My post on the 13th “A written business plan does not get you venture capital” seems to have waded into a world of controversy. Some of the comments left on PEhub (the publication that first brought my attention to the University of Maryland’s professors’ work) were quite angry. I thought it would be interesting to look at some of those comments and respond from a young VC’s perspective.
Here was one of the comments on PEhub:
What this Maryland study proves is that VCs no longer read or value business plans. Hmm. Wonder if that might explain why VCs have been failing of late in producing $1 billion homeruns, especially by building companies that have the wherewithal to achieve freestanding, sustaining value via IPO exit instead of lesser concerns aimed at quick flip exits by and large to previous portfolio companies… Maybe VCs ought to start demanding and reading business plans once again.
In the right context I agree with the first sentence. VCs do not value the formal, 50 page business plan as a means of initially screening investment opportunities. However, I’m not sure that the second point is a logical extension out of the first. It is clearly true that there has been a major dearth of $1+ billion exits of venture funded companies recently, but I do not believe that it is due to a failure to read (or write) business plans. In the near near term there have clearly been major disasters in the financial marketplace that have made IPOs not possible and have driven down the value of exits by M&A. Beyond that there are probably other structural issues in the venture capital marketplace causing fewer IPOs. One clear cause is that many web-based businesses can be created very capital efficiently, and thus it may make sense to more moderately fund a business to a smaller, non-IPO exit value. There may also be a (probably rational) lack of demand by major mutual funds for holding stock in younger technology companies at obnoxious valuations. But I do not think the fact that VCs don’t like reading huge business plans prior to taking an initial meeting is relevant to the issues facing the venture industry.
Another comment from PEhub
There are many poseurs that say things like, don’t make your plan 50 pages, no one will read it. If you are asking for six figures or more from an individual and they won’t even take the time to read a 50 page plan then ask them for more, it shows an ignorance that deserves to be exploited.
Imagine if you had to carefully read a 50 page plan prior to deciding if you were going to take a meeting with someone you had never met before. Now imagine that you get 5 to 20 of these plans a day. This is simply not efficient. Well-known investor are deluged with ideas looking for funding. If you want to succeed in getting a meeting with a potential investor then you need to get your point across quickly and succinctly. A 50 page plan is the total opposite of this; too much detail for an initial interaction with an VC.
I would like to make it clear: you usually do need a slide deck (maybe some people would call this a plan) to get a meeting with a VC. It’s a bit of a formality to be sure, but it is also a signaling factor that you as an entrepreneur aren’t ridiculously naive. The professors talk about this as being similar to the formality of exchanging business cards. I’m still trying to think of an analogy that fits better but haven’t yet come up with one. A VC wants to make sure that a meeting with an entrepreneur doesn’t waste both of their time, so that VC needs to know that the market is one that the VC is interested in and that the entrepreneur is … well, have you seen the Ali G skit where Ali G pitches venture capitalists on the ice cream glove? I’d estimate at least 1/3 of the plans that come into my fund without a warm introduction are, honest to goodness, a bit like that. Note that the issue captured by Ali G is different than a poor market fit – for example I recently got a pitch for funding a movie. We don’t do movie financing, so the business plan was very helpful in quickly screening out the opportunity. But a small slide deck would have been just as effective in that example as well, so the business plan really didn’t serve the entrepreneur or me any real purpose.
Comment:
I think this study shows why the situation of VC looks bad. Networking and social interactions are the determinant principles of VC funding. And the result… Poor returns…
I haven’t been in venture capital long enough to know for sure, but I’m still willing to bet that relationships and introductions were very important 10/15/20 years ago when VC returns were super strong. VCs fund people. People who hopefully execute plans, but still, people.
When I get interested in an idea I spend a lot of time working closely with the entrepreneurs to flesh out the business plan. I am not sure if I have seen a case where a founder walks into the fund and raises capital without the venture team spending a huge amount of effort working through/helping build and suggesting changes/modifications to the business plan. Thus, the initial plan submitted to the VC is less important of a factor in forecasting how that company will do post funding than the final plan agreed to by the VCs and entrepreneur at the end of the fund raising process.
Also, I think that is important to note that much of the business planning process is captured in the financial model. Customer metrics and costs to create technology are now capture-able in Excel much more easily than a word processor. I blogged about this a while ago in “Financial models – not as attractive as fashion models, but still useful.”
Oh, an one more thing: ENET, a Boston area tech entrepreneur networking group, is having a session on business plans. “Investor Guidance on Business Plans and Presentations” is on May 5, with some good speakers. Very experienced seed investors and one VC will be discussing the materials you should have when approaching an investor.
