What Are the Essential Components of a Business Plan?

As I prepare to mentor teams from MIT Sloan as part of the Business Plan Contest of its 100k Competition this month, I was thinking about what companies need to produce.  Business plans out there vary from a single page summary to an excruciatingly long dissertation.  The key to a good business plan is to only have the information you need and forget the rest.  Easier said than done though. However, here are some thoughts for companies as they are preparing their plans.  You can see an overview from some very recognizable entrepreneurs in this video.  The entrepreneurs here stress that the market itself, due primarily to the growth of the Internet, is different today than it was in the past, so the model for preparing a business plan is different.  The key is to know the market and have a good idea.  As Marc Andreessen, founder of Netscape turned venture capitalist, notes:

The process of planning ... is very valuable, but the actual plan that results from it is probably worthless.

And as summed up by Kevin Ryan, CEO of DoubleClick, the questions you have to ask to create a good business plan are (1) is this market big enough, (2) do we have a good idea, and (3) do we have good people.

So what should be included?

HubSpot founders Brian Halligan and Dharmesh Shah also have abandoned the large, detailed business plan because once you start showing it to investors, it won't last.  If you have put all of this effort into a 50-page business plan, you either have to throw much of it out as it evolves, or you will be so invested in it that you won't want to change the plan.  Neither result is a happy one for an entrepreneur.  They prefer to think of the "business plan" as a set of three items:

1. a PowerPoint deck describing the business and team
2. An executive summary of the target market and business (see more below)
3. A three-year pro forma profit & loss document

In the early stages of development and the first round of financing, investors are mostly looking at the team and what they are going to do.  It is only when you get into the later stages of financing that detailed financial data become important.  So focus on the market and the concept rather than getting lost in a complicated document.

For the summary, investors will be looking for the following:

1. The Team.  The people who will be running the business and developing the product are key.  The best startup teams will feature a mix of strengths working together.
2. The Market.  You need to describe the size of the target market and the environment to show that you will have customers and they are currently being underserved.  However, no business plan should say that the market is unlimited and there no competitors.  Be realistic.
3. Your Product.  What is unique about the product or service you are providing.  If you have trouble describing it, you will have trouble with Item #2.
4. Money and Forecasts.  Give a reasonable view of what you expect your financials to look like for the next few years (again, understanding that this estimate will change) and provide guidelines of what you see as development and customer relationship milestones to meet along the way.

See my previous post for another perspective.

The key to all of this to show that you have thought through your plan realistically but are ready to adjust when it inevitably changes.

What has been your experience with preparing business plans?  What have you found works or does not work?

Can Law Firms Act Like Startups?

Listening to a great webinar by Brian Halligan and Dharmesh Shah about "Money, Marketing, & Management with the HubSpot Founders", I was reminded about a discussion that has been floating around the Web recently and on this blog as well.  Can law firms act more like startups? One of the themes in the webinar was how companies (particularly a tech startup like HubSpot) should change the typical management philosophy in order to grow and thrive.  Among other things (and to paraphrase a bit):

1. An organization should break down the pyramid and flatten the org chart.
2. Extend the "open door" policy to eliminate doors altogether.
3. Trust your employees and don't try to over-structure company policies.
4. Be transparent and include your employees.

So everyone sits together and moves around every three months.  Online collaboration tools allow employees to contribute to tools, products, and presentations.  Employees are given latitude and flexibility, drive productivity.  These things work well in a tech startup where the emphasis is on agility and growth, but does that lend itself to a more "traditional" setting like a law firm?

Why not?

Large law firms have traditionally employed a pyramid structure - from the large pool of new associates at the bottom up to the few very managing partners on top.  Nothing is transparent and firm policies are monitored very closely.  Deals at large law firms get staffed with a range of partners and associates, which is sometimes more beneficial for the growth of the law firm (and higher bills) than for the sake of the deal.

