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What will an investor expect in return? 28 July, 2006

Posted by varoom in Business Plans.
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Some thoughts on what shareholding potential investor will ask for in exchange for an investment

The criteria for investor participation in your business are wide and varied. But it continues to surprise me that many entrepreneurs are shocked when they see the share holding requested by investors. There is a simple calculation you can do yourself, based on figures in your business plan, which will tell you the shareholding you will have to give up to gain an investment.

Firstly you should understand that the investor is looking for a return on their investment over a certain time period, lets say 5 years. The return could well be in the order of 10 times the original investment. So an investment of 100k in your business today should yield a return of 1Million in 5 years.

How could they get that return on investment? Well many ways; firstly the company could be floated and the shares owned by the investor sold to get the return. Secondly the company could be sold in a trade sale to another company in a similar business. Or finally a sale back to the shareholders or management buyout.

When reviewing your business plan the investor is trying to build up a picture of the business potential, the investment risk, the product risk, the market growth potential and an assessment of the people involved in the business. He will use this assessment in the valuation of your business.

How do they value the business? One important factor is the business size in 5 years time. They look at the Profit forecast in year five and multiply this with a figure which is typically in the range of 5 to 10. The lower number will reflect a more risky business and a higher number reflects more confidence in the business. This number is driven from their own risk assessment of the business proposal.

Another important factor in this evaluation is the business value today.  If no development has been done so far, or no investment has been made, or no market demand is clearly demonstrable then this will undermine the future valuation. If you have a working prototype, existing customer demand or even sales, then you have a stronger justification for the future value of the business.

Now the take the original investment which must yield a 10x return and divide that into the valuation of the company to get a rough shareholding needed to provide that return. For example:

If your projected profit in year 5 is 500k and the investment required today is 100k then the investor will take their assessment of risk (lets say 5x multiplier) and this will yield a company valuation of 2.5Million in 5 years time, so in order to get a 1Million return he must have at least 40% shareholding of your company. No doubt he will try for more than 40% to get increased reward for the risk.

If the investor has some concerns about the risk there may be more requirements on your business set by the investor to mitigate those risks like having other investors join in, specific board members or recruitment of Chairman or Marketing director.

The above simple calculation is NOT the only factor considered by investors, but it provides a good estimate of the range of shareholding likely to be requested by a potential investor assessing the business.

Notable exceptions tend to be special cases like Business Angels or VCs who specialise in a particular class of investment. But the rule of thumb above is a good guideline.

Varoom…

The elevator pitch can help 21 July, 2006

Posted by varoom in Executive Summary.
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The elevator pitch

This is probably a US originated technique but it remains a valuable exercise in refining your messages for use in an executive summary or for when you get the chance to pitch your idea to someone in a hurry.

The elevator pitch: Imagine you have an idea that needs the support of someone who holds the power to make it happen for you. Suppose this person is incredibly busy and very difficult to get in to see, but you are lucky enough to get in the lift with them on the way to the 10th floor of the building.

You have 1-2 minutes to pitch your idea and convince them to support your proposal.

Are you ready for the challenge? Can you make your proposal interesting enough to keep their attention and convincing enough for them to be persuaded in the 2 minutes you have?

In a similar way to the executive summary, of your business plan, you need to be able to convey the key points of the proposal but do not have the time or space to go into greater detail. After reading the executive summary the reader will have all the information necessary to decide if they are interested and, if so, continue reading the business plan.

In the elevator pitch all you want is to persuade them that your proposal warrants further discussion or review, it’s unlikely that you will get a decision but your target is to get them to ask for more detail. So just like in golf, you don’t aim to get a hole in one but placed just close enough to sink it at the next attempt.

So in preparing your elevator pitch you need to decide what it is that you want, funding, resources, technology…..?

Working backwards from that point what information do you need to convey? How much is really needed to make a decision to continue with the proposal, what benefits will this proposal bring? Timescales, market potential, sales/profit potential, technology benefits are all key subjects. The key thing to remember, with a tight time budget, you must get all the points across in as few words as possible.

The summary should have a beginning, middle and an ending…..Obvious really.

But what kinds of things go in the Beginning?

In the beginning you should introduce the market, market size and growth opportunities and some information about your idea. In this section it would be good to see the financial prospects for the business over a period of time assuming you gain a certain market share.

Then you should describe the product, technology or service you propose. How it differentiates with the other products in the market, if any competing products exist, and what value the customer sees in your product. The price position could be described here if it is a key part of your strategy.

Next you should describe what you need to be successful in the market and how the reader will benefit if they agree to your proposal.

The ending should summarise what you want from the reader.

Practise your elevator pitch and then go back to the executive summary and refine further.

Varoom.

The good executive summary 14 July, 2006

Posted by varoom in Executive Summary.
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Many will tell you that the executive summary is the most important part of any business plan and a good summary can go along way to ensuring success and a bad one can kill a great business.

I agree with most of this perspective, but, the success of an executive summary depends on who it’s for, an investor, banker, lawyer, customer? The end reader of the summary dictates some of the focus of the text, the investor wants to know what the potential return could be, the lawyer may be interested in protecting the idea, the customer may be interested in what kind of resources the company will have.

What is an executive summary for?

It’s to persuade the reader to review the whole business plan document and not file it under ‘B’ for Bin!

Take an every day example. You are in a bookshop at the airport. You are looking at the wide range of novels on display and need to choose one. How do you do it?

You may have preferences for a type of novel, science fiction, romance or comedy. Or you may be looking for a particular Author. Maybe you are attracted by the cover design or that there’s a 2 for 1 offer going. (That caused me to buy the Da Vinci Code in an airport long before it became famous). You start reading the summaries on the back of some novels that you like to look of and eventually you choose one. You did not read any of the novel before you chose the book to invest in.

There is some similarity with potential investors who have to review many business plans. It can be superficial aspects or the succinct executive summary that causes them to “buy” the book….In a business plan the executive summary can be make or break.

But right at the beginning how you approach the creation of an executive summary is important. I read 50 plus summaries, in business plans, a year and some take a great deal of effort to get past the summary and dig deep into the business plan itself to find out enough information to judge the business potential.

Some authors spend too much real estate in the executive summary trying to convince the reader that their idea is world class and too little effort convincing the investor that there’s money to be made.

A good executive summary is like the good novel, it has a beginning, middle and an end. It tells a story, in enough detail, that the reader can make a clear and informed decision whether to read the full document or file it under ‘B’.

So having a structure in mind and some key bullets will allow you to story board the summary before you start to write the actual text.

 

What’s the product idea, what is the market and its potential, how your product gets to market, how can you make money, what is the long term business potential and what resources and investment does your business need in order to capture the business?

More later….

Varoom.