Foolish MBA student business plans

One nice thing about teaching entrepreneurship at an independent technological university (like KGI) is the possibility of having actual science in our startup business plans. Tech startups may not create all of the shareholder value, economic growth or improved societal welfare, but certainly they play a disproportionate role in doing so.

The challenge of teaching entrepreneurship (particularly business plans) in a business school is (politely) sifting through all the restaurant, bar, website or other service businesses that are unlikely to amount to a hill of beans. Maybe the business plans of science and engineering students are equally likely to fail, but the potential payoffs are higher and they’re more likely to learn something relevant in the process.

I was reminded of this when reading a HBS case† from my intro entrepreneurship class. The case centers on four Harvard MBA students who want to start a business. So they spent a year sifting opportunities through six criteria, which included these quintessential MBA student goals:

• “Be their own boss”
• Invest a minimal amount of start-up capital
• Build a sustainable and defensible business

What’s wrong with this picture? I don’t know about the Harvard boys (and they were all male), but at least our KGI students take strategy in the first year and learn about something called “entry barriers”. (Perhaps the boys slept during Michael Porter’s class.)

This goes back to the fundamental problem of b-student business plans: anything a typical MBA student can start is something any fool can start. Meanwhile, science and engineering students are working on creating something that hasn’t been done before — one that hopefully has a lucrative commercial application.

So instead of dreaming about the perfect opportunity, the Harvard students would have been better off buying drinks down at the bars near MIT for smart technologists who actually have some secret sauce.

† Title omitted to protect the guilty.

Sometimes the VCs are right

Regular readers of this blog know that I’m of two minds about VCs. There are some business opportunities (such as the biotech companies KGI alumni work for) that require venture investing. However, VCs often work contrary to the entrepreneurs’ interests — sometimes comically so.

At an algae (and biofuels) conference in San Diego last week, David Tze of the boutique private equity firm Oceanis talked about what he looks for in an investment. Some of it was specific to his fund’s focus (aquaculture, i.e. feeding farmed fish), but some of it was more generic.

In particular, he lifted (with full attribution) Sequoia Capital’s advice for entrepreneurs seeking funding for their business plans. The checklist for business plans matches what any entrepreneur might learn from a business plan class, but the “elements of sustainable companies” was a little more provocative:

Start-ups with these characteristics have the best chance of becoming enduring companies. We like to partner with start-ups that have:

Clarity of Purpose
Summarize the company's business on the back of a business card.

Large Markets
Address existing markets poised for rapid growth or change. A market on the path to a $1B potential allows for error and time for real margins to develop.

Rich Customers
Target customers who will move fast and pay a premium for a unique offering.

Focus
Customers will only buy a simple product with a singular value proposition.

Pain Killers
Pick the one thing that is of burning importance to the customer then delight them with a compelling solution.

Think Differently
Constantly challenge conventional wisdom. Take the contrarian route. Create novel solutions. Outwit the competition.

Team DNA
A company’s DNA is set in the first 90 days. All team members are the smartest or most clever in their domain. "A" level founders attract an "A" level team.

Agility
Stealth and speed will usually help beat-out large companies.

Frugality
Focus spending on what's critical. Spend only on the priorities and maximize profitability.

Inferno
Start with only a little money. It forces discipline and focus. A huge market with customers yearning for a product developed by great engineers requires very little firepower.

Of these, some are motherhood and apple (or Apple®) pie. The “frugality” and “inferno” seem ironic given the role of Sequoia (and other Sand Hill Road) VCs in fueling various bubbles over the years.

However, I think two points bear repeating — and I will repeat both in teaching my entrepreneurship class and advising would-be entrepreneurs. One is the “pain point” idea, now a part of the guidelines give for many opportunity pitch competitions.

Perhaps more interestingly — at least for tech entrepreneurs — is the idea of price-insensitive customers to buy the early expensive products until the firm learns how to make the products faster and cheaper. This is how computers, cellphones, Internet service got started, and my own research into telecom engineers shows the same effect. Since joining a biotech-oriented institute, I’ve also learned how life science companies have targeted expensive pain points, as when Genentech targeted the human insulin with its first product, Humulin.

So overall, I believe the experience of VCs can help nascent entrepreneurs prioritize their efforts — as long as they watch their wallet when it comes time for actual investments.

