David R. Evanson
Where’s the Money?, Fall, 1999
Preparing a Business Plan
If you are raising capital, particularly equity capital, you need a business plan, period. Take note: a business plan is first and foremost a selling [italicize selling] document. It is initially what tells outside investors why they should take a risk with the company and put capital into it.
Ironically, the “planning” value of a business plan is actually a by-product. That is, itzzs only by committing to paper answers to all of the questions which an investor might ask that gets an entrepreneur to seriously consider in detail [italicize in detail], how the business must run and what it needs.
For instance how could the following typical questions from investors ever be answered without some hard thinking on the part of an entrepreneur: What will cause gross margins to improve as sales take off? Going forward, what percentage of your revenues will be recurring in nature? Or, therezzs always: Can you describe the skills, experience, salaries and responsibilities of your new hires for marketing, finance and sales management?
Donzzt Forget: No one ever raised capital simply by writing a business plan. They raised money by writing it, then presenting and defending their plan before investors. Therefore, writing a business plan is not an end, but the first step in the process of raising capital. It is, in effect, the blueprint for selling your deal to investors.
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BUSINESS PLAN STRUCTURES
There is little agreement on precisely how a business plan should be structured. Much of this disagreement stems from the fact that companies at different stage in their lifecycle require different business plans. That is, a company conducting research and development for a new product, generally has less to talk about than a company with, say 100 products, and several manufacturing operations.
This issue notwithstanding, here is a structure for a business plan, which is remarkably flexible, and seems to cover all the bases from the perspective of an outside investor looking in.
• Executive Summary – This abbreviated version of the plan this should be no more than 2 pages
• Description of the Company & Its Business – Provides detail on history, principal assets, products/services and properties.
• Market Analysis – Describes the dimensions, changes and potential of the companyzzs markets.
• Marketing Operations – Describes the specific tactics the company will deploy to capitalize on the opportunity identified in the market analysis.
• Key Personnel – Describes the background of the founders and operators of the business and validates their authority to makes claims in the plan about the market, market opportunity and marketing strategy.
• Financial Analysis – Contains use of proceeds, summary historical and projected financial performance, detailed historical and projected performance, and assumptions to financial projections. In many cases, the financial analysis should include a comparable valuation analysis, which shows how the company stacks up financially against its competitors or similar public companies, and provides some measurement of what the company is worth. Itzzs generally a mistake however to suggest a companyzzs valuation if itzzs not profitable, or is in its very formative stages. In these instances, itzzs better to let the investor get comfortable with the company and its prospects than to possibly short circuit the entire sales process with a cold hard number.
• Appendices – Offers opportunity for show and tell.
Taking Action: In business plans, bulk matters. If yourszz is light, add appendices. Also consider using a Courier font. Itzzs commonly accepted, large, and will increase your page count.
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The one deviation to this business plan model occurs with manufacturing companies. Companies with manufacturing can provide a detailed description of their operations in the section titled The Company & Itzzs Business, or can add a new section simply titled Manufacturing Operations.
In addition, while in the model above, the section titled Marketing Operations provides the right context for showing how a service company will expand, it doesnzzt work so well for a manufacturer which will expand capacity for new markets. Accordingly, an additional section titled Plan of Expansion is appropriate. Thus in total, a manufacturerzzs business plan might have the following sections:
• Executive Summary
• Description of the Company & Itzzs Business
• Manufacturing Operations
• Market Analysis
• Marketing Operations
• Plan of Expansion
• Key Personnel
• Financial Analysis
SIDEBAR: Here are the tables of contents from three actual business plans.
A Chain of Pet Supply and Animal Theme Gift Shops . . .
TABLE OF CONTENTS
Executive Summary 3
The Company and Its Business 6
General Description 7
Current Locations 8
Retailing Concept 8
Animal-Theme Product Line 9
Pet Supply Product Line 9
Critical Success Factors 10
Critical Challenges 11
Customer Base Characteristics 12
Ownership & Capital Structure 13
Market & Competitive Analysis 14
Market Analysis – Gifts & Jewelry 15
The Trend Toward Animal-Theme Products 15
Gift & Jewelry Market Sizes, Trends 16
Market Size & Dimensions – Pet Supplies 17
Market Shifts – Pet Supplies 18
Comparative Pricing Analysis – Pet Supplies 19
Market and Marketing Imperatives 20
Plan of Expansion 21
Model Unit 22
Geographic Expansion Strategy 23
Marketing Operations 25
Key Personnel 28
Financial Analysis 31
Pro Forma Summary Historical Financial Performance 32
Summary Projected Financial Performance 32
Projected Use of Proceeds, Liquidity for Investors 32
Comparable Valuation Analysis 33
Historical & Projected Financial Performance 36
Appendix I – Logos and Trademarks
Appendix II – Custom Store Interiors
A Manufacturer of X-ray Processing Equipment
TABLE OF CONTENTS
Executive Summary 1
The Company & Its Business 4
Digital Technology Acquisition 7
Facilities & Employees 7
Master Distributors 10
Original Equipment Manufacturers 11
Catalog Sales 11
Market Analysis 13
Summary Statement 14
Market Segmentation & Distribution 14
Market Dimensions, In Dollars 17
The Push From Film Manufacturers 18
The Threat/Non-Threat From Digital Radiography 19
Marketing & Manufacturing Expansion 23
Marketing Objectives 24
Direct Selling 24
Direct Sales Force Territories 25
Direct Selling Tasks & Responsibilities 25
Trade Show Exposition/Collateral Development 26
Manufacturing Expansion 27
Key Personnel 29
Financial Analysis 33
Summary Historical Financial Performance 34
Summary Projected Financial Performance 34
Use of Proceeds 35
Assumptions to Financial Projections 35
Projected Financial Statements 40
Projected Financial Performance Assuming Acquisition of Digital Technology 41
Additional Assumptions to Financial Projections Assuming Acquisition of Digital Technology
Historical Financial Statements
Appendix I — Selected North American Dealers
Appendix II — Product Literature
Appendix III — Suggested Dealer Price List
An Internet Promotions Company . . .
