t e a / ~ , n i l ~ f o 6 ectiv e ·· C i § t & ~ · Ma.c/itz-y- th-iJ· e-h-apte-'1-, po u ;h-oulcl !Je u-6/e to: 1 Explain the difference between human capital and social capital and indicate why the founding team of new ventures should be high in both. 2 Explain why it is often better for entrepreneurs to work with cofounders who have different experience, training, and skills than they do, rather than cofounders who are similar to themselves in these respects. 3 Describe a ne w venture's board of directors and explain ho w this board can assist the founding team. Describe other sources of help and guidance for the founding team; be sure to include boards of advisers, employees, investors, consultants, and government programs. 4 Explain why a growing number of employees is not necessarily a sign that a new venture is successful. 5 Explain why it is useful for cofounders to have clearly defined roles in their new venture. 6 Define the self-serving bias and explain ho w it plays an important role in perceived fairness. 7 Explain the difference between constructive and destructive criticism. 8 Define stress and describe several techniques entrepreneurs can use to reduce stress and its adverse effects. 135
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nlt's usually best to choose partners
similar to yourself •.. "
lt is a basic fact of life that people feel most
comfortable with, and tend to like, others who
are similar to themselves in various ways. ln fact,
a !arge body of research evidence points to two
intriguing conclusions regarding the appeal of
similarity: (1) almost any kind of similarity will
do-similarity with respect to attitudes and
values, demographic factors such as age,
gender, occupation, or ethnic background,
shared interests-almost anything; and (2) such
effects are both general and strong. For in
stance, research shows that similarity influ
ences the outcomes of employment Interviews
and performance ratings: ln general, the more
similar job applicants are to those who interview
them, the more likely they are to be hired.
Correspondingly, the more similar employ-
ees are to their managers, the higher the
ratings they receive from them.17
You can
probably guess why similarity is so appeal-
ing: When people are alike on variousdimensions, they are more comfortable in
each other's presence, feel that they know
each other better, and are more confident
that they will be able to predict each others'
future reactions and behavior. ln short, every
thing else being equal, we tend to associate
with, choose as friends or cofounders, and
even marry people who are similar to ourselves
in many respects.
Entrepreneurs are definitely no exception
to this similarity-leads-to-liking rufe. ln fact,
most tend to select people whosc back
ground, training, and experience are highly
similar to their own. This is far from surprising:
people from similar backgrounds "speak the
same language"-they can converse more
readily and smoothly than individuals from
distinctly different backgrounds; and often,
they already know one another because they
have attended the same schools or worked
for the same companies. The Overall result is
that many new ventures are started by teams
of entrepreneurs from the same fields or occu-
pations: Engineers tend to work with engineers;
entrepreneurs with a marketing or sales back
gmund tend to work with others from these fields;scientists tend to work with other scientists, and
so on (see Figure 5.4).
ln one sense, this tendency is an important
"plus": As we'll notein a later section, effective
communication is a key ingredient in good
working relations. So the fact that "birds of a
feather tend to flock together" in starting new
ventures offers obvious advantages. Further,
recent findings16
indicate that in new ventures
and especially ones that are truly doing some
thing new and innovative-similarity between
team members can contribute to successful
performance.
On the debit side of the ledger, however,
the tendency for entrepreneurs to choose
Figure 5.4
Similarity in Founding Teams of Entrepreneurs
Because people find it more pleasant and comfortable
to work with others who are simi/ar to themse/ves,
teams of entrepreneurs often consist of individualswith similar background, training, and experience.
board of directors and explainhow this board can a.ssist the
founding team. Describe other
sources of help and guidance
for the founding team; be sure
to include boards of.advisers,
employees, investors, consultants,
and government programs.
Beyond the Faunding Team:
Board of Directors, Key Employees,
AdvisersThe founding team plays a crucial role in the launch of any new venture-ho·w
could it be otherwise? But although it is important, the founding team is notthe entire story. Almost all new \'entures-and especially successful ones
"import" \'aluable human resources that supplement those provided by the
founding team. Although these resources come from many different sources,
three of the most important are the board of directors, key employees, and
advisors and consultants. Savvy entrepreneurs draw on these added sources
of knowledge, expertise, and skills and use them to boost their companies into
the fast-growth pattern they seek.
13tJa'zd tJif V i ' l e d o ~ v s -Any new venture that begins as a corporation (see Chapter 8 for a discussionof the legal forms new companies can take) is required by law in many
countries to choose a board of directors-a group of individuals who are
elected by the shareholders in the corporation and have the task of overseeing
the management of the company. Although the duties of such boards vary
(e.g., they appoint officers of the corporation, declare dividends, provide
financial oversight), their main contribution, from the point of entrepreneurs,
is to provide advice and guidance. Wise entrepreneurs choose as board
members individuals who are knowledgeable and experienced in areas
relevant to the·new venture's operations. For instance, returning once again to
Myomatrix, the start-up biotech company, the founders chose for their board
of directors individuals \ovith a rich store of experience in the biotech field-for
instance, the CEO of a much !arger company. Other members of the board
held important positions in local banks or sei1ior positions in nearby
universities. The result? The board of directors could-and did-provide the
founding team with important advice and guidance, input that helped them
make their new venture a success.
In addition, because these well-respected individuals agreed to serve on
the board, Myomatrix gained something eise, too: lt gained reputation and a
sense of legitimacy. After all, why would such prominent people agree tobe
on the board of directors of a small unknown company unless they feit that it
had a promising future? Venture capitalists and other potential investors
certainly reached this conclusion, and the presence of these individuals on
Myomatrix's board helped it to gain the attention of the company thatultimately purchased the young start-up.
Clearly, then, choosing an excellent board of directors is an important way
for new ventures to leverage their human capital-to add to the skills and
knowledge provided by the founding team in \vays that increase the chances
of success.
? Z e c ! U d t i l ~ ~ m p 0 j t M > · New ventures face serious obstacles \Vith respect to attracting outstanding
employees. As new companies, they are relatively unknown to potential
employees and cannot offer the legitimacy or security of established fim1s. Thus,they enter the market for human resources with important disadvantages. Hmv
do start-up companies overcome these difficulties? Largely through the use of
social networks. In other words, they tend to hire people they know either
directly, from personal contact, or indirectly, through recommendations from
(HA PT ER S Assembling the Team: Acquiring and Utilizing Essential Human Capital 143. ·
people they do know and trust19 (see Figure 5.5). This makes a Iot
of sense because unlike larger, established companies, start-up
ventures cannot readily train employees themselves; as a result,
they must obtain them from outside the new firm, and this they
usually accomplish by using their existing networks.Z0
By hiring people they knöw (often, family members, friends,
or individuals with whom they went to school or worked in the
past), entrepreneurs are able to acquire human resources quickly,
without the necessity for lang and costly searches. Second,
because they know the people they hire either directly or
indirectly, entrepreneurs can more easily convince these individ
uals of the value of the opportunity they are pursuing. Third, new
ventures often lack clearly established rules or a well-defined
culture; having direct or indirect ties with new employees
simplifies the task of integrating them into this somewhat loose
and changing structure.
One important reason for hiring people entrepreneurs
already know, directly or indirectly, is that serious errors in
hiring can be devastating for new ventures. Start-up companies
generally have limited resources, and making a bad decisionwastes these limited assets. Moreover, firing employees who
don't work out is always difficult and raises complex legal issues.
This aspect is certainly one reason why entrepreneurs often prefer
to use their social networks for hires, at least initially.
One exception to this general rule occurs when new ventures grow !arge
· enough to require highly experienced management, such as an experienced
CEO or CFO. Recruiting such people is difficult even for !arge companies, and
small ones face an even tougher task in this respect. For this reason, some
entrepreneurs turn to executive search firms that specialize in identifying and
recruiting top-level people. This approach is generally expensive, so it rarely
occurs until start-ups are no Ionger struggling to survive; rather, search firmsare more typically employed after the new venture has become profitable and
when it is growing rapidly.