Yet another business plan defense

Nearly every entrepreneur has heard about the value of a business plan. Two new publications I found today — one in the Wall Street Journal, one in the Journal of Business Venturing — both reminded me of this topic and updated what I know about it.

This is not the first time I’ve considered the topic. Right now on my hard disk, I have about 15 articles from the business press and about two dozen academic articles. This doesn’t count books, including the four books I bought to teach business plans last year.

This semester, I am also helping one of our undergraduate honors consulting teams write three business plans in less than a month. Due to the accelerated schedule, we had to decide which part of the standard format to use from Jeffry Timmons’ wonderful abbreviated handbook.

Of course, I also blog about business plans here on this blog.

The Controversy

Ever since I met a job candidate several years who did his thesis on business plans, I have been following the debate in academia and the popular press about whether or not startups should do business plans.

Two of the more convincing arguments in favor of business plans are that business plans are a way to communicate with external constiuencies — like investors — and that it provides discipline to the authors. Arguments against focus on the inherent incompleteness (or obsolescence) of the plan and the opportunity cost of preparing one.

Academics — as they are wont to do — also argue about whether there’s a large N, well-controlled statistical study that shows benefits (or lack thereof) for firms that do business plans.

All of these arguments are applicable to potential high-growth startups in technology-based industries. If anything, the stakes are higher — a restaurant might start with a $50,000 capitalization while a photovoltaic company today needs more than $50 million.

Latest in the Business Press

Today the WSJ small business section ran an article endorsing business plans by a business plan consultant. The defense was framed in the negative — a list of “common misconceptions”:

1. Business plans aren't necessary unless you're planning to raise capital from banks or VCs.
2. Investors don't take business plans very seriously. They know that the numbers are garbage.
3. Nobody reads business plans any more. All you need is a deck of PowerPoint slides.
4. Nobody has a crystal ball that can predict your business's future. You're better off figuring things out as you go.
5. Business plans aren't necessary for a company that's already up and running. They're a distraction from running your business.

Here in Silicon Valley, I have heard entrepreneurs argue that the PPT deck is more important. My sense is that the PPT deck is what it takes to get seriously considered, but then some sort of real data — whether a Word document or a spreadsheet — is necessary to get a VC investment. (Angels seem to make their own rules).

Latest Academic Research

Also recently (in academic timescales), the top entrepreneurship journal (JBV) ran an article by a German-American team reviewing the business planning literature. Alas, as seems true for some academic journals, the paper was accepted in October 2008 but not published until January 2010. (Also regrettable is the use of an unmanageable paper title length.)
As in any good meta-analysis on a mature but disputed research stream, the conclusion is roughly: “they’re all correct because there are contingency factors that explain when business plans are and are not useful.”

For example, the authors conclude that brand new startups get less value from business plans than more established startups. The former face so many uncertainties about the unknowable that (the authors argue) that the “go obsolete” argument outweighs the value of the “planning is good” argument.

Conclusions

In my own experience — as an entrepreneur and now as a teacher — I’ve come to three conclusions:

• Every firm needs a business plan — but only selectively as time, information and needs allow. There is a huge benefit to some parts of the planning, but the specific needs will vary both by company and (as in the JBV 2010 study) the company’s age.
• Business plans must have numbers, even though they are GIGO. A back of the envelope calculation allows the entrepreneur to identify assumptions, risks, and at least an order-of-magnitude sanity check of even the simplest plan.
• Opportunity costs are relatively low for business students to write at least a simple business plan. The undergrad (or MBA) core covers all the basic skills, and thus a very rough business plan can be done by a competent business student in less than a month. (For example, we’ve had very good luck sending business students to help students from the award-winning SJSU industrial design program.)

These are not scientific findings, but these are the advice I’d give an entrepreneur or student today.

So if a nascent entrepreneur asks: “Should I write a business plan?” my answer is simple: “Yes, but…”

References

Jan Brinckmann, Dietmar Grichnik and Diana Kapsa, “Should entrepreneurs plan or just storm the castle? A meta-analysis on contextual factors impacting the business planning–performance relationship in small firms,” Journal of Business Venturing, Volume 25, Issue 1, January 2010, Pages 24-40. DOI: 10.1016/j.jbusvent.2008.10.007

Best business planning books

This semester I’m teaching a business plan course for the first time since I left UCI in 2002. (I did use a business plan assignment in a 2006 strategy class — more on that later.) The course is an elective for both our undergraduate entrepreneurship and management majors, although I have a few students from other colleges on campus. At the suggestion of a local VC, we are shifting the title and emphasis of the course from strictly business plans to “Planning the New Venture.”

