For a couple of decades now, I’ve suggested that business owners plan a small business’s initial operations by answering five basic questions.
Thinking about a business plan as akin to a five-question essay test makes the planning easier, I think. (Short good answers are okay—maybe even preferable.)
And thinking about a business plan this way, as a little essay test, hopefully helps the entrepreneur focus on the quality of the answers in the plan rather than the quantity of information in or the form of the document.
Question #1: Is the Service or Product Actually Feasible?
Okay, so let’s start.
The first question you or I need to answer “yes” to in order to say we’ve planned our business venture adequately is, “Is the product or service even feasible?”
That maybe sounds like a stupid question to start with, but here’s the deal: Sometimes a product can’t be built or a service can’t be delivered.
For example, maybe the technology doesn’t exist. Or the needed scientific break-through hasn’t occurred. So you need to think about that.
And another thing to keep in mind about feasibility? We can’t only think about feasibility in terms of technology or science. Legal factors often matter just as much for small businesses.
For example, you might be able to operate a venture at some perfect location—except for local zoning.
Or I might be able to provide a super-desirable personal service—except I can’t get the required business license or licenses.
Accordingly, the first question one needs to research and answer is whether or not a product or service is feasible. One needs to try to prove feasibility before making any major financial commitment such as hiring employees or leasing space or equipment.
Question #2: Do Customers or Clients Want the Service or Product?
Next question: Is there demand for the service or product the planned business will sell?
Now obviously, if one starts a business to sell items that other businesses already sell, one of course knows customer demand exists. So that’s good. (Although this certainty comes with the disadvantage that these prospective buyers may already be some other business owner’s satisfied customers.)
But in many other situations, we don’t necessarily know that true, dependable demand exists. And so you and I need to try and validate demand before we bet big on any new venture.
By the way, I don’t know about you, but customer surveys and small focus groups provide little real proof in my mind. I kind of think we ought to go to more effort and expense and use pilot programs or studies and pay-per-click web advertising experiments.
A tangential sidebar: I am not a big proponent of buying an existing small business. Regularly, the small business buyer gets hosed. But an existing small business that already has customers buying products or services proves both product or service feasibility (the first question) and customer demand (the second question).
Question #3: Can the Business Profitably Operate?
Okay, so here’s a weird thing: Regularly people start businesses that deliver good products or services to tons of happy customers and clients—but then the business fails.
In many of these cases, I propose, the problem can be traced back to an unprofitable business model.
An obvious if absurd example of this would be if I started a business where I sold one dollar bills for $.95.
If I did start such a business, I could sell as many dollars as I could find. And I would (briefly) have a world full of customers. But my business wouldn’t last long because it just wouldn’t be profitable.
That’s a silly example, I know. But small business owners sometimes (maybe regularly?) construct similarly silly business models where the business delivers services for less money that the service actually costs. Or where the business sells products at prices that may exceed what the products cost wholesale but don’t fully pay for the operation’s overhead.
Accordingly, you and I do want to create an Excel spreadsheet that tallies all the costs of operation—including a reasonable salary for your or my time—and then make sure that the business we’re considering can be profitable.
Note: If you want a more elegant solution, consider our economical business planning workbook (available here), and do note that if you’re a client of the CPA firm, we’ll give you a free copy of the workbook and e-book, so don’t buy the download. Just email us.
Question #4: Is Capital Available—and Affordable?
A quick point: No matter how small, a new venture needs capital.
Clearly, then, one wants to make sure one knows where this money is coming from and that the investor or lender supplying the money gets whatever return he or she needs.
For example, if I need a $100,000 business loan and the bank will charge 6% interest, or $6,000, I need to make sure that I can pay the $6,000.
And for a slightly more complicated example, if you need $1,000,000 of outside investor money from angel investors or venture capitalists, you need to make sure your venture can generate the threshold compound annual rate of return. (Perhaps 25% for angels and 50% for venture capitalists?)
Caution: The high rates of return expected by outside investors means a business needs to grow really big and really fast. To satisfy a group of angels wanting a 25% annual return, for example, an initial $200,000 investment needs to grow to $600,000 in five years. To satisfy venture capitalists wanting a 50% annual return, an initial $2 million investment needs to grow into about $50 million in eight years.