How should entrepreneurs go about the tasks of recruiting, motivating,
and ultimately retaining excellent employees? We'll cover these topics in
Chapter 12, so here we merely call your attention to the importance of these
tasks that must be carried out successfully if a new venture is to flourish. We
should also mention, however, that a highly skilled workforce is especially
important to new ventures operating in highly dynamic (i.e., rapidly
changing) environments. In contrast, companies operating in more stable
environments or industries can benefit greatly from helping their ernployees
arquire the skills and knowledge they need. In other words, the humanresources practices new ventures adopt should-and often do-reflect thc
kind of industries in which they operateY
Two other issues relating to hiring employees are important and worthy of
mention: Is bigger always better? In other words, is a growing workforce
always a good sign that a new venture is succeeding? And should new
ventures hire temporary or permanent employees? We'll now consider both of
these questions briefly.
ls Bigger Always Better? Number of Employees As a Factorin New Venture Growth
New ventures face many difficult questions as they grow and develop,
but among these, orte of the most complex concerns the number of ernployees
they should hire. Adding employees-expanding the new venture's human
resources-offers obvious advantages. New employees are a source of
information, skills, and energy; further, the more employees a new venture
has, the greater the number and !arger the size of the projects it can undertake.
As we noted earlier, there is little doubt that in many contexts, people working
tagether in a coordinated manner can accomplish far more than individuals
working alone. But adding employees to a new venture has an obvious
downside, too. Employees add to the new venture' s fixed expenses and raise
many complex issues relating to the health and safety of such individuals-
issues that must be carefully considered. In a sense, therefore, expanding t h ~ company's workforce is a two-edged sword and the results of expanding thenurnber of employees can truly be rnixed in nature.
Overall, however, existing evidence suggests that on balance, the benefits
of increasing the nurnber of employees outweigh the costs. New ventures that
_start with more employees have a greater chance of surviving than ones that
begin with a smaller number.22 Similarly, companies with more employees
have higher rates of growth.than ones with fewer employees.23 Profitability,
too, is positively related to the size of new ventures. For example, the greater
the nurnber of employees, the !arger the earnings of new ventures, and the
greater the income generated by them for their founders.24
We should quickly note that these findings are all correlational in nature:
They indicate that number of employees is related in a positive rnanner toseveral measures of new ventures' success. They do not, however, indicate
that hiring new employees causes such success. In fact, both nurnber of
employees and various measures of financial success may stern from other,
underlying factors, such as the quality of the opportunity being developed,
commitrnent and talent of the founding team, and even general economic
conditions (i t is often easier to hire good employees at reasonable cost when
the economy is weak than when it is strong). So the relationship between new
venture size (number of employees) and new venture success should be
approached with a degree-of caution. Still, it seerns clear that to the extent
human resources are a key ingredient in the success of start-up cornpanies, the
!arger their workforce, the greater their success is likely to be.
Temporary or Permanent Employees? Commitment Versus Cost
Achieving an appropriate balance between costs and numbers of new
employees is not the only issue facing new ventures where expanding their
workforces is concerned. In addition, they must determine whether new
employees should be hired on a temporary or permanent basis. Again, both
strategies offer advantages and disadvantages. Temporary employees reduce
fixed costs and provide for a great deal of flexibility; they can be hired and
released as the fortunes of the venture dictate. Further, hiring temporary
employees perrnits the new venture to secure specialized knowledge or skills
that may be required for a spedfic project. When the project is completed, the
temporary employees depart, thus reducing costs.On the other hand, there are several ciisadvantages associated with
ternporary employees. First, they may Iack the commitrnent and motivation of
permanent employees. After all, they know that they have been hired on a
contract basis for a specified period of time (although this contract can often be
extended), so they have little feeling of commitrnent to the new venture: In a
sense, they are visitors, not permanent residents. Companies also face the real
risk that temporary employees will acquire valuable knowledge about the
company or its opportunity and then carry this information to potential
competitors. Permanent employees, in contrast, tend to be more strongly
-committed and motivated with respect to the new venture, and are less likely
to leave-especially if they gain an equity stake in the company. _Overall, then, the choice between temporary and permanent employees is
a difficult one. Which is preferable seems to depend, to a !arge extent, on
specific conditions faced by a new venture, such as the industry in which it
operates or the opportunity it is attempting to exploit. In situations where
CHA P' T F.. R 5 Assembling the Team: Acquiring and Utilizing Essential Human Capital 145
flexibility and speed of acquiring new sets of knowl
edge and expertise are crucial (e.g., arnong software
start-up companies), temporary employees may be
beneficial.25In situations where employee commit
ment and retention are more important (e.g., employ
ees rapidly acquire skills and knowledge that increase
their value to the new venture), then focusing on a
permanent workforce may be preferable.26
1 3 ~ a u t tJj acmiJ&v>-
Corporations are required to have boards of directors,
but no company is required to have a board of
advisers-a group of experts who are invited by a
company's managers to provide advice and input on a
regular basis (see Figure 5.6). Although not a legal
requirement, appointing a board of advisers is increas-
ingly popular among entrepreneurs. Why? Because doing so allows the new
venture and its founding tearn to draw upon the expertise and knowledge of
experienced individuals. Additionally, many experienced and prominent
people are more willing to serve in this relatively informal role than in the
more formal one specified by being on a board of directors.
Entrepreneurs interact with boards of advisers in different ways, but
typically, they rneet with thern several times a year to seek their advice and
guidance. Face-to-face rneetings are not always necessary; teleconferencing or
Internet connections can sometimes be sufficient. However they contact their
advisers, the basic principle for entrepreneurs rernains the same: Choose
people for this role who can really help. In other words, select ones who have
experience in the industry or rnarket where the new venture operates, who
have specific skills the founding team Iacks, and who are well-respected in
their various cornmunities. How can new ventures attract the help of suchindividuals? Generally, not by paying them in cash; the financial resources of
new ventures are usually too limited for this, and potential advisory board
rnernbers would often be very expensive if they were recruited in this manner.
Instead, such people agree to serve as advisers because they have intrinsic
interest in the business of the new cornpany, andin return for alternate forms
of compensation, such as shares in the new venture. However they are
recruited, their help can be invaluable and wise entrepreneurswill generally
seek it out.
S ' t w e > t t J ' V ~ c ~ n ~ atzet ~ v & l t l l r l & l i P ' t t J ~ y In addition to help from a board of directors and a board of advisers,
entrepreneurs can also often benefit from input provided by several other
sources. First, of course, investors have a real stake in the start-up ventures
they finance: They want thern to succeed and are often willing to provide
advice, assist in hiring key ernployees, and assist entrepreneurs in rnaking
key business contacts. This is hardly surprising; After putting their money
fnto a new venture, investors often rnonitor it closely and require detailed
reports from the entrepreneurs. This often Ieads thern to recognize when
things are not going well, and to intervene in various ways to irnprove the
situation.
In addition, entrepreneurs can sornetirnes obtain help from consultants,experts in various fields or areas whorn they hire for specific fees. For
instance, rather than hire their own accountants, entrepreneurs often prefer
to hire such help as needed. Similarly, they hire specia1ists in production or
engineering to help solve problerns relating to these areas. The same may
Figure 5.6
Boards of Advisers: Help from
the Experts
A growing number of new ventures
are appointing boards of advisers-groups of peop/e with skil/s, knowl-
edge, and experience relevant to
the company's business. New ven-
tures are not /egally required to
appoint such boards, but manyentrepreneurs recognize their value
and are estab/ishing them in orderto benefit from the help these ·
CHAPTER 5 Assembling the Team: Acquiring and Utilizing Essential Human Capital 147
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.. through ~ J t e n t 1 0 0 to nonverbal cues-
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ofteri frequeritly revealed by certain a s p c ~ t s of eye .cönfact. ·People \fo/hö are lying. often -.
blink m i , m ~ öften and -show pupils that a r ~ möre dil?ted thari someone. who is telfing
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_low leyel of eye contact or-surprisingly-.--an· \1nuiualiy high one, as they aftempt fo fake
C HA PT ER 5 Assembling the Team: Acquiring and Utilizing Essential Human Capital 149
true for new ventures: Assembling the necessary human capital-an
appropriate pool of knowledge, experience, skills, and abilities-is only
the beginning. The people who constitute the founding team must then
work tagether in an effective manner if the new ·venture is to succeed.