Recently though, driven in part by a changing economy, clients, VCs, and even lawyers have reacted negatively to this seemingly outdated structure and have called for some changes.  As companies evolve, shouldn't their law firms?

I have seen a number of new firms pop up in the last few years that seem to embrace this new model - my firm, Trinity Law Group is one of them - by leveraging technology to focus on clients rather than high-rent office space, billable hours, and expensive marketing.  By emulating the companies we represent, law firms can provide better value while adapting to a 21st century business model.

What do you think?  Have you noticed a change in they way you interact with your lawyers?

The Innovation Economy Starts Now

2010 has been the bright spot in the future that we have been looking toward for the past 18 months.  When the bottom started falling out in 2008, the immediate future looked abysmal, but we knew that at some point, things would have to turn around.  When you recall that some of the country's great business successes were born out of economic slumps, this recent downturn - the Great Recession or whatever you want to call it - could transition into the most striking growth in more than a generation. Tom Friedman's recent Op-Ed in the New York Times is a call to kick-start a 21st century innovation economy.  He is right that the time is now.  Think of all of the under-utilized talent in the country right now, not to mention the capital waiting on the sidelines.  Lab Day and the NFTE are ways that the country can and must continue to develop the entrepreneurs and innovators of the future, but while real education reform based on innovation is critical to long-term success (both my parents were educators - my dad for 42 years - so I believe in the importance of education), there are many things that we should be doing on a much shorter runway.

Here are three things that may help:

1. The Start-Up Visa.  This country needs to embrace innovation by bringing here and keeping innovators.  The startup visa movement is about making sure that technological innovation and the "expanding of the pie" happen in the U.S. In addition to recruiting entrepreneurs and giving them the resources they need, we should raise the HB-1 visa limits to bring more skilled workers that will be needed.  Giving visas to those who will create new companies does not take away opportunities for Americans - it expands the pie here to create more American jobs rather than allowing those companies to be created elsewhere.  In this regard, the U.S. is lagging behind China, India, and Pakistan, but even behind countries like the U.K. and Canada.
2. Green Card Diplomas.  The U.S. also needs to reverse the increasing "brain drain" of bringing in and training foreign nationals on student visas and then requiring that they leave the country.  On the contrary, we should actively recruit the best and the brightest from around the world, invite them to our higher educational institutions, and then grant them the right to stay in the country if they start businesses and innovate.  In the words of John Doerr, billionaire venture capitalist, we should "staple a greed card to the diploma" of these students and get them to set up businesses here.  Already, half of the Silicon Valley startups are now started by immigrants, including such pillars as Google, eBay, and Yahoo.  We should continue to encourage this kind of innovation.
3. Government Investment in Innovation.  Government is not a great source of innovation.  But proper government policies can encourage the type of innovation that will grow the economy.  Eliminating capital gains tax on qualified small business investment and giving tax credits for hiring employees is a start toward general economic stimulus, but the administration should also be focused on finding new ways to fund innovation directly while also staying out of the way.

When Does Your License Become a Franchise and What Can You Do About It?

In response to my earlier post about franchising as a business model came the following:  "but my business is not a franchise, it is just a licensing arrangement where I use distributors to sell my product".  This is where bells start ringing, red flags are raised, and whatever other metaphorical warnings you like pop up. Many successful businesses license the right to use software, technology, a trademark or name, copyrighted information, or other intellectual property to other businesses or individuals.  However, when it becomes tied to a business model or you use dealers, distributors, or other licensees to sell your product, you face an increased risk of liability.  Here's why.

That three-pronged franchise test is definitional, not chosen - once you meet each of the three criteria, you are deemed a franchise under federal law and under certain state laws.  That automatically subjects the company to an entire scheme of regulatory requirements for which there are penalties for failing to comply (ignorance of your status is not a defense).  Here's a common example:  a business (1) contracts with distributors to sell products using its trademark to create a brand awareness, (2) takes payments from the distributor in the form of a fee or royalties, and (3) exerts control over where the the distributor located and how it operates its business and sells the product.  That business just became a franchise regardless of what it calls its arrangement.

