How to turn your GREAT IDEA into a BUSINESS

I was speaking to a local entrepreneur this week who asked me about how to put a business plan together.  He had seen a market opportunity but did not know how to translate this into a form which he could then take to investors.  We spoke for around half an hour and at the end he told me he had learned more in that time than with three major sessions with his accountant.

I thought it would be helpful to summarise my discussion with him in the Six Minute Strategist format. This still lacks a lot of the detail of course but I hope the framework itself is useful if you are thinking about how to take YOUR Great Idea and turn it into Business.  As ever there are Six Stages.

1. Market

2. Profit

3. Plan

4. Capital

5. Value

6. Investors

Lets start then with the Market

a. How big is the market Opportunity and can you scale your idea to take advantage of the market?

b. Is there a real demand for your Product/Service/Solution.  Are you solving a real need/pain point/problem for your customers?

c. Define your Solution.  How do you solve this problem?  What is your Product/Service/Solution?

d. Review the Competition.  Who are your competitors?  (It is very unlikely that you are so new to a market or so orginal that you do not have any competition.  Investors also find it very unconvincing if you cannot identify them.)

e. What is your USP (Unique Selling Point)? Or in other words how are you going to compete successfully (and profitably) against the competition?

f. Value – In summary then, what value to you provide to your clients and how do can you transmute this value into cash value for you and your investors.  It is worth remembering that most of the value created by enterpreneurs only arises at the end of the process when the business is sold.

Profits – can your Great Idea make money?

a. You need to construct a simple 5 year, monthly profit and loss account which then creates a cash flow statement.   This is your template for your financial model.  You will need to build capital and operational expenditure into this but for the moment don’t worry about a balance sheet as integrating the three (while avoiding circularity) can be tricky.

b.  Work out your revenue assumptions; how much will you sell your product/service/solution for, how many will you sell and when.  You should create a separate assumptions sheet which feeds into the P&L so that you can alter your revenue assumptions without changing all the cells in the P&L account.

c. Next on the assumption sheet, create build in your assumptions relating to costs of sale to arrive at your gross margin.  Are there scale economies as you increase the number of units sold?  Is the pricing of your product defensible or will competition erode your pricing over time?  Have you factored in quantity or promotional discounts?  Below the Gross Margin you need to model your fixed costs; salaries, office costs, rent, rate, electricity, marketing etc. This is called SG&A in US GAAP.

d. These assumptions so far will enable you to reach the EBITDA line – Earnings before Interest, Tax, Depreciation and Amortisation.  This is the profit line most used for business valuation as profits after this are distorted by non cash items or by the balance sheet structure (I) or by tax – which is only paid once you have arrived at a profit and is therefore derivative.

e. You will need to work out your organic growth assumptions.  How quickly will sales grow.  You may chose to run different scenarios to see what impact this has on cash flow – and therefore how much “working capital” the business will need.  It can be just as dangerous to over trade as not to sell enough.

f. The profit and loss model should then be used to create the cash flow.  Into this you need to build in your assumptions about the capital costs needed to set the business up, the ongoing operational and investment costs you need as the business grows and run this on a monthly basis to include the cash generated from the operations of the business.  The key here is to identify the maximum negative cash position which, when added to a contingency amount, shows you how much capital you need to get the business up and running and to a point where it is self financing.  Depending on the cash requirement, this will help you to decide how much capital you need to raise and, based on your assumptions, how many rounds of finance you will require.

Plan – How are you going to Execute?