Unfortunately, this key point is often overlooked or given insufficient
attention by entrepreneurs. They are so focused on the opportunity they
identified and hope to develop that they pay scant attention to building
strong working relationships with one another-working relationships that
help the new venture to utilize its human capital to the fullest. Growing
evidence suggests that such relationships are an essential ingredient in new
ventures' success.27
For instance, in one recent study of 70 new ventures,
higher Ievels of cohesion among thefounding team (positive feelings toward
one another) were stron&ly associated with superior financial performance
by these new ventures.Z In view of such evidence, a key question arises:
How can strong working relationships between founding team members be
encouraged? Although this question has no simple answer, three factors
appear to play a crucial role: a clear initial assignment of roles (responsibilities
and authority) for all founders and other team members; careful attention
to the basic issue of perceived fairness; and developing effective patterns
and styles of communication (especially with resped to feedback) among
team members.
A major source of conflict in many organizations is uncertainty concerning two
issues: responsibility and jurisdiction. Disagreements-sometimes harsh and
angry ones---often develop over the question of who is supposed to be
accountable for what (responsibility), and over the question of who has the
authority to make decisions and choose among alternative courses of action
(jurisdictlon).Z9One effective way of avoiding such problems is through a clear
definition of roles-the set of behaviors or actions that individuals occupyingspecific positions within a group are expected to perform, and the authority or
jurisdiction they will wield. Once established, clear roles can be very useful.
For instance, consider once again the successful biotech company we
described earlier-Myomatrix. (We continue to refer to this company because
it illustrates so many principles we believe to be important.) The cofounders
had an almost perfect mix of skills and experience---one was an M.D. and the
other held a Ph.D. and an MBA. Seeking to build on this key advantage, they
negotiated clear and distinct roles for each to play. The physician ran the
laboratory and se t the direction for many of the company's research projects;
after all, he had detailed knowledge of the diseases for which Myomatrix was
seeking new drugs and treatments. The other founder, in contrast, handled
many of the business-related aspects of the company-everything from
maintaining required records through seenring new capital. Both contributed
to the scientific and research activities of Myomatrix. Because these roles
were discussed arid arranged even before the company was launched, the
cofounders could truly work in a complementary manner, with each providing
valuable contributions for the company. This, we suggest, was one ingredient
in Myomatrix's success.
The lesson is clear: Once the founding team has come tagether to form the
new venture, its members should. divide key responsibilities and authority
between them in accordance with each founder' s expertise and knowledge.
Anything eise may weil prove costly and detract from the new venture's
success. This sounds very simple, but the factisthat many entrepreneurs are
highly energetic, capable people, used to "running the show'' in their own
lives. Unless they can learn to coordinate with their cofounders, though, they
may run the risk of seriously weakening their own companies.
learningobjective 6Define the self-se_rving bias and
explain how it plays an impor-
tant role in perceived fairness.
A Note on Role Conflict
AB we just stated, it is important for entrepreneurs to establish clear-cut roles
for all cofounders in order to facilitate coordination between them and to
maximize the value of the new venture's human capital. But entrepreneurs,
like everyone eise, have roles outside their companies as well as within them.
For instance, they may be spouses, significant others, or parents; and they are
certainly sons and daughters to their own parent:S. A dassie finding in the field
of human resource management is that the roles all of us hold sometimes make
incompatible demands upon us. In other words, we experience role conflict-
contrasting expectations about behavior and responsibilities held by different
groups of individuals.30
Spouses and significant others, for example, expect us to
be areund to fill their emotional needs at least some of the time; similarly, children
have legitimate expectations for their parents. So dealing with role conflict can be a
stressful task-and a difficult jugglingact-for entrepreneurs who must devote so
much of their time to running their new ventures. Role conflict can be a serious
matter with important consequences; if the significant people in entrepreneurs'
lives cannot come to terms with the heavy demands on the entrepreneurs' time
and energies, serious interpersonal problems can result. These issues, in turn, can
add to entrepreneurs' stress and reduce their overall performance. Clearly, then,getting one's spouse, significant others, children, and other family members "on
board" is a task no entrepreneur can afford to overlook.
P&tceived 'FaPzM5-5-: an ~ l u w e l3ut 85&liid
CtJtnpotWd
Try this simple exercise: Think back over your life and remernher a specific
occasion when you worked with others on some project. The context is
unimportant-it can be any kind of project you wish-but try to recall an
incident in which the outcome was positive and the project was a success.Now, divide 100 points between yourself and your partners according to how
!arge a contribution each person made to the project. Next comes the key
question: How did you divide the points? If you are like most people, you
probably gave yourself more points than your partners. (For example, if you
had one partner, you took more than SO points; if you had three, you took
more than 33.3 points, and so on.)
Now, by way of contrast, try to recall another incident-one in which you
also worked with partners, but in which the outcome was negative and the
project failed. Once again divide 100 points between yourself and your partners
according to how large a contribution each person made to the project and its
outcome. In this case, you may weil have given others more points than yourself;
in other words, you held them, not yourself, responsible for the negative results.
If you showed this pattern, wekome to the dub: You are demonstrating a
powerful human tendency known as the self-serving bias. This is the tendency to
attribute successful outcomes largely to internal causes (our own efforts, talents,
or abilities) but unsuccessful ones Iargely to external causes (e.g., the failings or
negligence of others, factors beyend our control).31 This bias has been found to
be a strong one, with serious implications for any situation in which people
work together to achieve important goals. Specifically, it often Ieads all those
involved to conclu.de that somehow they have not been treated fairly. Why?
Because each participant in the relationship tends to emphasize her or his own
contributions and minimize the contributions of others, so they conclude that
they are receiving less of the available rewards than is justified. Further,
because each person has the same perception, the resul t is often friction and
conflict between the individuals involved.
In other words, this tendency raises complex questions relating to
perceived fairness-a key issue for entrepreneurs. Because of the self-serving
CHArTER 5 Assembling the Team: Acquiring and Utilizing Essential Human Capital 151
.:,:
Figure 5.9 The Self-Serving Bias and Perceived Unfaimess
Because most individuals have a strong tendency to perceive their contributions to any r e l a t i o n s h i p ' ~ l ' & t ~ e f ; i:han they are, they also
tend to perceive that theyare receiving a smatler share ofavailable rewards than is appropriate. tn oiher words, they conclude that theyare being treated unfair/y. This can be a serious problern for founding teams of entrepreneurs.
bias (plus other factors, too), we all have a tendency to assume that we are
receiving less than we deserve in alrnost any situatiön.In
other words, weperceive that the balance between what we contribute and what we receive is ,
less favorable than it is for other persons. In specific terrns, we perceive that
the ratio between what we are receivin.g and what we are contributing is srnaller
than that for others. In general, we prefer that this ratio follow the general
principle of distributive justice (also known as equity), which suggests that the
larger any person's contributions, the larger her or his rewards. Most people
accept this principle as valid, bu t the self-serving bias Ieads us to cognitively
inflate our own contributions-and hence to conclude that in fact, we are not
being treated fairly (see Figure 5.9).