TABLE OF CONTENTS
Executive Summary 1
The Company and Its Business 4
Summary Statement 5
Core Product – Custom Promotions 6
Emerging Product – Advertising 12
Off The Shelf Product – Syndicated Games 15
Facilities, Employees & Strategic Alliances 18
Patent Application 20
Market Analysis 21
Summary Statement 22
From Infancy To Critical Mass 22
Increasing Presence Among The Fortune 500 24
Directing All The Traffic – Sales Promotion 25
Key Personnel 27
Founders & Senior Management 28
Key Technical Personnel To Be Hired Upon Financing 30
Marketing Operations 32
Summary Statement 33
Direct Selling – The Short List 33
Direct Selling – Sales Staff Responsibilities 34
Direct Selling – Target Markets 34
Web Site Marketing 35
Financial Analysis 37
Use of Proceeds 38
Summary Historical & Projected Profit & Loss Statements 39
Projected Statements of Profit & Loss 41
Assumptions to Financial Projections 42
Historical Financial Statements 49
Appendix I – Sample Game Cards 1
Appendix II – Sample Promotional Programs 2
Appendix III – Home Pages Of Competitive Advertising-Based Web Sites 3
The following sections of this chapter will describe the purpose of each of the major sections of the business plan. They attempt to provide you the capital seeker with an insight into the perspective of the capital provider. That is they will tell you what kind of information the source of capital is looking for and why. Rather than starting with the Executive Summary however, which is generally the first part of the plan that investors read, wezzll start with the company and its business, and cover the Executive Summary last.
Shop Talk: The executive summary of your business plan must [italicize must] fit on two pages. In addition, when the plan is produced, make sure they are facing pages, rather than back to back, so that investors can take in the company in one glance.
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THE COMPANY & ITzzS BUSINESS
When investors put money into a business, they need to feel two emotions: comfort and confidence. Specifically, comfort that the business, the opportunity and the people who are running it are for real and confidence that the business can succeed. This section of the business plan is where entrepreneurs can build comfort in investors.
By describing everything about the business that is real, concrete and tangible. If the business is simply just an idea, this is hard to do. But, even if the business is a start-up engaged in product or service development but without revenues, therezzs more of a story than you might think meets the eye.
Look at business plan outlines above. Note for instance the X-Ray processing manufacturer. Under the section of the business plan titled The Company & Itzzs Business, the companyzzs products represent just one piece of the puzzle. Says the founder of this company, who has used the plan to raise $1 million, “I never knew that there were so many dimensions to our company beyond itzzs products, until I started answering questions from investors.”
In fact, you can write this section of the business plan simply by answering the following questions about your business. Of course every situation is different, but the following list should get you there, or at least 90% of the way:
• When was this company started?
• Who else is an owner?
• What has this company accomplished since its inception?
• Who are the companyzzs strategic partners in the areas of distribution, technology, supply, product or service development?
• What outside professionals, i.e. accountants, lawyers, business consultants, have made a material impact on the company.
• What are the companyzzs facilities? Do they own or lease? What is the square footage?
• How many people does the company employ, and how are these employees organized? By product? By function? By department?
• What does the company own that is proprietary in terms of customer lists, technologies, licenses, patents, manufacturing techniques,
• How has the company been financed to date? Where did the capital come from?
• What is the companyzzs product or service?
• What are the advantages of the companyzzs product or service over competitors?
Donzzt Forget: Your business plan is not complete without a table of contents. In fact a well organized table of contents can draw an investor into the plan, whereas the absence of one will cause them to randomly browse, and perhaps prematurely lose interest and put the plan down.
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Remember, as you answer these questions that the investor is looking to be comforted. Accordingly provide lots of facts about cities, states, dates, and telephone numbers, that the investor can check if and when they start with their due diligence. For instance, if you outsource the assembly of your product, name the outfit that does it, provide their name, address, telephone number and a contact. Ditto for professionals. Got a patent? Great, provide the U.S. patent number.
Shop Talk: Due diligence is an investigation into the business, its products, markets, facilities, competitors, and key employees. An investorzzs due diligence can be long and painful. And more than a few companies have gone out of business for want of capital, while investors dither through due diligence. Therefore, a business plan should offer easily verifiable information to speed up the process of due diligence, and get the investor in a state of readiness to proceed with the deal.
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Taking once again the investorzzs perspective, what is it that they want to know next? Well, assuming youzzve done a good job describing how you have organized resources in the preceding section, the immediate question becomes, what are these resources organized to capitalize upon? Specifically, what is the size of the market and what are the opportunities which it offers.
Donzzt Forget: Prose is nice, but investors want to see upwardly trending graphs in the market analysis section of the business plan.
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To write an effective market analysis, the entrepreneur must take off their business owner hat, and put on their captain of industry hat. Specifically, he or she must write the analysis with a supreme understanding (or at least the appearance of a supreme understanding) of the events and trends creating opportunity, as well as the trends shaping the market.
The overall objective of this analysis is to make a case for the market in which the company participates and thus by association, a case for the companyzzs product or service itself. Sometimes this is a tall order, even when the underlying market offers significant opportunity. Consider the above-mentioned manufacturer of X-Ray processing equipment.
The problem this company faced in making a case for its products could be summed up in a single word: digital. Specifically what angel investor, venture capitalist or investment banker would want to invest in conventional technology — the processing of X-Ray film — with diagnostic imaging standing on the brink of a digital revolution?
The company astutely made its case in the market analysis by asserting that the market for conventional technology had more legs to it than was readily apparent. It backed this assertion up with the following points:
• Digital imaging technology, though viable, would in most instances cost most users more than $1 million to install, and in addition, introduced a new challenge in data management that many healthcare institutions were unprepared to meet.
• Digital enhancements to conventional systems cost in excess of $100,000 — still outside the range of many healthcare practices.
• The filming and processing of X-Ray film represented a revenue center for many small practices and they would be unwilling to forgo this revenue when faced with capitated rates from health insurers.
• Chiropractic, veterinary, podiatry, D.0. and M.D. practices — the primary purchasers of conventional X-Ray processing equipment — were actually increasing [italicize increasing] in number.
• Sales of X-Ray film totaled some $7 billion annually with the market dominated by global manufacturers such as Fuji, Kodak and AGFA and 3M, that were not simply going to let a multi-billion market slip through its fingers.
• Most radiologists and physicians grew up on film-based diagnostic imaging and would resist a sudden shift to a new media.
