There is an old adage in the financial community: “Investing $1,000,000 to fail is expensive, investing $5,000,000 to succeed is cheap. Investors will respond to financing needs based on real-world assumptions. They will be very cautious when evaluating actual financing requirements. of a company.
Think of investment capital as fertilizer. If a farmer applies too little, he gets a bad crop or worse. Too much fertilizer and the harvest will also be disappointing. Successful and experienced farmers know their fields, their climate, crop planting patterns, and their equipment. They will apply every pound of fertilizer needed to maximize your harvest. Investors manage their capital in exactly the same way.
I review many business plan presentations each year. It’s amazing how many entrepreneurs can’t identify, quantify, or justify the investment requirements they outline in their business plans. This is an absolute knockout in terms of creating investor excitement to finance a project. This is one of the main reasons why many plans never receive a complete read.
Often the entrepreneur woefully underestimates the obvious level of funding that a new venture will require. The justification, declared or not, is usually that they try to keep the number of investment necessary to generate interest very low. They don’t understand that there is no such thing as an investment number that is too high or too low if the need for capital can be demonstrated, qualified, and narrated. Investors want a clear view of the use of funds and how they will earn an adequate return on their invested funds.
Seeking more than the number needed to successfully launch a startup is just as disastrous. Investors are not looking to build a Taj Mahal before the first dollar of income is generated. Here are some tips for building spending assumptions that will stand up to withering investor scrutiny.
Employees
Investors don’t want entrepreneurs to starve. They also don’t want to finance the lease of a BMW 745. Wages must be based on support requirements. Most investors I’ve worked with want their management teams to earn enough salary to pay their bills and not put negative pressure on personal finances and marriages. Comfortable is fine, but they are not going to finance luxuries. Be very realistic.
staffing
I often see plans with a list of proposed employees that looks like the list of animals from Noah’s Arc. Keep this area very thin. Use outside contractors, consultants, and part-timers to fill as many positions as possible. Employees add high fixed costs to the budget. Salaries, benefits, training and equipment can be too heavy a burden for startup projects to absorb. Another no/no is a VP squad. These are red flags that scream excess and will almost eliminate any chance of receiving funding for a new business opportunity.
Facilities
Plan to rent the necessary office space on short notice. If growth happens as planned, it’s always easy to find larger locations. You don’t want to get a larger space than is initially needed to run the business most efficiently. You will be using too much of your precious capital for an underutilized asset.
This may seem obvious, but you should read the business plans I make. Many entrepreneurs try to replicate the environment they enjoyed when they were corporate employees. I recently reviewed a cash flow projection that included an office expense for a daily flower delivery, and it wasn’t a floral business. Investors are totally put off by expenses like this. Unless the office environment is crucial to closing sales and making deals, keep the space as spartan as possible.
Don’t burden the staff with numerous family members unless they are performing an absolutely essential function. Just because Cousin Myrtle has been laid off for several years, the focus of her start-up is not to employ her, unless she can champion her unique skills and abilities. Her judgment will be questioned unless she can sell Myrtle’s profits.
The cash flows you project in your business plan will be in the red (cash) for several months. Your ability to secure investment money will be greatly affected by showing how quickly the rate of consumption stops and the business starts throwing cash away. This is a point that you must be able to defend aggressively. Investors will be very uncertain about your cash flow projections and therefore the level of investment you really need, not what you think you need. The better you do at examining assumptions and backing them up with industry-specific historical data, the more likely you are to win investors and their money to commit to your project.
A business plan that does not show cash consumption slowing, then stopping, and then turning positive in cash flow during the first 12 months of operations is not likely to be funded. Investors want to see quick sales traction. A plan that does not show fast enough growth will increase capital risk and sour investors.
Whether you need $1,000,000 or $21,000,000, the business plan must be written to justify the necessary level of financing being sought. Too low, or too high, and experienced investors will walk away. Think like a farmer who fertilizes his fields during spring planting. He has a lot of land and needs to make every square foot produce the highest crop yield possible. The farmer does not waste seeds, fertilizers, water, labor or fuel. He ensures that the harvest is cared for with due diligence and is given everything necessary to reward his efforts. Farming is hard work.
So is finding and securing investment commitments. There are thousands of projects on the street every day looking for investment capital, partners or a license. The number of projects far exceeds the supply of available resources. Don’t insult your opportunity by loading your offer with excess, fat and dreams. Your payout occurs after you achieve success and the investor has begun to see a return on their investment.