What do people do when they perceive that the distribution of rewards is
unfair? Generally, they react in a variety of ways, none of which are benefidal to a
new venture. The rnost obvious tactlc is to dernand a larger share; but if others do
not view these demands as legitirnate, conflict is the likely outcorne. Another
approach is to reduce one's contributions-to reduce effort or shirk responsibility.
This, too, can be very harmful to the success of a new venture. An even rnore
darnaging reaction is to withdraw-either physically or psychologically. Dis
aifeeted cofounders sometirnes pull out of new ventures, taking their experience,
knowledge, and skills with them. If they are essential mernbers of the team, their
departure can mark the beginning of the end for the ventures in question.
All these possibilities are bad enough, but even worse is the fact that
people tend to focus relatively little attention on the issue of fairness when
things are going weil (e.g., they are getting along weil with their cofounders),
but they devote increasing attention to this issue when things begin to gobadly.32
In short, when a new venture is succeeding and reaching its goals,
members of the founding team rnay show little concem over distributive justice.
If things go badly, however, they begin to focus increasing attention on this
issue-thus intensifying this source of interpersonal friction.
Given the existence of this cycle, it is truly crucial for the founding teams
of new ventures to consider the issue of perceived faimess very carefully. This
iinplies that they should discuss this issue regularly to assure that as roles,
responsibilities, an d contributions to the new venture change (which they will
inevitably do over time), adjustments are made with respect to equity, status,
and other rewards in order to reflect these changes. This is a difficult task since
all members will tend to accentuate their own contributions (recall the powerfulself-serving bias). But since the alternative is the very real risk of tension and
conflict between the fotmding tearn rnernbers, and since conflict is often a major
waste of time and e n e r ~ it is certainly a task worth performing well-and one
that will help the new venture utilize its human resotirces to the fullest.
Source: United Feature Syndicate, December 29, 1999.
Figure 5.10 Fairness: An lmportant lssue for Entrepreneurs, Investors and Everyone Else
Do you think this exchange is fair? Probably not! Although Dogbert provides the executives shown here with something
(e.g., experience in being cheated), few people would view this situation as fair. in fact, perceived fairness is a key issue in virtua/lya/1 working relationships, including those between cofounders of new ventures, founders and employees, and the new venture
and its customers.
One more point: Issues of faimess arise not only between cofounders, but
also between investors and entrepreneurs, between founders of a new venture
and their employees, and in fact, in all working relationships. For instance,
take a look at the situation shown in Figure 5.10. In it, one character seems to
be taking unfair advantage of another, which, as you probably know from
your own experience, can set the stage for major problems.
Issues of fairness also arise when companies form business alliances.
As we'll note in Chapter 10, such alliances can often be extremely helpful
to new ventures, but in order to survive, they must be perceived as fair
and mutually beneficial by both sides. Here's one example of a successful
alliance. 8minuteDating is a cornpany with an idea that has taken the
matchmaking industry by storm. At 8minuteDating events, single men and
warnen gather at a restaurant, chat in couples for eight minutes, and then
move on to the next table, where they meet another person (see Figure 5.11).
Figure 5.11 Fairness: A Key Principle in Business Alliances
Business alliances canbe highly
beneficialto
entrepreneurs,but
inorder
to
succeed, bothsides
mustperceive
themas fair and as
yieldingreal benefits. This is definitely the case for the alliance between BminuteDating and TP/, lnc. BminuteDating encourages people
pqrticipating in its dating events to check out the personal columns, and TPI promotes BminuteDating e v e n t ~ in the personal columns it
CHA PT ER. 5 Assembling the Team: Acquiring and Utilizing Essential Human Capital 153
This format allows each person participating in the event to meet many
potential partners in one evening instead of just one, as is true in traditional
dating. After the event is over, couples who have expressed liking for each
other can meet again. Recently, 8minuteDating formed an alliance with Tele
Publishing International (TPI)-a company that runs the personalad pages
for 550 newspapers in the United States. How did this alliance come about?
The faunder of 8minuteDating, Tom Jafee, learned that Adam Segal, an
executive with TPI, was having dinner with his mother at a restaurant where
an 8minuteDating event was being held. Jafee introduced hirnself and the
two entrepreneurs quickly realized that they could form a mutually
beneficial alliance: TPI would advertise 8minuteDating in its personal
columns, and 8minuteDating events would distribute free coupans and
sponsor other promotions to encourage its customers to try the personal ads.
The alliance worked like a charm, and both companies benefited consider
ably. Both see it as fair, and as helping them to attain their major goals. As
Segal puts it, "The beauty of our alliance is that it can expand with
8minuteDating's growth. Every time they start events in a new city, TPI will
already be there with our personal ads in the newspapers. Talk about a
match made in heaven." So i f you consider forming an alliance with another
company, please do devote careful attention to the question of fairness:Alliances that are not perceived as meeting this essential criterion areunlikely to survive.
~ § t e c t i v e C()tnJnMiui.tMtt
Perceived unfairness is not the only cause of costly conflicts between membersoLa new venture' s founding team. Another major factor involves faulty styles
ofcommunication. Unfortunately, individuals often communicate with others
in a way that angers or annoys the recipients, even when it is not their
intention to do so. This situation arises in many different ways, but one of the
most common-and important-involves delivering feedback, especiallynegative feedback, in an inappropriate manner. In essence, the only truly
rational reason for delivering negative feedback to another person is to help
this person improve. Yet, people often deliver negative feedback for other
reasons, such as to put the recipient in his or her "place," to cause this person
to lose face in front of others, to express anger and hostility, and so on. The
result of such negative feedback is that the recipient experiences anger or
humiliation, which can be the basis for smoldering resentrnent and Iang
lasting grudges.34 When negative feedback is delivered in an informal context,
rather than formally (e.g., as part of a written performance review), it is known
as criticism, and research findings suggest that such feedback can take two
distinct forms: constructive criticism, which is truly designed to help. the
recipient improve, and destructive criticism, which is perceived-rightly so-as
a form of hostility or attack.
What makes criticism constructive or destructive in nature? Key differ
ences are outlined in Table 5.1. As you can see from this table, constructive
criticism is considerate of the recipient's feelings, does not contain threats, is
timely (occurs at an appropriate point in time), does not attribute blame to the
recipient, is spedfic in content, and offers concrete suggestions for improve
ment. Destructive criticism, in cont;rast, is harsh, contains threats, is not timely,
blames the recipient for negative outcomes, is not specific in content, and offers
no concrete ideas for improvement. Table 5.1 also provides examples of each
type of criticism.
Research findings indicate that destructive criticism is truly destructive: It
generates strong negative reactions in recipients, and can initiate a vicious
cycle of anger, the desire for revenge, and subsequent conflict. In other words,
it tends to generate what is known as affective or emotional conflict-conflict
Tab(e 5.1 Constructive versus Destrcutive Criticism
As shown here, constructive criticism is negative feedback that can actuatly he(p the recipient improve. Destructive criticism, in contrast,
is far tess likety to produce such beneficiat effects.
Considerate-protects self-esteem
of recipients
Does not contain threats
limely -occur s as soon as possible
after the poor or inadequateperformance
Does not attribute poorperformance to intemaf causes
Specific-focuses on aspects ofperformance that were inadequate
Focuses on performance,not the recipient
Offers concrete suggestionsfor improvement
lnconsiderate-harsh, sarcastic,biting
Contains Ihreals
Not timely-occurs after an
inappropriate delay
Attributes poor performanceto intemal causes
General-a sweepingcondemnation of performance
Focuses on the recipient
Does not offer concretesuggestions for improvement
Constructive: "I was disappointed in your performance."
Destructive: "What a rotten, lousy job!"
Constructive: "I !hink improvement is really important.". Destructive: "l f you don't improve, you are history!"
Constructive: "You made several errors in today's report."
Destructive: "l've been meaning to tell about the errors
you made last year . .. "
Constructive: "I know that a Iot of factors probably played a role
in your performance."Destructive: "You failed because you just don't give a damn!"