• Finally, and most importantly, the United States, though a fertile market represented just a small portion of overall global demand. For many emerging industrial countries, seeking to establish even a base level of healthcare, digital imaging systems were not even a consideration. By contrast however, conventional X-Ray suites, with conventional X-Ray film processors, were in hot demand in countries such as China, with more than 55,000 hospitals.
Itzzs important to note that a good market analysis doesnzzt simply just make sweeping statements about trends in the market. Instead, it relies upon primary (i.e., original) research, secondary research which has been published, government statistics, white papers or studies supplied by trade associations, and authoritative articles in the trade press.
A Good Deal: Unless your business plan contains sensitive information which can be used against you, do not use a confidentiality agreement. You stand a better chance of raising money if your planzzs distribution in wide, rather than restricted.
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According to angel investor Bill Simms in Sacramento California, who invests his own capital and for a large corporation, “I continue to turn down business plans where the market analysis isnzzt wired tight, and doesnzzt make a convincing case for the companyzzs product or service.
Simmszz comment is well taken. After all, many investors are generalists, with no specific industry knowledge or experience. Therefore, as a form of protection against getting taken to the cleaners, many investors look for hard numbers backed up by third parties to support the market analysis. Another reason for generating a market analysis backed up by hard numbers has to do with the investorzzs due diligence. That is, no one will ever invest in a company without taking some sort of independent look at the market. By offering an analysis with authoritative sources, you provide the investor with a road map, which hopefully, gets him or her to the closing table faster that if they are out there floundering alone, trying to see if the market offers a real opportunity.
Keeping the above points in mind, here are some of the questions the market analysis of your business plan should answer.
• What is the market for your product or service in dollars?
• What is the market for your product in terms of units?
• What is the historical rate of growth in the market?
If the market is segmented many ways, (i.e. the personal productivy segment of the software market) what were the rates of growth for the segments in which you are offering product or services.
• What is the projected rate ?
• Why is there a deviation between historical and projected growth rates in the market for your product or service?
• What are the three primary determinants of demand?
• How is demand now satisfied in your industry; who are the major players?
• How has the market for the product changed over the past five years and why?
• How do you anticipate it will change going forward?
The marketing operations section of a business plan makes the logical break between the opportunity defined by the analysis, and the specific strategies and tactics the company will deploy to capitalize on the opportunity.
Donzzt Forget: For many equity investors, marketing operations represent the nib of the plan. After all, itzzs what the company will do to capitalize upon an opportunity thatzzs going to increase earnings, and hence the value of the equity investorzzs stake in the company.
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When writing a marketing operations section of a business plan, keep in mind that itzzs not so much a great market opportunity that gets investors excited, as much as a good solid marketing plan and a management team which inspires confidence that it can execute the plan.
Describing the marketing operations presents a different set of challenges for companies which are already selling their products and raising capital for expansion, versus those which are raising capital to commence their initial marketing efforts.
Marketing Operations for Established Companies
Naturally, companies with a track record have it all over upstarts. Why? Because they have some historically proven algorithm for generating sales. For instance:
• Each manufacturers representative will sell one unit a month.
• Every 1,000 catalogs sent in the mail generates approximately $1,200 in new orders
• The response rate on direct mail is 0.90% and the pay-up rate on resulting subscriptions is 97%.
• The telemarketers are able to make appointments 27% of the time, and the direct sales force closes on about 9% of those appointments.
• The ratio of sales to media purchases for our informercials is about 1.50.
Even if a business owner has never thought too much about it, if therezzs a history, there is some reasonably reliable relationship between marketing activities and sales. The value of this relationship in raising money is almost incalculable. Specifically, it will lend an air of credibility to the companyzzs projected financial performance — which for equity investors is perhaps the [italicize the] most important variable upon which their investment decision is made.
Look at your historical financial performance and quantify the relationship between marketing activities, and the net result. Thus armed, you are then in a position to make your case for how financing more of the same will lead to increased profits.
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Although companies which are already selling their product or service have an advantage over those which arenzzt, there are still challenges to be sure. Specifically, these companies must be able to convince investors that their current way of selling products is:
• The optimal method of marketing
• Scalable. That is, it will work as well or better when enlarged by an order of magnitude.
The challenge is particularly difficult if the company is selling its product, but not yet making any money. If the argument goes that zzWe simply need to run a higher unit volume over our fixed costs in order to reach profitability,zz thatzzs fine. But be prepared to answer the following question: zzWill throwing more money at marketing produce this additional business at a reasonable cost or will the additional expense offset the gains your are hoping for?
Marketing Operations For Start-Up Companies
Companies which havenzzt yet sold their product have a much tougher row to hoe than their brethren with some experience in the marketplace. And of these, companies with new or revolutionary products have the toughest sell of all. Why? Because the investor will question whether or not 1) the customer will accept the product or service and 2) whether or not the distribution channel will accept the product. Remember Internet cafes? Most failed because consumers proved unwilling to purchase on-line services in a retail environment.
Keeping these challenges in mind, most business owners go wrong in the marketing operations section of their business plan by making the following claim:
Upon financing, the company will engage in an integrated sales and marketing program consisting of advertising, public relations, tradeshow exposition, direct selling through a company-paid sales force and the use of a manufacturer representative.
The problem with this approach as it relates to pitching an investor on your deal, is that you are saying in effect, you really donzzt know the best way to sell the product. When the investor starts to get the sense that you want to go to school on his or her money, then they will likely say to themselves, zzNot with my money you arenzzt!zz Considering that only parents willingly pay for the education of another, and many of them with deep-seated reservations, you can only imagine what it does for early stage financings.
The whole affair of raising capital for companies that have yet to sell a product or service is an imperfect Catch-22 at best. However the best way to overcome the inherent flaws of the process is to reduce the marketing operations to one or two primary tactics.
For many companies, the old one-two punch delivers a majority of their overall sales anyway. Giant Dell Computer sells directly to consumers through catalogs and its own sales force. amazon.com sells books over the Internet. Amway sells door to door. And the venerable Thighmaster became a household name by using infomercials.
For start-up companies, the beauty of reducing marketing operations to a one-two punch, is that it then becomes feasible to conduct test marketing on a low cost basis. With actual results [italicize results] in hand, no matter how rudimentary they may be, the credibility of the business plan increases by a factor of 10.
To see just how simple test marketing can be consider the following low cost techniques that almost any company could deploy.