Can you Avoid Being a Franchise?

So what can companies do to grow their businesses while avoiding the cost and expense of the franchise regulations?  Some companies will try to contract around the franchise laws.  Since the test is a definitional one, you can eliminate one of the criteria to remove yourself from the franchise model.  Some will complain (WARNING: more metaphors ahead) that lawyers - particularly franchise lawyers - see everything through franchise-colored glasses, or that when holding a franchise hammer, everything looks like a nail.  But there are practical steps that you can take to reduce the risk of falling into the franchise scheme.  For example:

1. Remove the trademark.  If you don't license a trademark and allow your distributors to sell product with your assistance but without using your name, you might be able to avoid the franchise regulatory scheme.  However, you still have to be mindful of the related business opportunity laws that play a similar but more flexible role.  These are often associated with the vending machine business and similar systems of product placement, but can be triggered in elsewhere.
2. Don't charge a fee.  Eliminating the fee is not as easy as it sounds because most licenses include some form of payment.  Not charging an upfront fee is not enough here; the fee component can be satisfied by a variety of payments made to your business in the first six months, including royalties and the like.
3. Don't exert control or provide assistance.  Licensors can often maintain their contracted relationships, even with the use of a trademark and payment of a fee, if they do not control how the distributors operate.  The licensor is always able to control, for example, how a trademark is utilized.  Control over the use and image associated with a mark is important not only from a business branding perspective but also from a legal perspective in that trademark owners have a responsibility to control its use.  So a license agreement can impose quality control standards over use of the mark, such as submitting products bearing the mark for testing and monitoring or inspections.  But there is a hazy line across which a licensor steps into the franchise world.  The more that quality control extends to the business operations of the licensee, the closer it comes to franchising.

Do You Need to Avoid Being a Franchise? (or, can't I learn to embrace the system?)

As I mentioned before, franchising can be a very successful business model and is responsible for a sizable percentage of this country's economy.  The vast majority of the people in the United States (if not everyone) has purchased products or services at some point from a franchised business.  But creating and maintaining a franchise system is an expensive and time consuming endeavor.  I always tell business owners who are thinking of franchising that starting a franchise system is not an extension of their business, it is a new business that requires a full-time effort.

Franchise regulation is a creature of consumer protection.  The excesses and fraud of franchise schemes in the early to mid-20th century led the FTC to enact regulations in the late 1970s that treat franchises like the sale of securities.  Each franchisor is required to provide a detailed disclosure document called the Federal Disclosure Document (NOTE: until 2007, this document was called the Uniform Franchise Offering Circular or UFOC) which provides prospective franchisees with information about the system and the people involved in it to make an educated decision on purchasing the franchise rights.  I will save the details of the FDD and the other requirements for a subsequent post, but very generally speaking, you are looking at spending somewhere between $20,000 and $50,000 in legal costs for the first year alone to meet your regulatory obligations.

Risks of Noncompliance

The risk of failing to register a deemed franchise does not necessarily come from government.  While the federal government can enforce through the FTC Rule and some states have specific powers to penalize through their own state laws, the real risk of liability comes when your distributors become dissatisfied for whatever reason and decide to sue you for selling illegal franchises.  You could be subject to fines and other penalties (in addition to exorbitant legal fees and court costs), including offering rescission to each of your licensees.  So businesses that try to take the relatively inexpensive route of trying to contract around franchise laws may end up spending much more money in the end.

So what is the moral of this story?  Licensing can be an effective method for rapidly building your brand awareness and product sales.  However, exercise caution before you jump in and consult a qualified attorney who can counsel you on the specifics of your model to help you avoid major headaches and costs down the road.

Can a Court Rewrite Your LLC Agreement? You Might Be Surprised.