Constructive: ''The main problern was that the project was Iaie."Destructive: "You did a r ~ l l y tenibfe job."
Constructive: "Your performance was not what I expected."
Destructive: "You are a rotten performerl"
Constructive: "Here's how I think you can do better nexttime areund . _ "Destructive: "You better work on doing better!"
that is based largely an negative emotions. Such conflict can be costly for any
working relationship and can truly disrupt relations between founding team
rnembers.35 In contrast, another kind of conflict that is focused an rational
disagreernents over ideas or strategies-cognitive conflict-can actually be
beneficial, because it Ieads to careful discussion of points of disagreement.
Once again, the basic message for entrepreneurs is clear: Effective
comrnunication between cofounders is one essential ingredient in establish
lng and maintaining effective working relationships. If i t is lacking, serious
problerns may result. For instance, consider a new venture started by
partners who have divergent training and experience: one is an engineer and
the other has a background in marketing. Although the marketing cofounder
selected his partner carefully, he harbors negative feelings about engineers
(''They never think about people!"). As a result, he criticizes the engineer's
designs for new products very harshly. The engineer, offended by this
treatment, begins to make changes in the company's products without
informing the cofounder. Because the marketing entrepreneur doesn't know
about these changes, he can't get customer input before they are made. The
result? The cornpany's products "bomb" in the rnarketplace, and soon the new
venture is in deep trouble. This is just one example of how faulty comm'unication between mernbers of the founding tearn can produce disastraus effects.
The rnain point should be clear: Strang efforts to attain good, constructive
communication bctwccn co-fow1ders are very worthwhile.
One final point: Is all conflict between founding co-founders bad?
Absolutely not. Conflict between tearn rnernbers can, if it is focused on
specific issues rather than personalities, and is held within rational bounds, be
very useful. Such "rational" conflict can help to focus attention an important
issues, rnotivate both sides to understand each others' view more clearly, and
can, by encouraging both sides to carefully consider all assurnptions, lead to
better decisions.36In surn, conflict between founding team mernbers is not
necessariiy a bad thing. Rather, it-like all other aspects of the new venture'sopetations-should be carefully rnanaged so that benefits are rnaximized and
costs minimized. Overall, strong and effective working relationships between
founding mernbers are a powerful asset to any new venture, so efforts to foster
thern should be high an every founding team' s "Must Da" list.
CHA PT ER 7 Writing an Effective Business Plan: Building a Roadmap to Success 205
There is a real magic in enthusiasm. lt spells the difference between
mediocrity and accomplishment.
Whether they realize it or not, most entrepreneurs accept
these words as true. They are convinced that because
they believe passionately in their ideas and their new
ventures, others will too. As a result, they are often
dismayed when their initial efforts to obtain financial
backing meet with lukewarm receptions {or worse!) from
venture capitalists, business angels, and others who can,
if they wish, provide the resources the entrepreneurs
need. "What's wrang with these people?" they wonder.
"Can't they recognize a great thing when they see it?"
The problem, of course, may not be a Iack of good
judgment on the part of potential investors. Rather, it mayhave much more to do with the kind of job the
entrepreneur is doing in presenting her or his idea to
others. Yes, the entrepreneur is enthusiastic, and enthu
siasm does indeed sell. But in order to induce other
people-especially ones who have been taught by years
of experience to view new ventures with caution,
enthusiasm alone is not enough. ln addition, entrepre
neurs who want to succeed must realize that they face a
serious and tough task, one centered araund the process
of persuasion-the task of inducing others to share our
views and to see the world much as we do. After all, why
should total strangers hand over their hard-earned money
to something as risky in nature as a new venture,
-Norman Vincent Peale (1961)
especially if it is going to be run by someone who .has
had little if any experience in starfing .or running a. . . . ·.
business? Would you? We_ doubt iU:
lf enthusiasm alone is nokeno«gh, t h e ~ w h ~ ! can ,
entrepreneurs do to gain the r e ~ q ~ r c e s they n e ~ d ? For ·
many entrepreneurs, a Jarge ·pB.rtof the a n s w ~ r : i 1 1 : v q l ~ e $ .preparing a truly first-rate .b.Lisiness plan. This f Ö t r n ~ l ; ·written expression of the entrepreneur's vlsion···for
converting opportunities into äprofrtable, g o i n g ~ & s i n E 3 s S is, in most cases, the entry card for s e r i o u s c o r i s i d e r ~ t i o n by venture capitalists, banks, and other sources of
funding: Most won't even think about supporting a newventure until they have seen, and carefully evaluated, this
document. This basic fact poses something of a dilemma
for many entrepreneurs: They firmly believe in their ideas
and their own ability to carry them through to success,
but at the same time, they have had little practice in
writing formal documents such as business plans. ln fact,
unless they have a background in business {which is true
of only some entrepreneurs), they may not even have a
clear idea about what a business plan is or what it should
contain. The result? Many do not prepare such plans; in
fact statistics show that more than 60 percent of small,
new companies have no business plan-or no written
plans of any kind, for that matter.1
And that brings us to the main purpose of this chapter: helping you
understand what a business plan is and how to write a good one-one that
will assist you in attaining the support you need, financial and otherwise. Inorder to reach this gual, we'll pruceeu as fulluws. First, we'll examine the
question of why you should write a business plan, even if you are in the rare
and truly glorious position of not needing financial support to get started. As
wc'll soon note, preparing this document can be helpful in several important
ways. It can help entrepreneurs develop better plans for converting their
ideas and vision into reality-a viable, profitable company. And it can
certainly play a role in obtaining financial support. Whether having a strong
business plan is a good predictor of ultimate success, however, is a more
complex question, which we'll examine carefully in a Qualifying Common
Sense section later in this chapter?
Putting this important issue aside for the moment, we'll turn nextto
the taskof describing business plans in detail-the key sections they should contain,
how they should be put together, and so on. Throughout this discussion, we'll
do more than just describe the basic requirements; we'll also provide you with
suggestions for making your plan excellent-an instrument for transmitting
your own enthusiasm and vision clearly to others. We think this is crucial
information that will serve you weil as you move toward starting your own
venture.
After describing the major sections of a formal business plan, we'll turn
to another key question: How do VCs and other potential investors actually
evaluate them? In other words, how do these individuals, so crucial to the
future of almost any new venture, decide whether to provide the financial
resources sought by entrepreneurs (see Figure 7.1)? The answer, as we'll
soon see, contains some surprises. But in fact, you should not be surprised by
what research on this topic has found because, as we've seen in earlier
chapters, human thought-including decision making by experts-is rarely
entirely rational. .a:
Finally, we'll return to a key theme we wish to emphasize throughout this
E chapter: Persuasion is, indeed, the name of the game where starting a new..
. venture is concerned. For that reason, writing an excellent business plan,
g while certainly a crucial activity, is only the first step in a !arger process.ülo Persuading other people to support your new venture involves several other
steps as weil.· For instance, i f your plan is one that generates initial positive
reactions on the part of venture capitalists and other investors to whom yousend it (an outcome achieved by only a few percent of all plans) this may Iead
to the next step: an invitation for you to visit and make a formal presentation.
This presentation often plays an important role in decisions about whether to
support your venture, and to what extent, so it is a task you should definitely
take very seriously. How can you "shine" in this context? We'll provide
concrete suggestions for reaching these goals based both on careful research
and our personal experiences as entrepreneurs.
WhyWrite a
BusinessPlan?
Make no mistake: preparing a businessplan involves a Iot of hard work. In
fact, it usuaily requires many hours of careful thought, foilowed by an equal
or !arger number of hours spent converting these thoughts into a written
document. Although university professors may enjoy such activities,
entrepreneurs generaily do not. Often, they are eager to get started-to
launch their business and make their vision happen. And many realize that
once their new venture has been launched, it will rarely follow the steps and
timeline outlined in the business plan. So why should they devote so much
hard work to the task of preparing a first-rate business plan? As we'll now see,
there are two basic reasons. One involves benefits entrepreneurs (the founding
team) can derive from writing such a plan, nncl the other involveti the valuc ofa good businessplan as a means of gaining resources, financial anrl otherwise.