Example 1: Business janitorial service claims in its business plan that it will use advertising in local newspapers promoting free trial for commercial landlords in exchange for re evalauting their existing maintenance contract. Low Cost Test: Run three advertisements in local newspapers, and record response. When landlords call, use the occasion to poll them about needs, preferences and price sensitivities. Package these interviews as original market research to share with investors.
Example 2: A restaurant planning to franchise claims in its business plan that new sites will engage in so-called community-based marketing to draw customers from the surrounding three mile radius. Low Cost Test: Saturate three neighborhoods near the existing restaurant with hand-delivered flyers that have a coupon offer. Distribute approximately 1,000 flyers per neighborhood and record the response rate of consumers who bring these flyers into the restaurant to take advantage of the coupon offer. When customers come to the restaurant, offer a free dessert in exchange for completing a questionnaire. Compile these questionnaires and use the results as original market research in the business plan.
Taking Action: Figure out how to conduct low or not cost test marketing and go do it!
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Example 3: The manufacturer of a line of hand held garden tools claims in it business plan that it will sell its products through mass market distribution channels. Low Cost Market Test: Develop a list of 25 questions for buyers of garden tools at 25 mass market retailers. Focus the questions on the requirements to gain shelf space, minimum order sizes, policies on payments and returns, and the buyerzzs beliefs about the level of competitiveness in hand held garden tools. Survey the buyers by telephone at each of the 25 targeted retailers. If a majority suggest a willingness to purchase products on a trial basis after a sales call from the company, compile their answers in the business plan, write the marketing operation section of the plan so that direct selling is the primary marketing activity.
Any entrepreneur can making sweeping claims about what they will do once funded. But, in the eyes of the investor, itzzs the entrepreneur who is basing their claims on experience, rather than supposition, who represent the better bet.
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As a parting comment, whether your company is established or not, here are the questions the marketing operations section of your business plan should answer.
• What are the companyzzs marketing objectives?
• What are the promotional tactics the company will deploy?
• What is the cost of each of these promotional tactics?
• What is the estimated or historical relationship between the companyzzs proposed tactics and the resulting product or service sales?
• What are the primary channels of distribution for this product or service?
Most investors say they donzzt even read business plans. But if you question them more closely, they will all tell you their own proprietary technique for skimming the plan to see whether or not the company merits a serious look. Many of these “proprietary” glances actually turn out to be remarkably the same. The investor reads the first paragraph of the executive summary, skims the balance of the executive summary, then turns to the key personnel section of the plan.
A Good Deal: Advisory boards can be a great deal for companies, especially when it comes to bulking up the key personnel section of the business plan. Not only do members of an advisory board add intellectual depth to the company, but they increase the likelihood that outside investors seeing the plan for the first time will make some sort of personal connection with the company.
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Itzzs simply human nature. Investors want to see whozzs running the show. They also want to see if there is any connection between themselves, and the people involved in the company. And take note, some connection, no matter how feint — as in zzTheir controller used to be a CPA at the accounting firm we used at my last companyzz — can spell the difference between the investor deciding to take a closer look, and the investor deciding to take a pass for the moment.
But thatzzs just the first glance. Sooner or later the serious investor is going to settle down with the Key Personnel section of the plan to take a critical look at the people behind the company. While the old saying in real estate goes zzLocation, Location, Locationzz, the mantra for financing very tiny companies is zzManagement, Management, Management.” And for better or for worse, the first time a would-be investor meets the management team is in the biographical sketches written in the business plan.
SUB SUB HEAD: GETTING THE RIGHT SPIN ON BIOGRAPHIES
So, how must the biographical sketches be spun to do their work? Overall, the biographies of the founders and senior managers must be cast in terms of concrete skills and specific accomplishments, rather than titles and educational trophies.
Why is this so? Because for a company with most, if not all of itzzs history ahead of it, the investor needs some assurances that the members of the management team can execute. And the best way to offer this assurance is by showing a track record of execution.
Here is a biographical sketch cast two ways. Which one is more inspiring?:
James P. Morgan, Co-Founder & Director of Marketing.
Mr. Morgan has more than 15 years experience in consumer product marketing. Prior to co-founding the company, Mr. Morgan was associated with Northstar Industries. He joined the company in 1985 as a Marketing Associate, and during the next 15 years rose to successively more responsible positions with Northstar. Just prior to founding this company, Mr. Morgan was promoted to northeast regional marketing director of consumer products for Northstar Industries. Mr. Morgan earned a Bachelorzzs degree in business administration from Boston College. Currently he is active in several business and civic organizations.
or . . .
James P. Morgan, Co-Founder & Director of Marketing
Mr. Morgan has more than 15 years experience in consumer product marketing. During this time he has developed several critical skill related to the direct marketing of consumer products. Prior to co-founding the company, Mr. Morgan was associated with Northstar Industries. He joined the company in 1985 as a Marketing Associate, where his primary responsibility was telemarkeing and involved qualifying prospects which responded to company advertisements. Mr. Morgan enjoyed above average response rates, and as a result, was promoted to manager of telemarketing sales training. In this capacity, Mr. Morgan created and published a direct marketing manual which is still in use by the company today. After three years in this capacity, Mr. Morgan trained three individuals for his replacement, and was promoted to a regional management position fulfilling advertising and marketing functions. Specifically, Mr. Morgan hired and was the point of contact for regional advertising agencies to ensure their efforts were consistent with the companyzzs national strategy and advertising campaign. In addition, Mr. Morgan oversaw the companyzzs direct sales in the region by participating in sales calls, recruiting new personnel, and directing quarterly sales promotions. Mr. Morgan left Northstar last year to form the company. His responsibilities now include marketing planning, and he will be responsible for recruiting and training the companyzzs sales and marketing staff. Mr. Morgan earned a Bachelorzzs degree in business administration from Boston College. Currently is a member of the Direct Marketing Association, the Chamber of Commerce Council on Marketing 2000, and is an advisor to the board of directors of the downtown enterprise zone business incubation project.
Donzzt Forget: When writing the key personnel section of your business plan donzzt be modest, and talk in terms of skills and experience, instead of previous titles.
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OVERCOMING A THIN MANAGEMENT TEAM
Companies raising money are by definition needy. Many times financing the addition of new personnel is the point of the business plan.