April 15th, 2009 at 9:22 pm
Great job responding to the comments Healy. I love it when people respond to comments.
Business plans are a great teaching tool…for the author. Writing a doc like that can help you dive deep into the opportunity. It helps you work out the kinks before you get to the investor. It helps you make the best possible impression and most importantly, it gives you an improved chance for success.
However, funding startups is really about funding exceptions. Few really succeed. If there was a clear pattern for success, it would be the commercial banking business and it would be boring. And guess what, a lot of entrepreneurs don't need to write a business plan because they can already isolate the core issues. A presentation (or napkin) works just fine for these people because they have the right kind of experience, smarts or insight into a market and they can articulate the opportunity. That's cool too.
The bottomline is that you need to do what's right for you. No one cares how you work out the kinks for the next great idea. They only care that you can communicate the idea clearly, it holds up to scrutiny and most importantly for the VC that decides they like the idea, that you choose to work with their fund.
Scott
P.S. I think what you are doing with this blog is wonderful. You're putting a wealth of information out there and making people much, much smarter. I appreciate your work.
April 15th, 2009 at 7:44 pm
[...] See the original post: More on business plans and raisin&… [...]
April 16th, 2009 at 7:44 am
[...] * Last week, we wrote about an academic study that found business plans are mostly a waste of time, vis-a-vis raising venture capital. Venture capitalist Healy Jones has some additional thoughts. [...]
April 16th, 2009 at 3:23 pm
Healy, again another great post. I found your blog about two weeks ago and have not been able to stop reading. Keep up the great posts and insight.
April 16th, 2009 at 4:11 pm
Great post. I tend to think that a Business Plan by the Entrepreneur should serve as a formal exercise to distill exactly what your are trying to create. Poke and prod the idea from all angles not just the innovation, but how to make money, how to sell it, etc, which are all important topics to cover as a way on convincing VCs that you are the expert and have gone through the rigor of understand the enterprise you are trying to build from as many perspectives as possible.
April 16th, 2009 at 6:35 pm
As the poster of the second comment you responded to, thanks for reading. The sentence below made me laugh, it really did because it sounds like you are running a hamburger stand more than a fund.
"Imagine if you had to carefully read a 50 page plan prior to deciding if you were going to take a meeting with someone you had never met before. Now imagine that you get 5 to 20 of these plans a day. This is simply not efficient. "
Imagine that you are having 5-20 actual meetings with people that you have never met to discuss something as complicated as a new business idea. Otherwise you are limiting the universe of new ideas to people you know, not a good idea even for Kevin Bacon who is within degrees of everyone. Ref the Madoff experience.
How can you have a discussion without reading a plan, How can you have confidence they know what to do if they can't write it down, a very different process cognitively than a .PPT and talking. How do you know about IP, competitors, reference class based examples of why it will work, etc,
Your approach is doomed to failure, you don't think that Kosla read plans? It this for real or are you just messing with us?
April 16th, 2009 at 8:37 pm
Joe,
Thanks for the thoughtful response. I think I understand your position, but I am not sure I’m doing a great job articulating mine. If I can summarize, you are saying that you don’t think a VC can have meaningful meetings (let alone make good investments) if that VC hasn’t read a detailed business plan.
Although, first, I’m really not “running” anything, but if I was running a fund I wouldn’t mind having some “hamburger stand” like aspects. You can never have too much deal flow if you are a VC (as long as you are decisive). The theory is the more you get to see the more likely you are to see the good ones. I base this theory off of two data points 1) LPs (the investors in venture funds) are very interested in the quantity and source of investment opportunities when they choose which funds to invest in; and 2) One of the top performing funds, Summit Partners (where I used to work) had an amazing deal sourcing engine – this was a major reason for the fund’s success. Efficiently processing meeting requests is a major aspect of managing good deal flow. Currently there is good deal flow so VCs need to efficiently choose who to meet with.
I would postulate that a VC can make a good (enough) decision on which meetings to take without a 50 page business plan. There is too much operational/tactical information in a huge plan for it to be of use in making this initial meeting/no meeting decision. I understand that this may sound offensive to an entrepreneur who has spent a massive amount of time drafting a business plan. In fact, I’m actually asking that that entrepreneur spend even more time putting together a 12 slide ppt that summarizes their thoughts! Again, there is nothing wrong with writing a plan – I would hope that it would be very useful in running your business and may help you articulate your business model to VCs.