Although I use textbooks for core courses to cover the recommended corpus of knowledge, where possible I try to use regular (i.e. trade paperback) books for electives. They tend to be more readable, cheaper, more likely to be kept after graduation and more representative of what students will read after they graduate. So in preparing for the class, I searched on the Internet and Amazon for books related to business plans.

In 2006, I asked students to write business plans without much information on how to do it, other than walking them through our standard template, which was derived from the U. Maryland BPC. Both versions were derived originally from the standard MBA entrepreneurship textbook by the dean of entrepreneurship scholars, the late Jeff Timmons.

This year, I wanted to give them more help on the two most difficult tasks — estimating revenues and estimating costs — while also covering the broader questions of starting a new business. After buying five books and getting a 6th from the library, I eventually settled on three books.

The first book I picked was the smaller (and cheaper) Timmons paperback, entitled Business Plans that Work. It‘s not complete, but for an undergraduate course it gives a good consistent way of looking at the problem, and (not surprisingly) matches well to our (i.e. Timmons) BP format.

The second book I chose was Bankable Business Plans by Edward Rogoff. I did not expect to like the book, and with its “action steps” (rather than chapters) it’s a bit of a scattershot. However, I found it a nice complement to the Timmons text. In some areas, it’s much more concrete than Timmons, including one of the most important blind spots from 3 years ago — setting up a sales process.

These two books would have been enough for our 15 week course, if I had built a reader with 4-6 other articles to supplement the gaps in coverage. Together, they are only $28 at Amazon — a steal for anyone involved in entrepreneurship.

However, I wanted to give students a little more of the big picture of starting a business, including a sense of why they want to be entrepreneurs in the first place. In the end, I decided to use Guy Kawasaki’s The Art of the Start, which turned out to be much more substantive than any previous Kawasaki book I’d read. Still, I see Kawasaki and this book as a motivational speaker — identifying some important tricks and traps — rather than providing a business plan checklist.

One problem I’ve found in teaching entrepreneurship — with all the work of Timmons, and also many competing academics — is too much of an emphasis on venture capital-funded IPO-oriented startups. Kawasaki nicely balances this out with an entire chapter on bootstrapping, which (as he notes) can also be used by VC-bound companies to bridge between 3F money and their first professional capital. This nicely fits my course goal, which is to help students to identify the most appropriate funding approach for their idea and industry context.

The VC-centric counterpart to Kawasaki’s book is Raising Venture Capital for the Serious Entrepreneur by Dermot Berkery, a former McKinsey consultant turned VC and MBA lecturer in Dublin. It came highly recommended on Amazon, and after reading it, I saw why. It really walks entrepreneurs through the funding process — as VCs see it — and explains what they must do (and why) to put their best foot forward.

I decided not to use it this year for two reasons. First, it’s so VC centric that it would have undercut my message about being funding agnostic, and secondly, it’s more suitable for those already in business or graduate students. I would strongly consider it if I were teaching high growth-startups in the Stanford or Berkeley engineering school, and I’ll also recommended it for our new venture finance class.

Beyond the classroom, I would also recommend both the Berkery and Kawasaki books for those already in a startup. Despite 20+ years thinking about startups (as a founder, research, teacher and consultant) I picked up valuable tidbits from both — either things I didn’t know, or different ways of thinking about familiar problems. For example, Chapter 2 of Berkery’s book emphasized the importance of identifying 3-4 alternative exit strategies, so that investors (and founders) can still succeed if the initial plan is blocked.

One book that did not fit my immediate goals was The Business Plan Is Dead by Jeffrey Wofford. I’ll write more about it some other time.

10 fatal assumptions

In providing feedback to my MBA entrepreneurship students, I went looking for information on market sizing assumptions.

I didn’t find what I was looking for, but I did find another interesting document, from Purdue University’s extension program. The note on “Fatal Business Planning Assumptions” by Cole Ehmke of Purdue offers a list of 10 common but flawed assumptions made by new ventures.

Although he’s in agricultural economics, the first three would resonate with any tech entrepreneur or investor:

1. We have no competition
2. All we need is 2% of the market
3. Our product will sell itself

I would love to see a “10 most common tech startup mistakes” list, but for now this is a suitable cautionary list.