Still, itzzs very difficult to overcome the challenges posed by an incomplete management team. After all, management is supposed to be what the investors are investing in. And if therezzs no management in place, the question in the investorzzs mind becomes whatzzs the point here?
One way to overcome this problem is to put in the biography of the individuals that will be hired once the company is funded. Investors know that it takes time to find employees, and they would prefer that entrepreneurs not do the looking on their nickel.
Therefore if two companies are exactly the same in every respect, except that one has identified who it will hire and the other has simply suggested that it will hire once funded, then the former company is a more attractive candidate than the latter in the eyes of the investor.
Granted, few emerging companies have this luxury. The fallback position would be to offer a menu of responsibilities and a biographical sketch of the person that the company would [italicize would] hire. Here are biographical sketches from a company which contemplated the expansion of a retail chain of animal theme gift shops. (The table of contents of this business plan was shown earlier in this chapter as well.) The only other biography alongside these was the founderzzs.
District Managers. Every five new stores opened will require a district manager. The duties of the district manager will be to maintain inventories at each of their locations, hire and manage personnel, staff locations when regular employee disruptions occur, manage cash and daily deposits, manage repair and maintenance of fixtures and equipment, create store displays and coordinate with the companyzzs merchandise buyer. Ideal candidates for district managers will have two years of experience in a retail environment.
Regional Managers. Every 20 stores requires the addition of a regional manager. The duties of the regional managers will be to oversee and manage the companyzzs warehousing operations, direct purchasing and product distribution for stores in their territory, hire and manage district managers, inspect locations, develop and assist in execution of in-store promotions, analyze territory for potential new sites. Ideal candidates for regional managers would be district managers. Coming from the outside, ideal candidates would have 3 to 4 years experience in managing multi-location retail environments.
Chief Financial Officer, Controller. The company will hire a chief financial officer/controller in the first quarter after financing. The duties of the chief financial officer will be to establish disbursement controls, design and oversee multiple commercial banking relationships, implement cash management, initiate and maintain corporate banking relationships, and develop and oversee accounting and financial management information systems. The ideal candidate will have 10 to 15 years experience with a publicly held retailer, specific knowledge about how to manage multi-location banking and cash management activities and undergraduate and graduate degrees in finance and/ or accounting.
Marketing Manager. The company will hire a marketing manager during the first year following financing. The duties of the marketing manager will be to establish and manage database marketing operations, oversee and assist with new store opening promotions, oversee and assist with new store community-based marketing programs, and act as marketing consultant to regional managers. The ideal candidate will have 10 to 15 years multi-store marketing experience, good numerical and trend analysis skills, experience working with printers and graphic designers, and a graduate degree in marketing.
Business Development Officers. At the conclusion of the second year following financing the company will hire two business development professionals. The duties of the business development professionals will be to manage the build-out of 50 new stores per year. Specifically, to make final site selections, negotiate with landlords, hire and supervise contractors, hire and promote district and regional managers. Ideal candidates will have five to 10 years experience in a retail chain with a demonstrated track record of successfully opening new locations.
Buyer/Purchasing Manager. During the second fiscal year following financing, the company will hire a full-time buyer. More than operational expertise, this buyer will provide creative leadership, and help the company locate unique animal-theme products that its customer base will increasingly expect of our stores in clothing, pet products, gifts, cards and jewelry. To ensure the integration of this creative leadership at the store level, the buyer will also coordinate merchandising displays and holiday decorations. The ideal candidate will have a college degree, and at least five to seven years experience purchasing for a multi-location retail chain.
Entrepreneurs gain mileage for putting in the sketches of the people they will hire because it shows critical thinking and planning on the part of the entrepreneur. Simply saying you will hire additional people is merely a declarative statement.
Another device for overcoming an incomplete management team is to offer projected organizational charts. Here are some sample charts for a company at one, two and three years after financing.
Organizational Chart: Year 1
Organizational Chart: Year 2
Organizational Chart: Year 3
Again, critical thinking about how an organization will grow when funded will win over investors more often than sweeping statements about organizational expansion.
The financial analysis section of the business plan incorporates many separate elements. These elements are: Summary Historical Financial Performance; Summary Projected Financial Performance; Use of Proceeds; Valuation Analysis; Detailed Financial Projections, Assumptions to Financial Projections; Detailed Historical Financial Statements.
If you are raising equity capital a valuation analysis, which is an assessment of what the business is worth, will be important. If you are raising debt capital, then a valuation is not so important. The reason an equity investor wants to know what the business is worth is because he or she is buying a hunk of the business. Itzzs value determines the price the investor will have to pay.
Shop Talk: The term valuation refers to the worth of the business. When an investor asks “What is the valuation?” they are asking in effect, “What is this company worth?”
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For instance, assume a business worth $10 million wants to raise $1 million. The investor who puts up the $1 million will get 10% of the companyzzs equity. If the business is worth $2 million, the investorzzs $1 million jumps to 50%.
From the entrepreneurzzs perspective a higher valuation preserves their equity position. And this is precisely why a valuation analysis [italicize analysis] is often more helpful than a one line sentence which says zzThe business is worth $3 million.zz An analysis provides some clue as to how the entrepreneur reaches his or her conclusions, and provides a basis for negotiation.
Unfortunately, how to develop a valuation analysis is beyond the scope of this work. However, there are many excellent guidebooks which can guide you through the process. See Appendix A, the subsection titled Business Valuation Guidebooks.
