August 2009

Q. What do investors look for in a business venture?

A. When developing and growing your business, it is of value to consider it from the perspective of an investor, even if you don't intend to have outside financing. Investors have an approach to evaluation that will help you to understand your business better. Using an investor's mind set will also show where improvements need to be made. Any business, from an investor's point of view, is all about risk and return.

Let's start by defining an entrepreneur as "one who creates a new business in the face of risk and uncertainty for the purpose of achieving profit and growth by identifying opportunities and assembling the necessary resources to capitalize on them".

Notice three interesting words in the definition: risk, uncertainty and profit.

Risk is a concept that denotes the precise probability of specific eventualities. Risk is a state where some possible outcomes have an undesired effect or significant loss. In the business world, risk also includes too much of a good thing. For example, when too many customers want the product, we risk not supplying all of the customers. For risk we can estimate the likelihood and impact (outcomes) of events. These two estimates become critical components of the business plan as we try to reduce one or both of those estimates.

Uncertainty is a state of having limited knowledge where it is impossible to exactly describe the existing state or future outcome. Since uncertainty means that events will occur that we can't foresee, we need to have a flexible plan. This means that our strategy is a not a single point or a straight line approach to a set of desired outcomes. The business plan needs to deal with a broad array of possible outcomes.

An investor has two goals when reviewing an opportunity. An investor is seeking to maximize their return and minimize their risk.

Typically, when writing business plans, we are advised to write each section of the plan and finish the plan with a section on risk. In fact, each section of the plan should be designed to support the twin goals of the investor. An investor typically invests in a company in financial increments and there is some element of risk being addressed at each increment. Once a given risk has been addressed, the next increment can begin with a new set of risks to address.

The Opportunity

The business opportunity needs to have a basis, something that is happening in the market that says the opportunity will succeed. Introducing a product into a market that isn't interested is a high risk endeavour.

Typically, there are four elements that the opportunity must rest upon:

1. A trend that is happening in the market.

2. A serious gap has been discovered in the market. This means a customer is willing to pay for a solution but is currently using a less than optimal solution.

3. A problem has been identified but no solution has come forward.

4. An industry is either undergoing a mature revolution of the way it does business or a new hybrid industry is forming from two or more mature industries.

The discussion in the business plan of the opportunity needs to address both the:

  • chance that the window of opportunity associated with the trend, gap, problem, or revolution will be there when the product hits the market

  • strength of the connection between the solution the company will offer and the trend, gap, problem, or revolution being addressed

The business plan also needs a discussion of how long the window will remain open and what happens if the solution is too early or late.

Opportunity is connected to time. It will evolve as time passes, so there needs to a discussion of how the solution or product could evolve over time. This product migration can be connected to the evolving business environment, competitor reactions, or value metrics of the customer.

The Management Team

No business plan will be implemented exactly as it is written. Business environments change, competitors introduce new products on the market, and so on. Over the course of time, the actual decisions and actions taken will vary from the plan. What the investor is really looking for in the management team is the ability to handle new and unexpected situations. This goes beyond the ability to implement the current plan or possession of skills in some operational area of the company. This is known as agility, the ability to adapt simultaneously to many different business environments.

In the global environment, many events are occurring at once in the market, including the impact of government regulations and other peripheral forces.

Too often, the management team section of the business plan is written to highlight past experience. What needs to be emphasized are the types of environments in which the management team has been successful and the team's ability to adapt and be flexible. It's this ability to handle the risks as they happen that is important.

The business plan needs to show that management has the ability to anticipate. This is known as acuity, the ability to perceive the competitive environment clearly and thus to anticipate and respond to a customer's evolving needs and wants. Acuity really means to understand.

Gathering metrics on the competition's sales or personnel size or market share is not enough to tell us about the competition. We need people who understand the competition's capabilities and decision-making ability.

To directly address the need to adapt and be flexible, the management section of the business plan needs to show that management has the ability to:

  • recognize business situations and associated risks before they happen

  • recognize that there are many possible outcomes to a situation

  • derive adjustments to the business plan that deal with the highest likelihood or impact outcomes

  • recognize when its time to change

  • implement plans in a way that maximizes the potential for success in the new environment

In the business plan, the management team is not just chosen for their operational capability, but for their ability to address specific risk items.

Marketing Plan

Typically when starting a company, the product is new, the technology is new and even the market may be new. In the eyes of the customer, this is a high-risk situation when compared with staying with the status quo. The innovation adoption curve shows that the early stage of a technology's life cycle is a high-risk item for the customer. This risk lowers as greater adoption takes place. This means that the message and medium used in an advertising and promotion plan needs to differ, depending on where we are in the adoption life cycle.

The business plan needs to convey what the risks are to the customer and how they will be addressed.

The marketing plan needs to show that the resources spent will be focused on the highest potential for return.

The marketing plan usually has a focus on how the product will enter the market and how sales will be generated. There is always the risk of competition and, in most cases, competition is not just an if but a when. When entering a market and having performed our competitive analysis, if we don't see a difficult competitive situation we still need to ask: "Will this market be a logical extension of a well-established company that is currently operating in an adjacent market?".

If so, we need to plan for their arrival.

Final Take-aways

The final question is how do we measure risk levels? The answer is connected to the following sub questions:

1. What is ease of proving a risk? Can we quickly, cheaply prove or describe the attributes or eliminate a risk?

2. Certainty of proving: once done how certain are we?

3. Time to proof: when will we know?

4. What are the expenses to stay in the game long enough to prove risks?

The business plan must show that between revenue and investment all risk possibilities are covered. Typically most plans only show the ideal situation.

This article is an excerpt from the upcoming book "Shifting the Barrel", a book of articles written by Founders and CEOs of the technology industry, filled with practical advice. The book will be available from Ivenire.


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