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STREET SMARTS

Due Diligence

CEO Norm Brodsky explains that a complex business plan drawn up for investors can yield unrealistic numbers or mistakes. He suggests that entrepreneurs first write a simple business plan for themselves.

Norm Brodsky is a veteran entrepreneur.

You're setting yourself up to fail if you do a FANCY BUSINESS PLAN for investors before you do a simple one for yourself

Ask most people what it takes to start a business and they'll tell you, "Money." They're right--to an extent. Sooner or later, you do need money to get a business up and running. But money isn't the first thing you need, and you're making a big mistake if you focus on raising it before you're ready to spend it wisely.

Unfortunately, that's one mistake a lot of people are making these days, at least judging by the business plans I've been receiving lately. I'm talking about elaborate, four-color, 100-page business plans printed on high-grade paper, with photographs, tables, graphs, pie charts, flow charts, and every kind of number you could ask for. I mean, these plans are gorgeous.

There's just one problem: the numbers don't make sense. No business operating in the real world could ever produce them.

I'll give you the example of a particularly professional-looking plan I received from a husband and wife who were trying to raise $50,000 to start a cookie business. According to the plan, they were going to use that money to take the company's annual sales from zero to $2.9 million in just two years.

Understand, it's extremely difficult to achieve such a rate of growth in any business. It's almost impossible to do it in something like the cookie business with only $50,000 in outside capital. You'd run out of cash long before you hit your sales target. And yet the numbers were all right there in black and white, and they added up perfectly, which immediately aroused my suspicions.

I gathered that the plan had been written by the husband, a guy with very little business experience, using a sophisticated business-plan software package. Looking closer at the numbers, I saw how he had come up with such an outlandish projection. For one thing, he'd plugged in a ridiculously short collection period for his accounts receivable, about 20 days, while figuring he could get away with stretching his vendor payments to 60 days. He'd also underestimated the amount of equipment he needed and assumed he'd be able to lease whatever he wanted on his own signature--without putting up any additional security. None of those assumptions were plausible. If you replaced them with more realistic ones, you'd find that the couple needed at least another $200,000 in outside capital to have a prayer of getting the company's sales to $2.9 million in the second year.

I don't mean to suggest that the guy was intentionally deceiving anybody. Frankly, I doubt he even realized what he'd done. My guess is that, like most people with an idea and a burning desire to be in business for themselves, he was thinking only about the amount of money he needed to drop everything else and get started.

So how do you raise money? With a business plan, right? He'd gone out and bought the software, which had walked him step-by-step through the plan-writing process. Then he'd tweaked the numbers until he came up with a plan that showed the business achieving its goals after two years with just the amount of capital he thought he could raise.

It was all very neat and tidy, and the final document couldn't have looked more impressive. I've been in business almost 30 years, and I've never seen such a plan, let alone produced one. What it contained, however, was not a recipe for successful cookie making. It was a recipe for disaster.

Listen to me: the first business plan you write should be for nobody but yourself, and you don't need any special software to create it. You just need to answer four questions as honestly as you can: (1) What is the concept? (2) How are you going to market it? (3) How much do you think it will cost to produce and deliver what you're selling? (4) What do you expect will happen when you actually go out and start making sales?

The idea is to spell out as clearly as possible how you think the business is going to work--what you're going to sell, how much you're going to charge, who your customers will be, how you're going to reach them, how long it will take to close a sale, and so on. Be completely candid with yourself. Don't let your own economic circumstances cloud your thinking. Put aside for the moment any concerns you may have about earning a living or raising start-up capital. You'll deal with those issues when the time comes. At this point, what's important is to get your major assumptions down on paper.

Why? Because you need to test those assumptions before you go out to raise money, not afterward. You need to identify as many mistakes as you can while you still have a chance to correct them.

And, believe me, you will make mistakes. It doesn't matter how smart or how careful you are. There will be major flaws in your first business plan. When I started my messenger business, for example, I thought I'd collect my receivables in 30 days. I found out the hard way that the actual collection time was 59 days. When I started my archive-retrieval business, I thought I could charge a monthly storage fee of 35¢ a box. In fact, we learned we weren't able to land substantial accounts unless we charged about 22¢ a box--almost 40% less than the price in my plan.

The point is that you need to give yourself time to discover those mistakes. Not that you'll catch all of them in advance, but you can reduce them to a minimum. How? By doing research. By finding out how long companies in the industry typically take to pay their suppliers, and how long it takes them to collect their own receivables. By trying to make a few sales. By looking for cheap office space and furnishings. By visiting a leasing company to see what terms you can get. By doing everything you can think of to get as prepared as you can be.

Then, and only then, are you ready to bring out the bells and whistles and start looking for money.

In the long run, that research will turn out to be the best investment you can make in your business. Having done your homework, you'll be much more likely to raise the start-up capital you're looking for. More important, you'll be able to make better decisions about how to spend it. And you'll greatly increase the odds of making it last until you don't need it anymore--that is, until the business can support itself on its own cash flow.

Which is, after all, the whole idea.

Norm Brodsky is a veteran entrepreneur whose six businesses include a former Inc. 100 company and a three-time Inc. 500 company. This column was coauthored by Bo Burlingham.

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Last updated: Feb 1, 1998

NORM BRODSKY | Columnist

Street Smarts columnist and senior contributing editor Norm Brodsky is a veteran entrepreneur who has founded and expanded six businesses.

The opinions expressed here by Inc.com columnists are their own, not those of Inc.com.



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