Taken from a write-up I did for Wharton’s entrepreneurial community

Rather than attempt a comprehensive write-up of creating a new venture, which would fill several books, here are some practical, immediate tips you can apply. At the end of this article is a URL you can use to ask further questions, publicly or privately.

DISCLAIMER: I’m an angel investor and coach, not a VC. The below is based on my experience reading and responding to business plans. I can’t guarantee that VCs pay attention to all the same things.

What investors are looking for in a plan

Investors—whether angels or VCs—are looking for the same things when reading a business plan. They want to know how big the opportunity is, whether this is the right team to exploit the opportunity, who the competition is, what the risks are, and why they can expect this team to implement successfully.

Your job in writing the business plan is to address these questions convincingly and clearly.

Also make sure to check out Notes from a VC Panel Discussion.

Tips on Opportunity Recognition

The size of the opportunity depends on the market

“Opportunity size” is a very rough concept; there is no precise definition. You can think of it as roughly the number of potential customers times the expected percentage who can be captured as customers times their average purchase times their average purchase frequency. You can find huge opportunities by selling small things to many people over and over, by making huge sales to a few people, or anywhere in between. Know why your opportunity is the size that it is.

For example, RenalTech is a company which manufactures filters for dialysis machines. There are 320,000 people on dialysis in the United States. If they know how many filters per year those patients use, multiplied by the price per filter, they can have some idea of the size of their opportunity.

Choose a huge market

Especially in the internet world, venture capitalists are looking more at the market than at the detailed specifics of your financials. Choose a market that is big enough to be an obvious good opportunity.

A business which targets teenage girls who listen to music and has a reasonable chance of capturing 90% of the girls that are online is a huge opportunity. A business which targets net-savvy SAAB mechanics who need prosthetic limbs is not.

Find a business with great fundamentals

Choose excellent business models which have sound business fundamentals:

  • lack of competition
  • recurring revenues
  • low fixed costs
  • low asset requirements
  • a compelling reason other than “brand loyalty” why customers will stay with you once they join

If your business requires $30 million worth of advertising on an ongoing basis to keep bringing people back to the site, make sure to factor that into your pro formas.

You can think of product ideas as being either candy, vitamins, or pain killers. Candy is fun, but a luxury. Vitamins keep you healthy. Pain killers ameliorate an immediate problem. VCs like to invest in pain killers. If possible, addictive pain killers. People in pain are strongly motivated to buy, which isn‘t necessarily true of people buying vitamins.

If you like risk, ignore the fundamentals

In late 1999, plans don’t need a sound business model to attract capital. Plans with no business fundamentals and inexperienced 27-year-old management are raising money with valuations of $12 million. The IPO market is also going crazy: WebVan just went public on revenues of $395,000, losses of $35.1 million, and they have a market capitalization of $8.45 billion.

The market’s faith is keeping these valuations afloat, betting that (a) losing huge money building a brand will someday turn into much huger profits; and (b) someone will buy the business for its strategic/intangible value, rather than its cash-generating value.

If you’re comfortable making those bets, go for it. And of the 60,000 companies started this year, one or two will likely see those bets pay off.

Know why customers stay

If you show growing revenues year after year, but your customers have no natural reason to stay with you beyond a single purchase or two, think through why you expect the revenue number to grow. Are you somehow encouraging more purchases, or are you managing to attract completely new customers to fill the shoes of old ones?

Prepare to throw several ideas away

Discard non-superb ideas, ruthlessly. VC firms read 10,000 business plans a year to find 20 good investments. Warren Buffet waits years to find a single investment that meets his standards. You’re investing your time, energy, and reputation for years. You own it to yourself to have high standards.

Many entrepreneurs get an idea or two, latch onto them, and then rationalize away any serious holes in their plan. If you don’t go through a couple of ideas before settling on one, you’re either very lucky or your standards for a good opportunity are too low.

Research the competition, even in the pipeline

At the very least, do an internet search for similar ideas and companies. There are few things more embarrassing than presenting a business plan for a “new concept” only to find that concept up and running elsewhere.

And remember, there may be competitors who haven’t launched, yet. Have a plan to deal with the possibility that such competitors will crop up.

You always have competition.

Your competitors aren’t always in exactly the same business; they may not even be companies. Scott Cook, founder of Intuit (maker of Quicken) defines the competition for Quicken as being a pencil and paper checkbook. And using that definition, Scott has built a company that has dominated every financial software market it has entered.

To find your competition, ask the question: if people don’t have our product/service, what will they do instead to meet their needs? That is your competition.

Tips on Writing Your Plan

Let your elevator pitch drive…

This article is continued in the Entrepreneur’s Companion volume 1. Click here to purchase.

Hints on Writing Business Plans

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