A Basic Guide for Valuing a Company
Wilbur M. Yegge, 1996
How to Price a Profitable Company
Paul B. Baron, 1996
Valuing Small Businesses and Professional Practices
Shannon P. Pratt, et al , 1998
Valuing Your Privately Held Business : The Art & Science of
Establishing Your Companyzzs Worth, Irving L. Blackman,1995
Handbook of Small Business Valuation Formulas and Rules of
Thumb, Glenn Desmond, John A. Marcell, 1993
The Small Business Valuation Book
Lawrence W. Tuller, 1998
Understanding Business Valuation : A Practical Guide to Valuing Small to Medium-Sized Businesses
Gary R. Trugman, 1998
Small Business Valuation Book: Easy-To-Use Techniques for Determining Fair Price, Resolving Disputes, and Minimizing Taxes
Lawrence W. Tuller, 1994
Use of Proceeds
Many entrepreneurs handicap themselves by circulating a business plan that doesnzzt mention how the funds which are being raised will be used. This is utterly ridiculous. Would you put money into a business without knowing how it was going to be used? Itzzs even more ridiculous considering just how easy it is to prepare a use of proceeds table. Herezzs one for a manufacturing company:
Purchase of Mold Dyes $250,000
Raw Materials $125,000
Debt Repayment $125,000
Working Capital $150,000
Professional Fees $50,000
A service company might show proceeds with less emphasis on hard assets, and more on working capital, marketing and personnel expenditures. For instance one Internet services firm aniticpated the following use of proceeds:
Working Capital $500,000
Marketing, Development &
Administrative Personnel $570,000
Leasehold Improvements $100,000
Systems Integration $100,000
Professional Fees $80,000
Total Proceeds: $1,350,000
The Use of Proceeds section can trip you up though too. For instance, there needs to be some connectivity between it and the rest of the plan. If, as in the above example a company suggests $300,000 in marketing expenditures, the marketing operations section of the plan needs to be in sync. Sure a company might be able to suggest a $600,000 or even a $1 million campaign, by supplementing the proceeds with a percentage of the sales. But the plan canzzt show a $5 or $10 million marketing campaign, when the proceeds earmarked for these efforts is just $300,000 and total projected sales are just $3 million.
In addition, repayment of debt is also a red flag for equity investors. They simply resist putting money into a company for the sole purpose of paying off someone elsezzs debt. zzTherezzs no growth associated with it,zz is the common lament.
Taking Action: Itzzs always good to reserve some of the proceeds for professional fees. It looks naive to suggest a transaction of several hundred thousand to perhaps several million dollars can be completed without any fees being paid to lawyers, consultants and accountants.
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Summary Projected and Historical Financial Statements
Your business plan needs summary projected and historical income statements for three years going backwards and five years going forward. Here is a summary historical income statement. The line items for the projected and historical statements should be the same.
Sales 1,000,000 1,500,000 2,000,000
Cost of Sales 750,000 1,000,000 1,350,000
Gross Profit 250,000 500,000 650,000
Selling Genzzl &
Administrative Exp. 375,000 425,000 450,000
Operating Income (125,000) 75,000 200,000
The reason you need to provide summary projected and historical financial statements, is because most investors like to take a look at the big picture first. Detailed financial statements, which are usually quite complex, donzzt offer a mechanism to do this. Youzzve just got to dig in. Therefore, if therezzs no big picture to look at, many investors will simply put the plan aside until they have time to take a close look. Of course, that may be the first step in a long slippery road toward the investor never picking it back up again. With all the challenges posed by raising money, why throw up another hurdle? Put the summary financial statements in the business plan.
Historical & Projected Financial Statements
One of the most important things to say about historical financial statements is simply to have them. Unless you are doing pure research and development or are a pure start-up, therezzs very little chance you will raise any money without a set of historical financial statements. Giving an investor a business plan without financials is like giving a blind person a book to read without braille. Therezzs no way he or she will be able to make sense of it.
Donzzt Forget: To inspire the maximum amount of comfort among potential investors, your plan should include financial statements prepared by a certified public accountant.
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Even new businesses should have a full set of financial statements created after their first quarter in business. Why? Because founders of businesses often claim they are underpaid. If this is the case their salary deficit needs to go on the books as a loan to the company, and remain there year in and year out, if therezzs any hope of the entrepreneur ever recovering this foregone compensation. Once the outside investors get in the company, there will never be the opportunity for the entrepreneur to say in five years zzNow that the company is on its feet financially, I want the salary I passed up in the early years,zz unless of course, the loan has been known about from the beginning, and has remained on the companyzzs books. Then therezzs a better than average chance of success.
To understand how investors will look at these financial statements refer to Chapter 21, A Look at Your Financial Statements.
The projected financial statements on the other hand, consist of an income statement, a balance sheet, and a cash flow statement. Each of these statements generally goes out five years. Sometimes during the first two years itzzs wise to show the cash flow statements quarterly rather annually. This will help the investor and the entrepreneur understand any seasonal fluctuations which often have a significant impact on the cash flow of the business.
Five years seem like awfully far into the future to be making predictions. But keep in mind, the investor has a very specific reason for wanting to see the fifth year forecast. He or she doesnzzt expect much accuracy. But they get a very good window on the entrepreneurzzs thinking. That is, are they trying to build a $20 million empire? Or are they trying to build a $200 million empire? Keep this in mind as you develop years four and five of your projected financial statements.
Here are some more important ideas about developing financial projections. For the sake of brevity, these will be offered within the framework of the summary projected income statement, since the balance sheet and cash flow statement flow from it.
– Projected sales. First, refer to the Marketing Operations section of this business plan, which describes in detail some of the challenges associated with forecasting sales. As mentioned, companies which have never sold their product or service, must make some extraordinary efforts in guerrilla test marketing so they can make claims about future sales based upon fact rather than mere guesswork. Anybody can guess, but anyone who does, tends not to get financed.
Companies that do have sales must quantify the relationship between their sales and marketing efforts and the resulting sales. What sometimes challenges the credibility of the forecast is a company which has had fairly constant sales historically, but is projecting geometric increases after funding. The big question becomes how and why? If a company is going to use funding to do a higher volume of the same marketing program, it will tend to deliver a proportional, not a geometric sales increase. If you already sell a product and are projecting big gains, you need to be able to explain to an investor what qualitative changes you will make to your marketing program to deliver the goods on sales.
– Cost of Goods Sold & Gross Margin. For many service companies, there is no cost of goods. Take professional service or consulting firms. They simply donzzt have raw materials costs. In cases such as these, a discussion of the gross margin is not necessary. But companies that make things must discuss their gross margin. And again companies that are already manufacturing, or assembling products, know or should know what it costs to make them. In fact, a manufacturing company contemplating bringing in outside investors, ought to be organized enough that it has a bill of materials for each product which it makes and a companion schedule component costs. If there are no secrecy issues, a bill of materials should be included in the assumptions to the financial projections as a means of offering proof positive on the cost estimates.
Taking Action: If you are outsourcing manufacturing, get an estimate from the manufacturing company and make it one of the appendices of your business plan.
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Companies that have not yet commenced manufacturing, but will upon financing, need good estimates. If several manufacturers are providing parts, youzzll need several estimates. But once you have them, itzzs simply a matter of aggregating.
