Page 147 - Business Plans that Work A Guide for Small Business

138 • Business Plans that Work

Entrepreneurs should do both approaches, and, with work and skill, the
two approaches allow entrepreneurs to paint a textured picture of the
financial structure of their new venture.

Creating Initial Estimates

Comparable Method

Entrepreneurs are notoriously optimistic in their projections. One phrase
that entrepreneurs overuse in their business plan, especially the financial
plan, is “conservative estimate.” History proves that 99 percent of all
entrepreneurs are amazingly aggressive in their projections. Professional
investors recognize this problem and often discount financials up to
50 percent from the entrepreneur’s projections. Such action greatly impacts
the valuation of your company and means that you will have to give up
more equity for the needed financing. How do you prevent this unhappy
surprise from happening? Validate your projections by comparing your
firm’s pro forma financials to existing firms’ actual performance. If you
can convince investors that your projections are reasonable and refer to
existing companies as a basis for your beliefs, you will get a valuation
closer to what you expected. Obviously, no two firms are exactly alike,
and if you were to launch an online bookstore, it would be unlikely that
your firm would perfectly mirror Amazon.com. However, the comparable
method doesn’t mean that you substitute another firm’s financials for your
own; it means that you use that as a starting point. Early in this process
variances will emerge that require analysis and explanation. Some of the
variances will highlight your competitive advantages; others will be red
flags marking weaknesses. Many of the variances may be explained by the
stage of your company’s development. New ventures go through a learn-
ing process, which translates into less efficient use of resources early on
(higher expenses). You need to understand why the differences exist.
The first step is to start with your benchmark company’s common-
sized income statement through the use of percentages for all line items.
With the revenue line equaling 100 percent, work your way down the
income statement and express each line (e.g., cost of goods sold, gross
margin, etc.) as a percentage of revenue. We use year five projections for
Lazybones because the early years tend to be more volatile due to rapid
growth. We have identified two good comparables for Lazybones. The