The Value of Business Plans

A while back David Miller did a post on the value of business plans based on some research out of the University of Maryland (Campus Entrepreneurship). From a NYT piece about the research:

Researchers found that venture capitalists, who screen hundreds or thousands of solicitations each year, pay little or no heed to the content of business plans. Instead, the study said, because they make decisions “under conditions of high uncertainty,” venture capitalists rely on instinct and their expertise in ferreting out information by other means to evaluate the prospects of a business.

David pointed out correctly, I think, that this study looks at how VCs use the plans, not on the value of the plans to entrepreneurs, bankers, potential partners, and others. There is a clear value to entrepreneurs because the bplan forces them to think concretely about the potential business. A good plan is really the culmination of hours spent doing market research, thinking about potential profit streams, identifying the target audience, and so on.

An interesting new study in the Academy of Management Journal by Xiao-Ping Chen, Xin Yao, and Suresh Kotha looks at the role of entrepreneurial passion in securing funding from VCs. The summer issue of the Stanford Social Innovation Review has a good write up of their findings:

"There are different levels of passion," explains Xiao-Ping Chen, a professor at the University of Washington's Foster School of Business and the study's lead author. "On the surface level - affective passion-you see whether people are excited, whether their faces light up. A deeper level is their cognitive processes - how much and how deeply they think about their idea. An even deeper level is behavior: Did the entrepreneurs, say, quit their jobs to start their own business? How much of their own money did they invest?"

To test whether and what kinds of passion win venture funding, Chen and her colleagues first created scales that observers could use to rate other people's cognitive and affective passion. (The scale does not measure behavioral passion.) They then asked 55 investors hailing from venture capital firms, banks, and financial companies to use the passion scales in rating 31 presentations at a university business plan competition. The researchers found that the more prepared - that is, cognitively passionate - the entrepreneurs, the more likely they were to win funding from the judges. Affective passion, however, did not lure the lucre.

I think this really captures the value of business plans. VC's can tell whether someone really put in the time and due diligence when preparing a plan, and I think this is what they're looking for when vetting potential companies. So be wary of skipping over this important step. To be fair, you could argue that as long as you really know what you're talking about, the BP may not matter as much, but the write up is still a demonstration of determination and will to succeed. Putting in the time really could make the difference between getting funded or not.

I couldn't find any free copies around, so I'll just include the relevant citations:

Xiao-Ping Chen, Xin Yao, and Suresh B. Kotha, "Entrepreneur Passion and Preparedness in Business Plan Presentations: A Persuasion Analysis of Venture Capitalists' Funding Decisions," Academy of Management Journal, 52(1), 2009.

Alana Conner. "Think Passionate," Stanford Social Innovation Review, 7(2) 2009.

For a discussion of the UMD research, check out this page, which contains a synopsis and video interview with lead author Brent Goldfarb.