The business plan is normally a reasonably lengthy word document in which you set out to explain how you are going to turn your idea into a business.  The purpose is two fold; to explain to potential investors, but also to help you to think through the execution thoroughly.

a. Who?  As you are unlikely to be a one man band – who are your team, co-founders, executives, staff with whom you are going to create the business.  You will need to fully cost them into the plan, even if you decide to work for nothing in the initial stages.

b. How?  Explain the steps you are going to take to set the business up, your marketing and sales strategy, product sourcing and/or manfacturing.  Just think yourself through the sales cycle and set it down.  Then go back and make sure the costs are still correctly reflected in you financial model.

c. Where?  Will you need to rent premises, will you start from home?  Serviced offices can be a good flexible solution.  You will need to be clear where the business will operate from.  Is this consistent with where your colleagues live or will they have long commutes.  Is the location the right one to reach your market?  Working from home is often not the best (even if it is the cheapest) solution.

d. When?  What is the timetable.  This needs to be clearly thought out as the time to market and first sales are critical to your cash flow assumptions.  Be realistic but also be determined and when you have set out a timetable and your colleagues and investors have bought into it, it can be critical to confidence if you do not stick to it.

e. Risks – these need to be thought through and anticipated.  Often a SWOT (Strengths, Weaknesses, Opportunities and Threats) analysis for all stages of your business can help you to brain storm these issues.  Consider drafting in a SWOT analysis for each section of your document to help you think, but I do not recommend including all of these in the final published version.

f. Executive Summary – once you have written the plan, go back to the beginning and create an executive summary – essentially summarise the key sections at the front of your document to help new readers rapidly assimilate the contents of the document.  The main sections should be; Management, Business Summary, Market, Summary Financials.  You will need to add later to this Executive Summary and the Plan a section on your financing requirement and how much money you are trying to raise.  This neatly seques to the next section.

Capital Requirements

a. Capital Expenditure – as you set up your business you will have start up costs to get things up and running.  This will also include legal, accounting and other professional services costs to get properly set up to trade.  These costs should be carefully detailed in your business plan and you should strike the right balance between thrift and efficiency and not cutting corners on investment which may later compromise your delivery quality or ability to operate efficiently.

b. Opex – operational costs will increase as the business grows.  Businesses need “working capital” to operate – think of it like the oil in your cars engine.  As the revenue grows your working capital requirement will grow with it.  When your model includes and integrated balance sheet, this working capital is captured in the balance sheet and changes to cash are adjusted by the working capital giving you a realistic cash forecast projection.

c.  Lean and Mean – you should aim to watch every penny.  The dot com boom days of “never mind the cash burn measure the hype” are long gone.  Reduced salaries can be exchanged for small equity interests for your start up team.  More about equity a bit later.

d. 18 Month Runway – when considering your cash requirement you should aim to ensure that you raise enough capital to run the business for 18 months.  Raising capital is very time consuming.  You need to be able to do a capital raise and then focus on the business and achieve some milestones in its development.  Running out of cash is THE cardinal sin.  Investors will rescue you but almost inevitably on very, very expensive or highly dilutive terms.

e. Cash burn.  I believe that the CEO of every start up business should know his opening cash position in the morning and at the end of the work day.  Watching and measuring the cash burn is critical.  Understand where the money is going and continually ask yourself if this is the best use of the cash.  Money can only be spent once.  Should you be doing something differently or can you do it more efficiently?

f. How much?  All this analysis should enable you to answer the question – How much capital do I need to raise.  You should include a contingency fund – I would use 25% as a working number.  You should also have run a range of scenarios, adjusting your assumptions to see what impact it has on cash.  What happens if sales increase at twice the expected rate?  What happens if the take up is only 50% of what you have assumed?  These are questions investors are likely to ask you so you better have the answers ready.

Value or Slicing the Pie

A company’s value should be thought of like a pie.  More for you means less for someone else and vice versa.  You all hope the pie will get larger but the key to your personal value creation is the size of your slice not the size of the pie.

a. Founder Equity – your Great Idea gets you the biggest slice of the pie.  To start with this will be 100%.  From here your slice is only getting smaller but managing that carefully, particularly in the start up phase is critical to your future net worth.  If you don;t believe me, ask Mark Zuckerberg.  If you bring in a co-founder they will also expect a good slice so think hard before you share your baby with someone else.  Early stage employees may get equity but as non founders they can expect small single percentage slices.

b.  Valuation: The value of the pie will normally be measured by a small range of financial metrics.  A multiple of EBITDA (see above), a multiple of cash flow, a calculation of the future value of the cash produced by the business (not surprisingly referred to as a Discounted Cash Flow or DCF).  Companies are not valued on multiples of revenue although their value is often expressed in these terms.