If you are doing your own manufacturing, estimates are tougher to calculate, but even more vital to show in the business plan. Remember, the investor is looking for just two things from the plan. Comfort [italicize comfort] that the plan and the opportunity are for real, and confidence [italicize confidence] that the management team can pull it off. You can hit on both cylinders with a good estimate, and completely stall with half-baked, sloppily prepared estimates. And if thatzzs not enough to convince you to make good estimates, remember this, no one will invest in a company that does not know what it cost to manufacture its products. Would you [italicize you]?
In truth, the cost of goods sold is simply a means to the gross margin. Gross margin is defined as sales less cost of goods sold and is usually expressed as a percentage. During the first and second glance, investors will probably pay more attention to the gross margin than the cost of goods sold figure which produced it.
Investors will look very closely at the gross margin. It must not be too far out of kilter with industry norms. For instance, the National Restaurant Association reports that the gross margins for so called full-menu table service establishments are about 36%. Therefore if you are opening a restaurant and your projected gross margin is 25%, thatzzs a
problem. The investor will tend to say zzWhy should I invest in an embryonic company with below average margins, when I can invest in any number of public companies with average or superior gross margins?zz Why indeed?
On the other hand if your gross margins are 45%, it can provoke problems as well. The investor will question the credibility of the entrepreneur. zzDoesnzzt he or she understand how this industry works?zz Of course breakthroughs in technology, or marketing or management styles, or products, are precisely what can change the economics of an industry and create an investment opportunity. Therefore, if your margins are above average, thatzzs great. Just have a credible explanation what you are doing that allows you to beat the number which represents the collective knowledge and experience of your industry since its inception.
A Good Deal: Whatever your gross margins may be, for the purposes of making financial projections, itzzs best to pull them back a couple of percentage points. Why? Because a gross margin on a projected income statement is utopia. In real life there are strikes, stockouts, shrinkage, equipment outages and absenteeism.
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– Estimating Selling, General & Administrative Expenses.
The easy part of SG&A are the general and administrative costs. This is the one place in your projected income statement where you might actually be able to simply let the spreadsheet software increase the expenses by a factor of 5% each year. Centralized administrative costs are not that hard to calculate, and should remain fairly constant even if therezzs significant revenue increases.
But where companies go wrong in their projected income statement is with the zzSzz, or selling expenses. Estimating selling costs can be one of the most challenging aspects of developing financial projection, because to do it right the entrepreneur must be absolutely certain that their sales model works.
And once again, for products or services which have been sold before, these selling costs are known. The only exception occurs when an established company tries selling in a new venue such as when giant book retailer Barnes & Noble began selling over the Internet.
But for companies that are launching a new product, these costs are subject to guesswork. Unfortunately, nothing makes investors more jittery than guesswork. One way that selling expenses can tip off the investor that the entrepreneur isnzzt really sure how to sell the product is when there are several different line items under selling expenses. For instance if there are costs for advertising, direct mail, telemarketing, sales salaries, public relations and tradeshows — its too much, at least for a smaller company just starting out. Remember, the mst effective marketing operations rely on the old one-two punch, and in some instances, just the single punch. Keep this idea in mind when developing projected selling costs.
– Projected Operating Income. With respect to financial projections, operating income is [italicize is] the bottom line. In a full blown income statement the only things happening below operating income are extraordinary gains and losses, which defy projection, and taxes, which despite the best efforts of tax reformers in government, also defy projection. Simply put, in most instances, it just doesnzzt add to the understanding of the business opportunity to project the future tax liability. And so, operating income is the bottom line.
Many of the concepts for building credible projected gross margins, apply at the operating level as well. Specifically, build in conservatism rather than extremism so that itzzs possible to exceed the projections rather than fall short of them. And where operating margins exceed industry averages, have a tenable explanation of why. In the same way that technology, management styles and manufacturing techniques can cause a breakthrough on the gross margins, they too can have a positive effect on the operating margins as well.
For example, a midwestern equipment leasing company had a near vertical rise in revenues during start-up operations, and saw the opportunity to generate above average operating margins. Why? According to an executive with the company, the companyzzs investments in technology that would allow them to interface seamlessly with third party sales organizations delivered significant operating leverage. “After a certain point,” he said “we were able to handle large increases in lease volume with no increases in personnel costs on our end.” Apparently, the strength of this reasoning delivered the goods, and allowed the company to consummate an $11.25 million public offering during the fall of 1996. Even after the offering, the growth continued apace, and the company was bought out by a larger leasing company less than two years later, making millions for founders and shareholders.
Assumptions to the Financial Projections
The last elements of the financial analysis section of the business plan are the assumptions to the financial projections. These are not quite mathematical equations, but they are not quite prose either. Somewhat of a hybrid mutation, assumptions nonetheless are the linchpin of the business plan. That is they are what makes the financial forecasts mesh with everything that comes before it.
A Good Deal: Organize your assumptions to financial projections by the line items in the summary projected financial statements. This is first list the sales assumptions. Then list the cost of sales assumptions followed by your assumptions on selling, general and administrative expenses.
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Specifically, if the assumptions declare that marketing expenditures will be 9% of sales, and sales in year one are two million, then the marketing budget must be $180,000 and the marketing strategies and tactics described in the plan better well be achievable for $180,000. If not, there is something seriously wrong with the business plan.
Here are the actual assumptions to financial projections for a manufacturer of photoprocessing equipment. This company was successful in raising more than $1 million.
• The selling price of the MicroProcessor to dealers remains constant throughout the planning period at $2,850.
• The selling price of the MegaProcessor to dealers remains constant throughout the planning period at $6,900.
Direct Cost Assumptions
• MicroProcessor and MegaProcessor unit sales during the five years following financing are:
Year 1 Year 2 Year 3 Year 4 Year 5
Micro 1,335 2,510 2,646 2,778 3,062
Mega 96 210 220 231 256
• Direct materials costs for MegaProcessor and MicroProcessor processors are:
Year 1 Year 2 Year 3 Year 4 Year 5
Micro $1,550 $1,375 $1,300 $1,300 $1,300
Mega $2,000 $2,000 $2,000 $2,000 $2,000
• In the first year following financing, the direct labor payroll, exclusive of benefits and payroll taxes starts at an annual cost of $354,000 and rises to $510,000 for an average payroll cost of $432,000. With benefits and payroll taxes, the average direct labor payroll is $523,000.