I guess a specific example might be around IP strategy. A bullet point saying “we have 5 patents and 14 patents applications and expect to file several more to protect aspects of our machine learning engine” is more useful when evaluating a meeting request than pages and pages listing a startup’s patent numbers and their descriptions at the initial meeting stage. The bullet point shows that you have an IP strategy. If the IP is going to be an important part of the VCs investment decision then the VC is going to hire a patent attorney to do a review of the patents in the space before making an investment.
Can an entrepreneur and a VC have a meaningful discussion if the VC hasn’t read a 50 page plan? I’d like to think so. I’d hope that the VC already knows something about the industry that is being discussed. I generally also like to do a bit of preparation on my own for meetings that I’m really excited about. Why should I take the word of the entrepreneur at face value? I want to do my own research to come to my own conclusions.
A VC spends a huge amount of time, post initial meeting, with the startup’s team before actually funding the company. During this period there is plenty of time to read, redraft, reread, redraft, refine and reread a business plan. Sometimes this is in the form of a formal, 50 page business plan. Other times this is in booklets/ppts/word docs/excel files focusing on specific aspects of the business such as R&D or marketing , etc. It would be silly to assume that a VC would make an investment without doing this business plan discovery work. Just as it would be silly to assume that a VC would accept the first draft of a business plan (the one that they would get from a startup seeking a meeting to talk about funding) as a final, written in stone, execution strategy.
Is the approach doomed to failure? Well, it is possible that venture investing is doomed to failure, but again, I don’t think that the more to ppt vs. 50 page business plans as the intro to a business idea is the cause of this failure.
April 16th, 2009 at 8:50 pm
Joe, a good analogy is that when looking to hire someone, an HR employee would rather look at a well-written 1-page resume than a memoir. Do you miss out on some great people with bad resumes? Of course. But it allows you to consider 100 people per day versus 2 per day and then filter for the skills and attributes for which you're looking. A single venture capitalist can't have 20 meetings per day (as you recommend in your comment) as a lot of prep work goes into each meeting.
April 16th, 2009 at 9:00 pm
I didn't recommend that a VC have 20 meetings a day, the point was that a VC couldn't have 20 meaningful meetings a day. I guess we may be looking at different stages of investment, if you are investing $25K of mostly government money then picking from a PPT and a conversation may be a good idea.
In larger investments there are more considerations, in Healy's last response I saw that he meant this as a first meeting and in IP examples develops the plan, or at least information that will wind up in an operating document. So if you are talking about having a coffee, I agree, don't read a plan.
As far as the personal interview with the individual instead of reading the information as they understand it, all current research shows that data driven decisions in investments and in hiring are better as they exclude the biases we all have in face to face meetings. So because the people look like your favorite relative, or remind you of a smart guy you knew you put more weight on what they say than someone you can't relate to.
This type of thinking helped us get in the current mess as the same wrong valuation and rating models were used everywhere without question and when it was wrong the collapse began, all because someone didn't want to read or test the model, which was about 50 pages:^)
Interesting set of opinions, it is good to have diversity, that makes the winners and losers.
April 16th, 2009 at 10:07 pm
I had assumed that the discussion is aimed at technology entrepreneurs seeking at least $250k to a normal sized A round of several million dollars. I don’t know much about government programs that invest money, but I’m willing to be they have some pretty serious reporting/forms that need to be filled out prior to funding. I don’t know if I’d call that a traditional business plan or not…
The professors’ paper was based around the initial documents submitted to a venture capital firm by startups seeking funding. They then used VentureXpert (I think that was the database) to see which of those startups succeeded in getting funding. They were only able to compare the initial documents (i.e. business plans) submitted to the amount of funding raised. I’d basically call that initial document/business plan the “meeting request” document; i.e. the stuff the entrepreneur uses to entice the VC to take a first meeting. The professors’ results showed that the quality of that written business plan was not a predictive factor in which startups got funding. This makes sense, as it’s not the initial document that you submit to the VC that gets you funded, it’s the final business plan that you hash out with the VC that gets funded. The professors’ had no visibility into this final business plan.
I’m unable to comment on the causes of the current financial mess but I’m willing to bet it was a deadly combination of greed, stupidity and misalignment of short-term compensation and long-term incentives.
August 29th, 2009 at 2:13 pm
[...] More on business plans and raising venture capital | Startable – Healy Jones’ & Prasad Thamminen… http://www.startable.com/2009/04/15/a-couple-more-thoughts-on-business-plans – view page – cached My post on the 13th A written business plan does not get you venture capital seems to have waded into a world of controversy. Some of the comments left on — From the page [...]