Entrepreneurs have their own ideas about what they want to accomplish financially. Articulate these goals and make sure that your business partners share your goals and your investors or lenders understand and support your goals.
Here are some general frameworks for financial goals:
External investors plus exit (Classic).
You’ll accept investments from a variety of sources, most likely angel investors and/or venture capitalists. You’ll ramp up revenues and profits and plan an exit strategy in which your external investors can achieve a great return based on an IPO or acquisition.
During execution, you need to focus on revenue growth and profit, and finding sustainable sales growth independent of cash infusions from lenders or investors. The value of the company upon the liquidity event will be based on a combination of trailing financial performance and future (leading financials) earnings potential.
External investors plus exit (Proof of Concept Only).
You’ll accept investments from a variety of sources, most likely angel investors and/or venture capitalists. You’ll perform research and development to prove a concept and plan to be acquired by a company that wants to commercialize that concept for which you have reduced the risk.
Upon acquisition, external investors can achieve a great return. Notice that you may not have necessarily achieved any revenue or profit prior to acquisition.
This approach works in only a few industries, e.g., pharmaceuticals, although it has occasionally worked in industries where “eyeballs” (i.e., having many visitors to your website, not necessarily generating revenues, let alone profit) could be seen by acquirers as potential sources for future revenue.
Two great examples are Corus Pharma and Instagram. Corus Pharma was acquired by Gilead Sciences in 2006 for $365 million, based on terrific proofs of concept for two new drugs, although it had effectively zero revenue.
Instagram was acquired by Facebook in 2012 for $1 billion, based on its “eyeballs,” although it had effectively zero revenue.
This is usually a highly risky “plan” for a business. Although such companies make headlines, so do lottery winners.
External investors with income.
You’ll accept investments from non-traditional investors. You’ll ramp up revenues and profits and distribute profits annually to the investors who can achieve great returns in the form of income.
This tends to be appealing to “non-traditional” investors because neither angels nor venture capitalists are commonly interested in income-producing deals. Friends and families might be. During execution you need to focus on profits.
Your plan is to grow and achieve enough cash from the company so you can support your family. You may or may not accept loans, but if you do, you plan to pay them back with interest. There is no “exit.” During execution, you need to focus on cash generation.
External investors with MBO (Management Buyout).
I see quite a few inexperienced entrepreneurs put together business plans that call for this option.
They really don’t want investors as business partners. Investors are simply a short-term source of capital, a necessary evil; not business partners.
Typically, their business plans are highly optimistic and generate huge amounts of cash, so their plan is to buy out the investors and get rid of them.
This framework has a few problems:
(a) First of all, this is not a management buyout; this is a stock repurchase. The “proposal” calls for the company’s cash to purchase the investors’ stock, not thefounders’ cash.
(b) Second, if the company is doing extremely well, the investors likely want to be part of the action, and they have a vote! Of course, if they want to exit, and you don’t want to exit, there is a mismatch in objectives and the right thing to do is to help the investors exit, but that’s not something you’d plan to do from inception!
(c) Third, rarely do new entrepreneurs appreciate how much uncontrolled risk external investors are taking, and thus how much return they expect (and deserve). If the company is doing extremely well, they want big returns.
(d) Fourth, in all likelihood, the company will not be creating as much cash as the plan calls for. In fact, a responsible company reinvests its cash into ongoing operations to insure future growth; it doesn’t hoard its cash.
Obviously, it is also possible to combine various elements of the above. Your company can achieve financial success if it is on the path toward accomplishing any of the above five scenarios. Make sure that you understand what you are trying to achieve and make sure that all your business partners understand and have compatible goals as well.