We'll now consider both of these issues.
1 3 ~ ttJ the " [ ; ~ katn: 7he 7/aiue
()j- CieaJv- Cut q o a ~ y Perhaps the simplest yet most important answer to the question, "Why write a
business plan?" is this: l t provides important benefits to the entrepreneurs
themselves. More specifically, a good businessplan is not simply a document
designed to "sell" investors on the entrepreneurs' ideas: It is also adetailed road
map for co!lverting a recognized opportunity into a profitable business. Writing a
business plan requires an entrepreneur to carefully and fully address a
number of complex issues relating to the process of creating an actual
company. A comprehensive business plan describes the opportunity (what
needs the new product or service will meet, what markets it will have), how
C k A P;·!:: R 7 Writing an Effective Business Plan: Building a Roadmap to Success 207
the product or servicewill be produced or delivered, what skills and abilities
the founding team brings to the new venture, how the new company will be
structured, how the new venture will. gain a competitive advantage, what
critical risks it faces, what financial resources it needs, and so on.
In other words, the term plan in ''business plan" is really appropriate:
Writing a carefully prepared and well-reasoned business plan can indeed help
entrepreneurs with the process of planning-it really can provide the roadmap
to success mentionedin
the title of this chapter. More to the point, a wellprepared business plan will explain what the new venture is trying to
accomplish and how it will go about attaining these goals; in other words, it
describes the new venture's business model-how it will actually operate and
how it will, potentially, make a profit. Venture capitalists and others who might
support a new venture often seek this kind of inforrnation. In fact, the more
clearly a business plan explains precisely ho-w the goals sought by the new
venture will be reached, the more impressive (and persuasive) the plan will be.
But remember: Entrepreneurs do not write business plans solely to persuade
others to invest in their new venture. They also write them to provide
themselves with a clearer understanding of the best ways of proceeding. That
guiding outline, in turn, can contribute significantly to the u1tirnate success of
the new venture. In fact, recent findings indicate that carefu1 planning is a key in
the success of new ventures. For instance, at least up to a point, the more time
entrepreneurs spend engaging in guided preparation-planning of research and
other activities performed with the aid of expert advisors prior to start-up-the
greater the success they later attain.3
Clearly, there is an important Iesson in
these findings for entrepreneurs, and they serve to underscore the importance of
the planning aspect of good business plans.
Business Plans: An Alternative Approach
Now, having made these points, we should balance the scales by noting that a
businessplan is a living document, one that can-and perhaps should-change
often as a new business develops. Because entrepreneurs can never know inadvance just how their new businesswill develop, how much planning they can
do is limited. For this reason, successful entrepreneurs often avoid "analysis
paralysis" in which they spend countless hours in the library developing long,
formal business plans with lots of data and assumptions, fancy spreadsheets,
and beautifu1 illustrations. Instead, they do just enough business planning to get
their new companies started, and then use the information that they gather from
actually running their new ventures to refine their plans in the light of reality. In
essence, the successful entrepreneur's business planning model often Iooks
something like this: (1) develop a simple, basic business plan, (2) start the
business, (3) take the inforrnation that is gained from starting and running the
new business and use it to refine the plan and obtain funding as it becomesnecessary. For example, consider Alex D'Arbeloff, faunder of Teradyne, a large
scientific instruments cornpany. When D' Arbelaff founded his company, he
wrote a short business plan only a few pages in length. He assumed he would
derive little benefit from developing a long, detailed business plan made up
mostly of assumptions and analysis of data resting on largely unsupported
assumptions. Rather, it was better to focus on the key pieces of information that
he knew tobe true and get the business started. Then, once the business was up
and running, he revised hisbusinessplan many times, adding new information
as it was acquired. D' Arbeloff' s success as an entrepreneur made him quite
wealthy, and he now works as a business angel who has backed such notable
companies as Lotus. As a business angel, he maintains the same philosophy thathe used when he started his own company: Look for entrepreneurs who have
written simple, Straightforward business plans that focus on key dimensions of
business opportunities and treat their business plans as "living documents"
that change and develop a1ong with their new ventures.
rather than on untestedassumptions.Then they start their businesses and
use the information they gain from
running them to refine their business
plans as weil as to secure additional
funding as needed. The cycle con-
tinues, thus making business plans
true "living documents" that are open
to change in response to new
information
. Prepare a
relatively simplebusiness plan,which can beused 'to obtciin
initiC,ti Fimding.if'
itis needed . ·
Refine. the businessplan on 'the basis of
~ e n c e , 99ined from
r:unnin9. t h e ; b ~ s . i r e s s , ·and lhe r e v i ~ plpn .to c o n d ~ c t . b u s i r i e s s and$ e c u ~ e c : K l e l i t i 9 r i ~ l funding
a . s n ~ ~ s s C J . r y
Coili1nueki
9 r o w i i i ~ · · b u ~ i r i ~ s s , : - ; ·
: P t : ~ ~ ~ d .•
The advantages of this approach are obvious: Entrepreneurs can spend
their time getting their business started rather than on writing a formal business
plan, and thus have something tangible to "sell" when they finally do seek !argeamounts of outside funding to expand their growing businesses (see Figure 7.2
for a summary of the model of business planning we have just described).
So overall, is it better to start with a long, detailed business plan or a
shorter and simpler one? As you can guess, the answer is, "it depends." In
some situations, a long and detailed plan is necessary-for instance, when
!arge amounts of funding are required to Iaunch the new venture or the
market for it is not immediately clear. In others, a shorter and less detailed
plan will suffice-as long as it provides sufficient guidance to get the business
started, and it is changed "on the fly" to reflect new information as it becomes
available. The guiding rule, then, is to always engage in careful preparation
and planning, but to be flexible and to match the form of the business plan youdevelop to the specific needs of your new venture.
13u5irleJ-5- Plans fAy a 70tJt j - t J - ~ o / a i l ~ F i l z a ~ U i a t 5uppt;.1/;
As we already noted, few entrepreneurs enjoy the task of creating a detailed
business plan. And, sad to relate, many don't recognize the value to them
of writing one-they don't appreciate the value of working through many
details involved in launehing and running their new business. In contrast,
CHA PT ER 7 Writing an Effective Business Plan: Building a Roadmap to Success 211
It is sirnply a fact of life: Experienced decision rnakers operate this way in
many business contexts, not just with respect to evaluating business plans. For
instance, research on job interviews indicates that many interviewers m a l < ~ ·
their judgrnent about the suitability of each applicant within aminute or two.5
Why? They sirnply don't have time to waste on applicants who are clearly not
suitable, so they reach a decision about whether to continue the disCU$sion
very early in the process. If their decision is "this person is not suitable," they
conclude the interview quickly. If, instead, they decide "this candidate could .,_ .
be a good employee," they keep it going in order to acquire moreinformation .
The same principle is at work with respect to business plans: becisions are
made quickly by venture capitalists and other potential source8 of funding
and are rarely, if ever, reversed.6 In other words, you rnust begin strong, and ·
continue strong if you want to succeed. And the place where a business plan
begins is the executive summary-the first rnajor cornponent of business plan
and, in sorne ways, the rnost irnportant.
Where will inforrnation for the businessplan corne frorn? The answer, in
part, is frorn the careful feasibility analysis entrepreneurs should perform before
proceeding far into the process (see Chapter 4). This prelirninary work should
provide investors with valuable information about feasibility of the product or
service, the industry in which the new cornpany will operate, potentialmarkets, competitors, and the founding team's ability to run the company. Soin a sense, if entrepreneurs begin as they should, they will have much of the
information they need to write a strong business plan at their fingertips-<>r at
least, they will be close to obtaining this information.
