plan flows smoothly.
A question frequently asked is how long (how many pages) a business plan should be. While that depends on the nature of the product or service, whether the business contains a technology plan and/or a production (outsourcing) plan, and the extent of Section 3 (exhibits and appendices), most business plans are around 30 to 50 pages. Remember, you have 12 pages of financial statements and several pages of résumés. Most important, you want all the necessary material covered in a clear, concise manner.
Summary
Every new venture needs a business plan to set the direction for the firm and obtain financial resources. The essential elements of a business plan are contained in three sections, with the main elements being in Section 2. The most important document in the plan is the executive summary, as most potential investors do not read beyond it.
Each business plan needs to be well written and organized and address as many anticipated questions as possible. It needs to flow smoothly and consistently without errors so that the reader has a clear understanding about the details and future success of the new venture. Time will tell whether TerraPower meets its plan of having a prototype ready for demonstration in 2022.