What do you do if you never put a limited liability company operating agreement on paper?  In some cases, the answer may be decided against your wishes by a court. I was recently speaking with a small business owner who ran into trouble with the other member of his limited liability company.  The two had formed the LLC six years ago by filing with the Commonwealth but never put an operating agreement on paper.  However, he indicated that they had an oral agreement on a variety of things that would normally be in an operating agreement - how the LLC is managed, how the profits and losses are divided, how to buyout a member who leaves, etc.  Now he wanted to use some of those agreements to resolve the conflict.

In Massachusetts (as well as many other states), a written operating agreement is not required; members can have an oral agreement on how their company is structured and operated.  But that flexibility can bring risk.  Here's why.

States have a common law concept called the "statute of frauds".  (For those of you who eyes are immediately starting to glaze over at the sight of technical legal talk, you can skip to the paragraph that begins "So what does this mean for your company?" to understand the practical implications.) State laws vary, but generally the statute of frauds states that certain contracts must be in writing and signed if you are going to enforce them.  In addition to other things, this common law principal includes any contract that cannot by its terms be performed within a year.  Note that an agreement that happens to take more than a year is not automatically subject unless the agreement specifically states that it will take more than a year.  If so, the contract is not automatically void, but one party can raise the statute of frauds in order to have the contract voided.  Remember that this is a complex topic because there are some exceptions, but as a general principal, long-term unwritten agreements carry some uncertainty.

This issue became much more relevant to LLCs last year when the Delaware Chancery Court ruled that an oral LLC agreement was subject to the statute of frauds.  In Olson v. Halvorsen, C.A. No. 1884-VCL (Del. Ch. Dec. 22, 2008), a hedge fund founder who was removed by the other members demanded that the court enforce a multi-year earnout agreement that was included in their unsigned draft of an LLC agreement - an earnout worth well over $100 million!  The court held that because the earnout was to be paid over the course of six years, it falls within the statute of frauds and was therefore unenforceable.  The former hedge fund manager's claim for the payout was rejected.

The applicability of this case in Delaware adds some uncertainty to the operating agreements of LLCs formed there.  Other states, including Massachusetts, have yet to decide this issue definitively, but the Delaware courts often serve as a model for other courts when they are facing corporate and LLC issues.  So this decision may eventually have implications for your agreement.

So what does this mean for your company? If your LLC is operating under an oral operating agreement, many of the provisions with respect to management and such may be enforceable because they can be performed within a year.  However, as the court decided in Delaware, if you have an oral agreement with the other members that entitles you to some benefit that extends beyond one year, you may lose that right in a dispute.  For example, if the members agree that if you were to be hit by a bus tomorrow, the other members would buy back your membership interest with installment payments over five years, the other members might be able to successfully void that provision upon your untimely demise under the statute of frauds.

So here are some tips with respect to operating agreements in light of this case law:

1. Put your LLC operating agreement in writing.  Operating Agreements do not have to be fancy.  You can write the provisions of your agreement in any way that expresses the true intent of the parties.  Working with a lawyer may help save a tremendous amount of agony since they have experience in drafting agreements that will be enforceable.  But don't get caught up in the formalities - just get it in writing.
2. Make sure everyone signs the agreement.  A critical element of the statute of frauds is that the agreement must be signed by the person against whom it will be enforced.  As in the Olson case described above, the members wrote out the provisions of an agreement, but the courts did not enforce it because the parties never signed it.  I have dealt with other situations where clients "forget" to sign a document.  It may be easily overlooked a the end of a negotiation, a critical issue to protecting your rights.
3. Revisit your agreement periodically.  Companies that have been operating for several years might be surprised by what is in their operating agreements because the needs of the members and the company may change over time.  This is even more important if you are operating with an oral agreement.  After a few years, the members may have very different recollections of your agreement, which may lead to messy disputes down the road.  I would recommend that you take a fresh look at your agreement annually when you have an annual meeting.