By the way, if your or my venture does require outside funding from a bank, an angel, or a venture capitalist, we also need to figure out how to either payback or refinance the loan or how to cash out the angel or venture capitalist with a sale or public offering.
Often times, therefore, the optimal long-term sources of small business capital are sweat equity from the owner or owner’s family and reinvested profits. This lets the founder retain ownership and avoid compromising the business plan to suit outside funding sources.
Question #5: Does Management Have the Necessary Skills?
A final point: You or I also want to make sure that the leadership team possesses the needed managerial and industry skills.
In other words, even with a feasible product, solid customer demand, a profitable structure and all the funding desired, a business won’t work for long without people in the wheelhouse who know what they’re doing.
Something like an undergraduate degree in business or an MBA and then a few years of managerial experience in a similar operation, of course, would be great ways to get the general management skills (if not the experience).
But most people, let’s face it, don’t get the opportunity for formalized learning in a business school setting. And most entrepreneurs aren’t going to want to take the time to work at another firm in the same industry for, say, five or ten years.
Accordingly, some small business owners probably want to think about the other ways they can get any missing knowledge.
As far as the general business knowledge stuff, therefore, can I suggest a new business owner’s reading list? I think I’ve read every major book on management in the last three decades. And you can probably get quite a bit of the information one needs from the following (in most cases, “classic”) texts.
For leadership and general management stuff: Peter Drucker’s Innovation and Entrepreneurship (Harper & Row 1985) and The Effective Executive (Harper & Row, 1967).
For operations management stuff: Michael Gerber’s The E-myth Revisited (Harper & Collins, 2009) or one of the occupation or small-business specific editions, such as The E-Myth Contractor, and Eliyahu M. Goldratt’s The Goal: A Process of Ongoing Improvement (North River Press, 2014)
For accounting and finance stuff: Stephen L. Nelson’s QuickBooks for Dummies, All-in-one Desk Reference (John Wiley & Sons, 2013). This is my book, obviously. I mention it here only because chapters on general accounting and financial management essentially give you a distilled version of undergraduate accounting and finance courses. (By the way, if you’re a client, ask me for a free copy of the book.)
For strategic planning and business policy: Michael E. Porter’s Competitive Strategy: Techniques for Analyzing Industries and Competitors (Free Press, 1998) This book is a dense read, but the strategic and tactical insights it provides are truly useful if you will operate in a competitive market.
As far as the more “tacit” insider knowledge—the stuff you can’t get in a book or classroom—I have only a couple of ideas to share (both of which have worked well for the ventures I’ve participated in).
First, if you can establish a small network of three or four fellow business owners who are sort of in the same business but not actually competitors, you can create a knowledge sharing partnership. I did this with a couple of fellow small press publishers when I operated a publishing house. And the sharing of insights and solutions along with collegial emotional support hugely helped me and my publishing business.
Note: In many industries, numerous practice coaches or “management consultants” also offer their services to help you grow your venture or “take it to the next level.” Probably some of these services are worthwhile. My own experiences, however, have usually been disappointing. In many cases, the people who truly benefit from such services (because they’re starting from such a modest knowledge base) probably shouldn’t be yet starting a firm.
Second, some industries and most professions include trade associations that provide useful continuing education workshops, classes, and conferences, as well as all sorts of niche publications. This stuff can be invaluable. By the way, typically the information isn’t free—often you’ll pay significant amounts for surveys or special whitepaper reports. But you can get detailed information about what your new business should look like, how profitable it will be, what staffing levels will look like, and so forth. Whatever information like this is available in your situation, you want to have purchased, perused, and processed.
Another tangential sidebar: In my mind, the big benefit you get when operating a proven franchise business is that you know other business owners operating the franchise model have been able to answer the first four questions “yes”… but many franchise operations also provide the business owner with really solid management and industry training. Accordingly, some prospective business owners (maybe especially young or new-to-small-business entrepreneurs?) may want to look hard at the franchise route to small business ownership. Let me also note the fly in the ointment: You always pay big for the franchise’s proven business model and management training–and so the question is, are you sure you’re not paying too much?