Formulating a business plan

My last article (The Sunday Times, July 15) presented a widespread conventional methodology used to carry out a feasibility study of your entrepreneurial venture, once again using a software developer as an example. The case had concluded that the mCommerce operation envisaged to be set up by the software developer is indeed viable for both his situational context and for prospective investors.

The next step in the process is to clearly define, articulate and communicate the business concept into a form that is easily understood both by yourself and prospective stakeholders. This can be done through the formulation of a business plan.

The development of a business plan is a critical activity that any entrepreneur and/or business owner needs to carry out in situations faced with opportunity costs. The higher the opportunity cost that an entrepreneur is facing, the more valuable a business plan.

Unfortunately, the usefulness and importance attached by would-be entrepreneurs to such activity has eroded considerably in recent years due in part to some consultants who have reduced business planning to a form-filling exercise.

Many critics of business planning argue that this is no more than a futile exercise of crystal ball gazing. They argue that the business plan already becomes outdated by the time of completion because circumstances in the future are different to those at the time of compilation.

In my view, what most of these critics fail to understand is that business planning is as much about a learning process as it is about developing content. In other words, the value of the business plan does not only derive from the interpretation of future outcomes but also from the learning experience gained in becoming sensitised to the critical issues, concerns and risks faced by the enterprise.

In the context of our software developer for example, the derivation of revenues amounting to £23.5 million by the fifth year of operation is contingent upon the attainment of a patent that protects his invention from being copied by others in the source market.

Should the granting of such patent be denied, the prospects for revenue generation are likely to be considerably lower, since barriers to entry in the market by potential competitors would be weaker. Hence, it is in the interest of the software developer to invest considerable time and effort to secure appropriate intellectual property rights in his target market before commercialising his idea.

Since there is so much to learn from the process of preparing a business plan, I would strongly advise against farming out the process completely to a consultant. In my view, the entrepreneur should take an active part in the formulation and development of assumptions pertaining to the business plan, and should also be sensitised on the potential impact on the bottom line of his business, should the assumptions on which his business plan is based not materialise in practice.

For example, in the context of our software developer (currently involved in the development of mCommerce food retail business solutions), the food retail take-away market is likely to be highly income elastic such that an unexpected recession in the UK economy would have an adverse impact on consumption, resulting in lower commissions and reduced demand for the installation of such solutions. Through the business planning process, the software developer has become sensitised to such risk, and therefore intends to adapt his solution to the supermarket industry (which is likely to be less income elastic than the take-away market) in an effort to balance out his high exposure to economic growth in the country as a whole.

If the software developer had outsourced the business plan completely to a consultant, he might have missed out on the sensitivity of the results to changes in the environment in which he is operating. While these may be pointed out by the consultant himself, this does not replace the tacit knowledge that would have been gained by the entrepreneur in directly engaging himself in the preparation of a business plan.

This is not to say that consultants do not provide value-added in the business planning process. Their greatest contribution lies in facilitating as opposed to leading the process. Consultants provide an external, unbiased and unemotional view of the viability of a project or a business venture which might not be appreciated by the entrepreneur.

The entrepreneur may be emotionally attached to his idea and may unconsciously tend to project better results than those realistically achievable. Moreover, while an entrepreneur may be highly technically competent in the production and development of his invention, he may lack the commercial expertise, experience and knowledge required to commercialise his idea.

This gap may be filled by external consultants who, apart from impartial and unemotional advice, can also support an entrepreneur with their experience in helping out other similar innovative ventures to take off. Finally, a consultant may also play 'the devil's advocate' by challenging the entrepreneur on the reasonableness and robustness of the assumptions on which the business plan should be developed, and by offering alternatives and recommendations for improving the 'commercial sense' of an entrepreneur's idea.

Inventors often tend to become obsessed in the technical complexity and features forming part of their solution. What many of these fail to understand is that it is the consumer who will ultimately have to pay for the development of such complexities and such consumers may not be willing to pay for these additional features. The best technical solution may not always be the most commercially viable option.

Consultants may help and encourage such entrepreneurs during the business planning process to consider a stripped-down version of their invention/solution to match the needs of identified target markets and customers in the process. For example, in the case of our software developer, while an enhanced feature of tracking progress of the meal order placed through an mCommerce system in real time offers an elegant solution, the customer would really only be interested in being alerted on time whenever the meal is ready for pick-up.

In this context, the additional feature does not offer any significant tangible benefit, thereby adding on unnecessarily to the cost of developing the system. In this context, the development of such feature should be abandoned. At this point, consultants may provide valuable input to the entrepreneur by asking relevant questions, such as:

• Who is your target market for such feature?
• Would you personally be willing to pay additional fees for making use of such a feature?
• How much complexity does it add to your system?
• What additional costs need to be incurred to introduce such a feature?

Such probing helps an entrepreneur to frame his mindset into a more commercial as opposed to a technical setting.

Not only is business planning an important part of the learning process of your business to ensure its viability and assess associated risks, but it is also a vital document for communicating your idea and bringing it into fruition. Such communication is important, especially when you as an entrepreneur are seeking prospective partners or alternative sources of financing to fund your business.

Almost any financial institution will require you to prepare a business plan to assess the viability and risk associated with your business venture before committing relevant funds. Such institutions are likely to carry out background checks on the reasonableness and validity of the assumptions made in the business plan, as well as checks on your professional integrity, competence and experience.

In some cases where funding requirements are substantial, a fully-fledged due diligence process is carried out. On the basis of these results, financial institutions will as a minimum decide:

• Whether to approve your funding application;
• Whether to approve your funding application against some form of security (such as a hypothec against your personal home);
• The amount of principal to be advanced, and in what form;
• The rate of interest payable;
• Terms of repayment.

The decision made by financial institutions on each of these variables has a considerable impact on the entrepreneur, since such variables have a direct bearing on both the weighted average cost of capital and cash flows. Investing appropriate time and resources in the business development process is well worth the effort!

Having raised a case on the importance of business planning, my next article will focus on the content to be included in a business plan, and how such a business plan may be changed and adapted to reflect the audience for which it is intended.

David Galea, B. Com (Hons), CPA, MBA (Warwick), is director of 4Sight Consulting Group, an entity involved in the provision of a wide range of professional services through a network of service providers. Mr Galea, who has recently successfully completed a Master's degree in Business Administration with distinction with the University of Warwick, has extensive management consulting experience in both the private and public sector. For more information visit www.4sight-consulting.com.

davgalea@maltanet.net