• In the second year following financing, the beginning direct labor payroll is $510,000 and the ending direct labor payroll is $667,000 for an average payroll of $588,000. With benefits and payroll taxes, the average direct labor payroll is $642,000.
• In the third year following financing, the beginning direct labor payroll is $667,000 and the ending direct labor payroll is $770,000 for an average direct labor payroll of $718,000. With benefits and payroll taxes, the average direct labor payroll is $862,000.
• Payroll expenses remain flat for the fourth and fifth year following financing.
Year 1 Year 2 Year 3 Year 4 Year 5
Labor Payroll $436,000 535,000 718,000 718,000 718,000
Payroll Taxes &
Benefits $87,000 107,000 144,000 144,000 144,000
Labor Payroll $523,000 642,000 862,000 862,000 862,000
• Rent and utilities are $3,000 per month at the beginning of the first year following financing, and $4,700 per month at the end of the first year, for an average rent and utility expense of $3,900. During the second year following financing, rent and utilities start at $4,700 per month, and rise to $7,000 per month, for an average rent and utility expense of $6,000. During the third year following financing, rent and utility expenses stabilize at $7,000 per month.
Selling Cost Assumptions
• The company will pay the chief executive officer, and executive sales manager a salary of $150,000, with an expense account equivalent to 100% of salary and benefits equivalent to 25% of salary.
• The company pays the sales manager a salary of $55,000, with an expense account of $15,000 and benefits equivalent to 25% of salary.
• The company adds salespeople in the following years at the following costs:
Year 1 Year 2 Year 3 Year 4 Year 5
# Salespeople 1 4 4 4 4
Salaries $45,000 180,000 180,000 180,000 180,000
Expense Account $41,000 164,000 164,000 164,000 164,000
(90% of Salary)
(20% of salary) $9,000 36,000 36,000 36,000 36,000
Total $95,000 380,000 380,000 380,000 380,000
(% of Gross Sales) 3.5% 3.5% 3.5% 3.5% 3.5%
• In the first year following financing (Year 1) the company hires one full time salesperson with an annual salary of $45,000.
• The salesperson hired in Year 1 has travel and entertainment expenses equal to 90% of salary.
• The salesperson hired in Year 1, has benefits and payroll expenses equivalent to 25% of salary.
Administrative & Engineering Cost Assumptions
• The companyzzs administrative staff consists of a receptionist, and purchasing/materials administrator and bookkeeper at an average annual cost of $100,000. In the second year following financing, expenses for administrative staff will increase to $140,000. In the third year following financing, administrative costs are $190,000.
Year 1 Year 2 Year 3 Year 4 Year 5
Staff Salaries $100,000 140,000 190,000 190,000 190,000
(25% of salary) $20,000 $35,000 47,500 47,500 47,500
• The companyzzs engineering personnel expenses remain constant at 3% of sales, plus payroll taxes and benefits equivalent to 25% of salary.
No business plan is complete without appendices. After all the ifs ands and buts of the rest of the business plan, the appendices provide the investor a refreshing dose of reality. Specifically, the appendices of the plan are where you show the investor everything about the company that will give them additional dollops of comfort and confidence. Hear are items typically found in the appendices of a good business plan:
• Product literature
• Patent certificates
• Company sponsored research
• Sample sales contracts and agreements
• Trade articles
• Advertising literature or ad concepts under development
• Supporting financial schedules
• Licenses and permits
• Trade references
• Customer testimonials
• Site or personnel photos
There are no set rules about what can go into the appendices of a business plan. After all each company has its own unique story to tell. The general theory though is to include items which increase the credibility of the company with the investor.
When assembling appendices, itzzs important make clear separations between different appendices. The many parts which can go into them are graphically and visually disparate and when presented without the guidance of cover sheets or separations, the effect is more confusing than enlightening.
Even though itzzs presented first, the executive summary is written last. The reason to write it last is because if the rest of the plan is well written, the executive summary is just a question of lifting sentences and stringing them together.
The executive summary must be two pages in length, no more. It must be written and structured in such a way that it can function as a stand alone marketing document for the deal. To do this it must simply contain a paragraph or two about each of the major sections of the business plan. Specifically:
• The Company And Itzzs Business
• Market Analysis
• Marketing Operations
• Key Personnel
• Financial Analysis
The only deviation from the rest of the plan is the first paragraph of the Executive Summary which should be a separate section called a Summary Statement, Introduction or Preface.
This statement is like the introduction to a book. It tells the reader why they must read the plan. But unlike a bookzzs introduction, which can run several pages, the introduction to an executive summary, hence the business plan, must get its work done in just a few paragraphs. Here is a sample summary statement:
Pope X-Ray Products, Inc. manufactures X-ray processing equipment, and has over 30 years experience inventing and manufacturing image-related equipment. Its products have a large, worldwide installed base and are recognized for quality, functionality and economy. The company has established a dealer network and stimulated significant demand. Meeting this demand has been constrained by capital considerations.
Meanwhile, diagnostic imaging is undergoing evolutionary change with traditional film gradually being replaced by digital technology. Pope X-Ray seeks to exploit both markets. Specifically, the company has capitalized on the entrenched position, third world potential, and longevity of film radiography by continuing to build and distribute high quality film processors. In addition, the company will enter the digital diagnostic market through the acquisition of technology to exploit the eventual replacement of film in developed countries.
To capitalize on these opportunities, the company seeks an equity capital infusion of $1 million to finance the expansion of its film processor manufacturing and sales activities. Based on this capital infusion, the company believes it can achieve sales of $9.5 million and operating earnings of $3 million within three years of financing. The company seeks another $3 million to acquire digital imaging technology or assets that will enable it to enter the emerging market for digital imaging. Based upon technology it has identified, developed by DMZ Systems, Ltd., Tel Aviv, Israel, Pope believes that it can achieve sales and operating income of $33 million and $11 million within five years of financing.
Taking Action: Start drafting your business plan. For most of the financing sources outlined in this book, the first request they will make of you is to zzSend me your business plan.zz And as mentioned earlier, when someone asks for a plan, it should be there the next day, not six weeks later while you finish drafting. So, if youzzre serious about raising money, do the right thing. Start writing.
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