In the startup world, two key topics emerge time and again (sometimes becoming ubiquitous) are business plan and valuation. Although these concepts are often associated with the fundraising stage and the subsequent due diligence, their importance goes far beyond that.

The objective of this in-depth focus is therefore to explore more closely the importance of the business plan not only as a tool for attracting investors, but also as an internal operational guide and to give criteria on the valuation process of a startup highlighting how it represents a “flexible” starting point subject to multiple factors and market dynamics, rather than an immutable value.

THINKING A BUSINESS PLAN: WHAT IS ITS USE?

As mentioned, the business plan is not just a formal document, necessary to attract financing, but is the cornerstone on which the company’s entire operational strategy is based. Its job is to serve as a detailed guide to outline the company’s goals, the strategies to achieve them, and the operational and financial plans to keep the company on a sustainable growth path.

The final document also provided with a financial plan must clearly define: mission, vision, the company’s short- and long-term goals (roadmap), the activities put in place to achieve them (activity plan, business model and marketing plan), and the economic and financial fallout of this action. In this sense, it is evident how a well-crafted business plan is not only a key document for investor due diligence, but also directly helps the founders and the team to keep the focus on what matters most at a given historical moment in the life of the company and to work toward common goals, reducing the risk of dispersion and disorganized efforts. In addition, a well-articulated business plan that presents clear activities, tasks and sub-tasks (gantt) facilitates internal communication, aligning the expectations and responsibilities of all team members.

A special note is in regard to the financial planning part (the output of which is mostly rendered in excel).

In fact, a good business plan must include a financial plan consistent with the goals of the company. This document is as crucial for the investor’s evaluation during due diligence as it is for the founder(s). In fact, the goal is to reason and understand what the expected cash flows are (in terms of revenue, costs to be incurred and cash flow), funding needs (defining the ask for fundraising – how much money the company needs before reaching breakeven) and operating budgets for various activities (e.g., marketing plan) allowing the startup to effectively manage its resources, be they physical, tangible and intangible and to prepare for possible financial difficulties (sensitivity analysis). Indeed, on this last point, a well-designed plan must allow for the identification of potential risks and the possibility of having drivers for the development of mitigation strategies ensuring that the company is ready to respond to challenges and opportunities with agility and speed.

THE ROLE OF VALUATION

Analogous discussion is what is carried out for the valuation of a startup, which, in fact, represents the estimated economic value of the company. This process, which combines qualitative and quantitative data, is crucial not only to determine the price of the shares to be sold to investors (and fuel the exit fantasies of the founders), but also to properly understand and communicate to the outside world the growth potential of the company. 

However, a valuation, no matter how well executed, does not return a value that is certain and unchanging; on the contrary, it is inherently dynamic and subject to interpretation. The variables involved, from growth projections to market risks, are often complex and susceptible to revision, making the entire effort prone to major revisions.The final number obtained, therefore, is not a static number, but a real starting point necessary for subsequent negotiations between founders and investors. 

Indeed, investors may require further evidence of the growth potential or business model, leading to a revision of the company’s value. Likewise, founders may need to consider new economic conditions or changes in the competitive landscape, which affect the perceived value of their company.

Valuation, in short, is not a trivial task, but to navigate this complexity there are various approaches that can help shed light on how to determine the value of the startup. The following are 3 that often turn out to be the ones given the most attention:

• Method of Market Multiples

The market multiples method is one of the most common approaches to valuing a startup because it is extremely simple and intuitive. 

This method compares the startup with similar companies that operate in the same industry and are of comparable size.When we talk about multiples, we most often refer to revenue multiples (ratio of market value of comparable companies to their annual revenues) or EBITDA multiples (ratio of market value of comparable companies to their EBITDA).

• Discounted Cash Flow (DCF) Method

The DCF method estimates the present value of expected future cash flows by discounting it to the present through the use of a discount rate that reflects the risk of the investment.

