The Business Plan: What is it and Why?

Writing a business plan is a helpful way to get your thoughts down on paper --- which then forces you to justify what you want and how you propose to operate your company. Further, you won't be able to effectively raise money without one.

Before you start to build a house, you don't just drive to the nearest lumber yard, buy materials and start building. You need to plan. In construction, that plan takes the form of a set of blueprints --- and those blueprints will have taken more time and thought to develop than the entire construction process that comes after. If you have ever been involved in even the smallest construction project, you will know why.

Typically, you start with an idea; say you need another bedroom, or a family room or a kitchen. The first thing you do is start drawing boxes on paper. Then you study your plan, and find flaws in it. You have to walk through your bedroom to get to the family room. There's no way to get to the bathroom except from the outside. That sort of thing. So you redesign your plan. Then you start taking measurements, and you discover that you've put your family room inside your neighbor's garage. Back to the drawing board.

And so it goes. Your next plan fits inside your property line, but requires plumbing to be brought over from 100 feet away. It can be done, but its more expensive. You will need a new electrical panel to meet code requirements. More expense.

At this point maybe you look at your finances, and you realize you can't afford this project. You need a loan, so you go to your banker, and the first question he asks is "How much?" And you scratch your head, because you don't know. Back you go to that wretched drawing board, and now you start filling in the details. You price out the cost of excavating a basement, of pouring foundation walls, of framing lumber, insulation, sheetrock, doors, windows, trim, cabinets, screws, nails, rafters, roofs and roofing material. You figure how much plumbing and electrical will cost. You add it all up, add ten to fifteen percent to cover screw-ups (which are inevitable), and you go back to the banker.

He tells you that you're nuts, that you're building a Taj Mahal whose market value will not cover the expense. So back you go to rethink your plan. You consider maybe modular units instead of hand-built. You think Home Depot cabinetry instead of European imports. Until, finally, you have a workable plan, both in terms of construction and cost.

Preparing a business plan is something like that, with one important wrinkle. In construction, you can be pretty sure that if you nail all your materials together according to your plan, you will get the building described in the plan. Not so with a business, for a business is subject to uncertainties and events not in your control. Most houses follow their plans; most businesses do not. Yet, all entrepreneurs write business plans, and they should. Why?

The superficial answer--probably given by nine out of ten entrepreneurs--is that investors won't invest in you if you don't. That answer is in the same category as "you need an education to get a good job." Both are truisms, but neither tells you the real value of the thing you are doing.

The better answer is that you need to write a business plan because the act of doing so forces you to think long and hard about your business, so that you can advocate for it forcefully to an investor who'd rather not give you a cent. Too many entrepreneurs think of the business plan as a sales brochure, and will put into it anything they think will capture an investor's attention. But a good business plan is more akin to a carefully crafted legal brief than a piece of slick sales literature. Its purpose is not to dazzle with glitz, but to persuade with facts and logic. The business plan tells a savvy investor volumes about the prospects of the business:

Does the management understand the market and products of the business?

Has management done its homework in researching the competition?

Has management realistically assessed the market's future reception of the product?

Has management thought through the foreseeable pitfalls to be avoided?

Has management documented and supported its facts and its assumptions?

Do management's forecasts flow logically from those assumptions?

In short, does management appear to know what it is about--are they pros or amateurs?

Notice that each of these questions includes the word management. They say that the three most important factors in real estate are "location, location and location." In business, they are "management, management and management." Even more than product, quality management is the key to a successful business. Good management can make a poor product sell; poor management can make a first rate product a loser. In the extreme, a good management can ditch a poor product, but a great product cannot fire a poor management. More than anything else, a good business plan tells you about its authors, the management. Are they smart or dumb; deep or shallow; hardworking or lazy; generous or niggardly; gentlemen or con-men? Are they to be trusted with your money. A business plan, by its feel, language, and rigorousness, by the amount of work evident in it and the care taken in its preparation, will tell.

What exactly does a business plan purport to do?

A good business plan describes in simple terms the product you hope to sell, including why people would buy it. It analyzes the market for the product and demonstrates that the market will receive your product favorably. It details how you intend to market your product. It candidly assesses the competition and forcefully argues why your product can succeed in spite of them. It forecasts how much you will earn in the future from the sale of the product, and what expenses you will incur along the way, all being derived from stated and documented assumptions. And it does so in a work of prose that is engaging and readable, that is well-written.

Writing a good business plan is hard work, near-scholarly in nature, and not everyone is up to it. From speaking with venture capitalists and from having seen a number of plans myself, I can say with confidence that most plans are awful, and never get read past the first two paragraphs. Perhaps it is not surprising then that most business ideas do not get outside funding, and that most businesses fail. Writing a good business plan is a new enterprise's first test, and one to which a great deal of attention should be paid.