One additional point: We want to ernphasize that, ultirnately, the quality
of the idea behind the new venture and the quality (experience, expertise,
skills) of the individual(s) who put it together are the crucial elements.
Experienced investorswill quickly recognize whether the idea is sound and
has economic potential, no matter how well-written or persuasive the plan
appears tobe. So before you decide to invest large arnounts of time and effort
· nto preparing a super-impressive business plan, you absolutely must getfeedback on the idea behind your new venture. If this response is. not
encouraging, stop right there, because proceeding is alrnost certain to be a
waste of time.
' i h e ~ e t J ~ Have you ever heard the phrase elevator pitch? One of us (Robert Baron) first
became familiar with it while working at a government agency (as a program
director at the National Science Foundation). He observed that many of his
more experienced colleagues went to lunch at a specific time each day and that
theyjockeyed for position in front of the elevator. Why? Because they wantedto stand next to the assistant director--the person who made key tlecisions
about how funds available to this part of the agency would be distributed.
They knew that the director would be standing on the elevator when the door
opened, because her office was on a higher floor. (If she was not, they would
wait for the next elevator and check that one.) On the way down to the street,
they rnade their "elevator pitches"-brief but irnpassioned statements about
the wonderful things going on in their particular areas of science, and why
funding of such work would be a great investment (see Figure 7.4). The
director usually rnade no concrete response, but in a few cases, she could be
heard to rernark, ''That sounds interesting ... make an appointment so we can
discuss it." That statement signified great success because it meant that the
one- or two-minute "pitch" delivered in the elevator had at least opened the
door to further discussions-and the real possibility of additional funding.
The rnoral of such situations is clear: Often, we have just a brief opportunity
to stimulate another person's interest-to get them interested enough to want
CHA PT ER 7 Writing an Effective Business Plan: Building a Roadmap to Success 215
the market for their products and had evidence that the products would gain
acceptance in these markets.
In essence, this section of a new venture's business plan should be
designed to convince skeptical investors that the entrepreneurs have done
their homework: They have examined potential markets for their product or
se!Vice carefully, and have obtained evidence indicating that consumers or
other businesses (depending on the product or service) will actually want to
buy it when it becomes available. Further, investors want to know the specificsof how the new product or service will be promoted, and at what cost. Market
projections are, of course, always uncertain; and no one ever knows for certain
how consumers will react to new products, no matter how carefully they are
market tested. But at the very least, the entrepreneur should have engaged in
appropriate efforts to find out why people will want to buy or use their
product, and to pinpoint an effective marketing strategy for it. If, instead, it is
simply assumed that the product or service is so wonderful that people will
line up to buy it, a loud alarm will sound in the minds of sophisticated
investors, and they will quickly lose interest.
It's not possible to market a new product or service unless it is available, so
two other issues that must be carefully addressed in any effective business
plan are product development and production. Potential investors want informa
tion about where the new venture's products and services are in this process:
Are they still under development? Or are they fully developed and ready to be
manufactured? And i f so, what are the projected costs and tirnetable for ·
making the product or for delivering the service? Related issues include steps
to assure quality and safety for consumers or other users (e.g., has the
company applied for Underwriter's Labaratory Approval or similar certifica
tion?). As one of us (Baron) learned while running his own company, such
processes can require months-and large fees-so investors want to know thatentrepreneurs are aware of these issues and have them weil in hand (see
Figure 7.6).
The further along a start-up company is with respect to these issues, the
more attractive it will be to potential investors-not simply because the
company has developed beyond the initial launch phase, but also because
this progress dernonstrates that it is operating in a productive and rational
manner.
7 h ~ 1 1 1 ~ 'TeaJnMany venture capitalists note that they would rather invest in a first-rateteam with a mediocre idea than a rnediocre team with a first-rate idea.
Although this statement is something of an exaggeration-venture capitalists
and other investors actually tocus on many diHerent issues-it does contain a
substantial grain of truth. What venture capitalists are saying, in essence, is
that talented, experienced, and motivated people at the top of a new venture
are important for its success. For this reason, a key section of any business
plan is the one dealing with the people who will run the new venture.
What, specifically, do potential investors want to know? Primarily that,
taken together, these people have the experience, expertise, skills, and
personal characteristics needed to run the new venture successfully. We say
"taken together," because as we pointed out in Chapter 5, investors want toknow that the rnanagement team has complementary skills, abilities, and
experience; what one member of the founding team lacks, others provide, and
vice versa. Further, they want to be reasonably certain that the members
of the team have developed good working relationships; each has clearly
CHA PT ER 7 Writing an Effective Business Plan: Building a Roadmap to Success 217
lncludes sates as they are generated
lncludes depreciation
lnterest on loans is included
Beginning inventory and ending inventory areincluded in the calculation of cost of goods sold
Shows sales a8 "Cash in" only when ·
payment is received · ·
Depreciation is·added back in because ·
it is not a .cash expense
8oth interest and principal are included
lnventory purchases are recorded as bills ·
when they are actually paid
and timing of further financing and needs för working capital. Many
beginning entrepreneurs are unclear about the difference between income
statements and cash flow statements, so we have highlighted these distinctionsin Table 7.1
Another key part of the financial section-one also discussed in Chapter6 -
~ h o u l d be a breakeven analysis, a table showing the Ievel of sales (and
production) needed to cover all costs. This analysis should include costs thatvary with the Ievel of production (manufacturing, Iabor, materials, sales),
and costs that do not vary with production (interest charges, salaries, rent,
etc.). The breakeven analysis is an important reality check for entrepreneurs,
who often have an overly optimistic view of how quickly their new venture
can become profitable, and it is often examined with considerable care by
potentialinvestors.
Overall, the financial section of the business plan should provide
potential :investors with a clear picture of how the new venture will use
the resources it already has, resources generated by continuing operations,
and resources provided by investors to move toward its financial objectives.
If there is any section in which entrepreneurs should strive to hold theirenthusiasm and optimism in check, this is it: Many investors have learned to
view entrepreneurs' financial projects with a healthy dose of skepticism.
They have seen too many overly optimistic predictions to view the situation
otherwise; in fact, many begin by discounting entrepreneurs ' projections by a
minimum of 50 percent!
C'titicd 7 a ~ 5 - : 1Je5dti61nf 7l/hat 1 1 1 ~ You probably know this saying, known as Murphy's Law: "If anything can go
wrong, it will." And perhaps you know the corollary too: ''Murphy was an
optimist." Entrepreneurs, filled with enthusiasm for their new ventures, are
not thP. most likP-ly candidates on earth to think hard and long about what can
go wrang with respect to their new ventures. On the contrary, they prefer to
focus on the upside and are often genuinely dismayed when things do not go
according to plan. This is one reason why effective business plans should
contain a section specifically focused on what rnight potentially go wrong
critical risks that can prevent the new venture from reaching its key objectives.
Thinking about these risks is 1/good medicine" for entrepreneurs, and formu-
fating ways of responding to thesepotential calarnities before they occur can
be constructive indeed!
What are the potential risks new ventures face? Here is a partial !ist:
l i Price cutting by competitors, who refuse to "roll over and play dead" forthe new venture
"' Unforeseen industry trends that make the new venture's product or
service less desirable-or less marketable than was true initially (see
Figure 7.7 for an example)
· Table 7.1
l n c ~ o m e . Statements and Cash
Aow Statements: Some'Key
D i f f e r ~ n c e s ·As shown here, income statemf!crts
and cash flow statements dirlitt in .severa( importeint respects . .