c. Investors – when you turn to third parties for your initial investment you can expect them to ask for around 30%-40% of your pie in return for your investment.  From their prospective, however good the Great Idea, this is a risky proposition and they are looking to make 10x their money.    Understanding this can help to start to narrow down and fix some of the variables around valuation.

d.  Formula.  Think about it this way;  Identify your capital requirement for an 18 month runway and add 25% contingency. Divide by 30 and multiply by 100.  This is your PRE-Money valuation.  So for example, if you need to raise £300,000, your valuation is £1 million.  If you sell existing shares, the PRE-Money valuation does not change, but normally you create new shares which means the POST-Money valuation is £1.3 million.  Clearly if part of the investment is a loan, this alters the valuation but the terms of investment are almost a blog post in their own right.

e. Dilution.  As the owner of the pie, you need to do some careful thinking about your cash raising strategy to understand its impact on your dilution (the reduction in the size of your slice).  In a successful start ups, the valuation of the company increases at each new fund raising stage (known as an up-round).  Clearly if you raise £300,000 at a £1m valuation you will suffer greater dilution than you would if the valuation was £3m.  Staging the fund raising allows you to achieve clear business objectives and return to investors with higher valuations – the company is more developed, less risky and therefore more valuable.  This needs to be carefully balanced against my 18 month runway rule.

f. Reality Check – you should ask yourself if your capital requirement and valuation are reasonable.  Look at your financial model and use it to see what returns you are generating for your investors over 1, 3 and 5 years.  Early Stage investors would normally be seeking 10x their money in the 3 to 5 year stage.  Less than this and either your assumptions need adjusting (while still keeping them realistic) or your Great Idea may now be revealed to be only a Good idea!

Finally a word on Investors

The whole identification of and approach to investors is a complex subject but here are some key pointers to be thinking about in this preliminary stage.

a.  Elevator Pitch – imagine you enter the elevator (lift here in the UK) with an investor. You have 60 seconds to pitch him your business.  What do you say to get his attention and to make him want to hear more.  VCs typically say if you can’t describe your business in one sentence you either haven’t thought it through or you don’t have a compelling proposition.

b. Slide-Deck – Powerpoint presentations can be the grave yard of many a Great Idea and it is important to get them right.  This again is another subject in its own right.  Guy Kawasaki put it succinctly in his 10: 20: 30 Rule; 10 slides, 20 minutes, 30 point font.  I normally recommend 13 or 14 slides but I completely agree with the other two points.

c. Role?  You should carefully consider the role you want from your investor; passive to active? On the Board? If your investor has relevant business experience you should try to find a way to benefit from it through a working arrangement that suits you both.  In this case it is not simply about the money.

d. Sources of start up equity capital are typically from two sources; Friends and Family (and Fools) or Angel investors.  You should be clear if taking your aged Aunt’s hard earned savings that she can afford to lose the entire amount and understands that this is a very possible outcome.  Angel investors tend to be financially successful people who are more sophisticated, understand the risks but may demand more for their money as a result.

e. Bootstrapping.  Before rushing off to find equity investors, are there other ways to finance this Great venture.  At one level, credit cards can be useful, bank loans or other debt loans which do not involve you surrendering precious equity at this point.  This is called Bootstrapping – a curious term referring to the act of pulling onself up by ones own bootstraps which is clearly a physical impossibility if you are wearing them at the time.

e. Six Reasons – this is normally my final slide in the deck but it also works with the Elevator pitch.  I ask entrepreneurs to summarise their business in six (of course) reasons why investors should invest in the company.  These should be compelling and are intended to close the sale, to convince the investors that it would be folly to miss the opportunity to invest in your Great Idea or worse, invest in someone elses!

Six Minute Strategist Start Up Course – Is this for you?

Are you struggling to get your Start-Up Started?

Do you need to learn more about Business and Financial Plans

Do you need to learn how to pitch to investors?

Take a look at my brief Video…

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