Why Business Plans Fail To Attract Investors

By John W. Cullins

Edited by Jeffrey Taylor for clarity and content

An economic downturn is a great time to start a business. Costs are lower, and more talent is available, thanks to layoffs. Prospective clients are more likely to try a new supplier who can help them cut costs or increase their competitiveness. Established players, too, are focused on cutting costs instead of increasing market share.

All of this helps clear the way for the next venture with the better mousetrap—but only if the entrepreneur can write a clear and convincing business plan. Anything less is heading straight for the wastebasket. Let’s face it. The intended recipients of such business plans—investors and lenders, family and friends, anyone with capital to invest in the project—are all much more wary of risk now in these turbulent times.

Most business plans fail to impress potential investors. Most aren’t even read in full. Their shortcomings tend to be obvious largely because the people seeking money have not done their homework. Plans fail for the following reasons:

1) The writer is self-absorbed with the elegance of his or her technology. The plan begins not with the identification of a customer problem to resolve, but with a detailed explanation of how the technology works, why it is cutting-edge or state-of-the-art, and how it is better, faster and cheaper than current solutions.

Such a plan is typically readable only by those already in-the-know in its particular technical realm. Seasoned investors know that the better technology does not always win.

There is a better way. A good business plan starts with a clearly defined problem—something that’s really troubling or compelling—supported by evidence from marketing research, testimonials, letters of intent, or whatever, that the pain is real.

If you can convince your readers that this problem is real, they’ll be hooked, at least for a while, as they read on to see whether you’ve found a solution that can resolve the pain. If the pain isn’t real, stop writing. There’s no need for a solution.

2) This writer rests his case on a truckload of data to show how large and fast-growing a market is. The plan then makes a heroic leap and assumes that the new venture will grab X percent of that market—it could be 1%, 10%, 30% or whatever. “Surely,” the plan argues, “with the large number of customers in our market, we’ll easily get enough. We only need a small fraction to have a very nice business.”

Plans like this reveal that the writer isn’t sure what the initial target market is. It’s much easier to win a large share of a carefully targeted but narrow market than it is to win a small share of a very large market.

Further, penetrating a new market requires customers who are aware of the new product, and distribution systems that allow them to buy it. These plans gloss over details. They ignore the difficult work—not to mention the expense—of crafting a strategy to gain market awareness, persuade customers, and set up distribution.

This kind of plan also often signals that the writer is reluctant to get out from behind his or her Internet connection and actually talk to prospective customers. Talking to customers is harder work, but brings all kinds of benefits and insights, not only to the business plan, but also to the business itself. Such conversations can reveal what customers really want—and help tailor the offering to meet those needs.

3) Of our five fundamentally flawed business plans, this one is perhaps the most difficult to spot. Such business plans often contain detailed spreadsheets showing why the numbers would work. That’s why these kinds of plans are difficult to spot—the numbers look like they work.

Savvy investors not only tear apart the spreadsheets but ask fundamental questions. Does the revenue model depend on making a large number of small transactions (think Amazon.com) or a small number of large ones (automobile manufacturing)? Do its profit margins depend on high gross margins to cover high product-development costs (think Microsoft), or lower margins to cover slimmer operating costs (Costco)? Is a large investment in development or other fixed assets required (a manufacturing facility, for example)? Is the working capital cycle favorable or unfavorable (do you expect to be paid in advance), or will you have to carry inventory and receivables that can tie up scarce cash (manufacturing and distribution businesses)? Some combinations of these factors are clearly attractive. Others are obviously flawed from the start.

4) Investors won’t be snowed by top-tier diplomas or past employment with a leading company. Investors care first about the main challenges of the industry in question, and whether the proposed team has hands-on experience tackling those challenges.

Every industry has critical success factors—typically two or three—that, when addressed effectively, are likely to bring success even if less-important challenges aren’t handled well. Location, for instance, is a critical success factor in much of retailing.

A business plan that identifies its critical success factors and shows how the team’s expertise and experience are suited to addressing them is much more likely to attract capital—or at least a second look.

Surprisingly, plans that point out the lack of a key skill or capability in the management team can fare quite well, by acknowledging the missing link and encouraging the prospective investor to fill that slot with a qualified person whom he or she favors.

Plans that succeed in attracting capital often include one or more members of a team who have failed in a prior venture. When that failure is accompanied by lessons learned, it’s often viewed, as an education on someone else’s nickel.

5) The most common type of business plan, and the one that goes most quickly into the trash, is the one in which the writer can’t find anything but good things to say about the opportunity and plans to pursue it.

Investors know that in the real world most opportunities, even good ones, have some weaknesses. Typically, it’s not yet clear in an early-stage business whether the customers will buy, or buy at the price that’s been proposed. Most industries are not filled with infinite possibilities, either, especially given the overcapacity in today’s global economy.

Experienced entrepreneurs know better than to assert that everything is wonderful about their opportunity. They know there are potential pitfalls in their market or industry.

The facts are that most opportunities are highly uncertain. Most new ventures will fail. Of the few that do succeed—winning capital, customers and positive cash flow—it’s usually not because of the original plan, “Plan A,” about which the business plan is written, but because of an as-yet-unknown “Plan B.”

Candor is key. There probably will be some questions implicit in your business plan that have not been answered. Will your solution actually work? Will customers buy it? How much will they pay? How will competitors react to your entry? Does your entrepreneurial team have what it takes—the experience and expertise—to deliver on the critical success factors that apply in your industry?