C HA PT ER 7 Writing an Effective Business Plan: Building a Roadmap to Success 219
be reached. Again, giving careful thought to the question of when various
tasks will be performed or specific goals achieved is useful both for
entrepreneurs and potential investors. Identifying target dates may help
entrepreneurs overcome a powerful cognitive bias known as the planning
fallacy that we described in Chapter 3-the tendency to assume that we can
accomplish more in a given period of time than is really possible.9 Careful
scheduling can serve as important reality check. From the point of view of
investors, it indicates that entreprenet,.ITs are indeed paying attention to theoperations of their company and have developed clear plans for its future
progress. What are these milestones? Included among the most important
are the following:
l l
1!1
il l
Formal incorporation of the new venture (i f it has not already occurred)
Campletion of product or service design
Campletion of prototypes
Hiring of initial personnel (sales or otherwise)
Product display at trade shows
Reaching agreements with distributors and suppliersReaching agreements with corporate partners i f these are desired
companies with whom the new venture will work closely and for mutualbenefit
Moving into actual production
Receipt of initial orders
First sales and deliveries
Profitability
This Iist is just a small sample of the many milestones new ventures can
include in their business plans; many others exist as weil. The important point
is to select milestones that make sense both from the point of view of thecompany's resources and the _industry in which it is located.
Upf?&zdice5-
Because the main body of the plan should be relatively brief-as short as is
adequate for presenting all essential information-several items are best
included in separate appendices. Items typically included are detailed
financial projections and full resumes of the founders and other members of
the top management team. By placing such items in appendices, entrepreneurs
assure that this important information is present for anyone who wishes toexamine it, but at the same time keep the length of the business plan itself
within desirable Iimits.
a 71ote on t1te s ~ l e y What we have described in the preceding section is an outline of the
essentials-the sections that are generally viewed as necessary for any
thorough business plan. What wehaven't addressed, of course, is what might
be termed the intangibles-the extra "something" that Ieads readers of a plan
to drop their slightly jaded attitude and to conclude, perhaps with some
excitement, that sornething here is worth a closer Iook. Because we have bothdone a !arge amount of writing, we believe that such factors as organization,
clarity, choice of words, and style do indeed matter. Unfortunately, no one has
yet been able to draw a bead onhow these factors operate or how you can turn
them to your own advantage. Given the importance of the business plan in the
learningobjective 6Explain how venture capitalists
actually make their decisions
about whether to provide financial
suppo_rt to new ventures.
Figure 7.9
Often, We Do Not Have Full
Understanding of the Factars
That lnfluence Our Decisions
Basic research in cognitive science
indicates that in many cases, we
are not fully aware of alt the
factors that influence our decisions,
or the relative importance of these
factors. Take, for examp/e, the
young woman in this cartoon. Wedoubt that fmancial issues were
real/y the ones that /ed to her
decision.
How VCs Actually Evatuate Business
Plans: ldentifying the Key FactarsEarlier, we noted that a large body of research points to the conclusion that in
making their decisions about whether to offer financial support to nevl' ventures,
VCs and other investors are most influenced by the following factors: (1) thefounding team's capabilities, (2) the attractiveness of the product or service,
(3} potential markets and existing or potential competitors, and (4) potential
returns if the venture is successful. This Information suggests that in preparing
their business plans, entrepreneurs should devotecareful attention to providing
information on these issues. But as you can readily see, even more specific
information on how VC's make their decisions would be more valuable to
entrepreneurs as they prepare a business plan. For instance, what aspects of a
founding team's capabilities are most important to VCs? What factors cause
them to view a product or service as attractive or a potential market as affering
good possibilitiesfor financial retums? In other words, what factors do VCs and
other investors weigh most heavily in making their decisions about newventures? Obviously, this kind · of infom1ation could guide entrepreneurs
seeking financial support frorn investors. Research on this basic question has
yielded some surprising results. In fact, the factors involved are not always the
ones you might expect. For instance, as we saw in Chapter 5, VC's often tend to
give an irnportant "edge" to entrepreneurs who are similar to themselves in
various ways-background, training, professional experience.10
But many other
factors, too, enter the picture, so we need ways of identifying these.
One way to answer this question, of course, is to simply ask VCs and other
investors to describe the criteria they use in evaluating business plans and new
ventures. On the face of it, this is a reasonable way to proceed. In fact, though, there
is a basic problern with this approach. Research in the field of cognitive science
confimlS what you may already know from your own experience: In general, we
are not very good at recognizing or describing the factors that influence our
decisions-especially complex ones-or at estimating the relative importance of
each of these factors. 11 (See Figure 7.9 for a
humoraus illustration of this basic fact.)
This leaves us facing an intriguing puzzle:
Tw dom tlx IUI111bm, and I willmanyyou."
Is there any way to obtain a better answer to
this question-to draw a bead on how VC's
and other investors actually make their
decisions? Fortunately, there is. A method of
research known as policy capturing can often
shed light on the question, "What factors
influence certain kinds of dccisions?" without
asking the persans making these decisions to
teil us what they are thinking or what, in their
opinion, they are doing. The method works
like this. First, factors that are believed to play
a role in the decisions being studied are
identified. Next, these factors are built into
various cases or examples in a systematic
manner, and these cases are given to VCs,
who are asked to rate the chance of success of
each new venture described in the cases. Forinstance, suppose one factor believed to affect
VCs' decisions is market familiarity-the
extent to which founding tearn members
The New Yorker, January 10, 2000.have experience in this market. The experience
CHA PT ER 7 Writing an Effective Business Plan: Building a Roadmap to Success 225
Making an Effective Business PlanPresentation: The Ball ls Definitelyin Your CourtR e s e a r c h ~ r s who study stress agree that the way in which people think about
stressful"situations is a powerful determinant of how they react to them. One
possible reaction is to emphasize the downside-to imagine what will happen
if they simply can't cope with the stressful situation. Many people feel this way
about making formal presentations: They imagine forgetting what they planned
to say or harsh rejection from the audience, and these thoughts cause them toexperience high levels of anxiety, which can in turn interfere with their actual
perfonnance. In contrast, another way to think about high-stress situations is to
view them as a challenge-an opportunity to rise to the occasion and show the
world what you've got (see Figure 7.11). When people think about stressful
situations in this way, they experience lower levels of anxiety and their
perfonnance often matches their expectations: It does rise to new heightsY
Figure 7.11 Contrasting Approaches to Making a Business Plan Presentation
learningobjective 8
Describe the steps
entrepreneurs should
take to make their
verbal presentations to
potential investors truly
excellent.
Making a business plan presentation is an important activity, and as shown here, it can be perceived in two different ways: {1) as a
threatening situation in which one can fail badly, an attitude that can actually interfere with performance; or {2} as an opportunity to
exce/, which can actua/ly enhance performance. Clearly, we recommend the /atter approach for entrepreneurs.
To the extent entrepreneurs (and this includes you!) keep these points
firmly in mind, they will increase their chances of making an excellent
presentation. But suppose that despite your best efforts, and despite the fact
that you did an excellent job, you still receive a "no" from a group on which
{
you pinned high hopes. Should you be discouraged? Not at all. Few ~ entrepreneurs obtain support from the firstpotential investors they approach.
In fact, highly successful entrepreneurs often note that their companies wererejected by many investors initially. In view of this fact, rejections should be l-
viewed as an opportunity to leam-a source of valuable information. Try to
find out why the proposal was rejected, and whether there were aspects of the
plan and presentation that the potential investors found especially weak-or ~ strong. Then, go back to the drawing boards and rework both the plan and
presentation. Along these lines, there are two key points entrepreneurs should
keep firmly in mind: (1) There is almost always room for improvement, in
virtually everything; and (2) Success does not have to be immediate to besweet. Good luck!
A business plan is a written document
that explains the entrepreneur's basicbusiness model: how a recognized
upporlur1ily will be converted into a prof
itable company, and how this company
will operate.
Venture capitalists and other potential
sources of funding generally require a
formal business plan as a first step for
considering investments in new ventures.
· , An additional and often important step
involves a ace-to-face presentation of
the plan by the entrepreneur to venturecapitalists or other interested parties.