In order to reach at the final value, it is then necessary to estimate future cash flows (free cash flow) and the appropriate discount rate, often based on the weighted average cost of capital (WACC), and finally the residual value of the company from the end of the forecast period to the future (terminal value).

• Venture Capital Method

This method consists of two moments: “pre-money valuation” (i.e., the pre-investment valuation) to which once the total funds put in by the investor are added, the “post-money” valuation follows. In order to carry out the pre-money valuation it is necessary to:

• Estimate the investment needed (define the “ask”).
• Predict the startup’s revenue and cost data.
• Determine the timing of the exit (e.g., IPO or M&A).
• Calculate the exit multiple (based on comparable transactions).
• Discount the future value (PV) with a discount rate that coincides with the ROI.
• Determine the % ownership stake you want to leave to the investor.

For a startup, a robust business plan is more than just a fundraising tool and can determine whether or not an investment is successful. Valuation, on the other hand, is a complex and dynamic process that establishes an initial value but is subject to negotiation and revision.

However, what is clear is that both of these tools are critical to successfully navigating one’s entrepreneurial journey and building a solid foundation for the startup’s future.

There is one big common cause of failure for most start-ups: not creating something that consumers need.

If you are focusing on making something that users need, it doesn’t automatically mean that you will succeed, but you will at least avoid failure for the same reason that most startups fail.

On the other hand, if you are not focusing on realising something that users need, it means that you will almost certainly fail.

At the end of the day, it is a matter of using probabilities in your favour: if I know the first major cause of failure and try to avoid it, then I will be statistically more likely to succeed.

Moreover, it seems easier to follow a list of things not to do, rather than things to do.

Having reached this point, let’s go a step further and explore the question: why do startuppers end up turning their focus away from the end consumer?

Focusing on the possible profit rather than on the needs of the user

Emphasizing the importance of prioritizing the market’s needs doesn’t diminish the significance of profit or a sound business model. Rather, it underscores the inherent difficulty in fulfilling consumer needs compared to achieving financial gains. Neglecting the consideration of a business model is deemed irresponsible, but it is even more imprudent not to commence by addressing the fundamental requirements of the market.

“The companies that win are the ones that put users first. Google, for example. They made search work, then worried about how to make money from it”. – Paul Graham

Targeting a market niche in order to avoid competition 

Unless it pertains to a ‘blue ocean’ market, as elaborated in subsequent articles, the creation of something valuable inherently involves confronting market competition, be it from direct competitors or alternative products/services. Evading competition becomes possible only by forgoing the cultivation of innovative ideas, and sidestepping success is the sole strategy to avert possessing a noteworthy concept.

Not having a specific consumer in mind 

Generating a product that resonates with consumers necessitates a thorough understanding of their preferences. Many prosperous startups initiated their journeys by addressing challenges personally experienced by their founders. This approach is advantageous as it allows for capitalizing on a familiar necessity, and one is most familiar with their own needs. For instance, Apple emerged from Steve Wozniak’s desire for a personal computer, Google arose due to the founders’ struggle to find online information, and Hotmail originated from the founders’ inability to exchange emails at work. While it’s feasible to create a product for a consumer demographic distinct from oneself, it remains essential to cultivate a deep understanding of their preferences.

Have one founder  

Have you ever observed the scarcity of thriving start-ups initiated by a single individual? Even in cases where a prominent figure appears to be the sole founder, it’s often the case that there are actually multiple contributors. However, what are the drawbacks associated with having a sole founder? It suggests that the individual may have struggled to persuade friends or acquaintances to share the business risks, or they may have believed they could handle it independently. Even if these friends or acquaintances underestimated the potential success of the start-up, the sole founder would still face significant disadvantages. While it may seem trivial, having colleagues for comparison and collaborative brainstorming is crucial, along with having someone to provide support during moments of low motivation. Making decisions alone increases the likelihood of poor choices.

These factors contribute to the challenges that start-ups encounter, causing them to deviate from focusing on what truly matters in the business realm: creating something people genuinely want.