The debate as to whether or not business plans matter is one that comes up at least once a year.  This week the New York Times published an article debunking the usefulness of business plans. Based on a study done by The University of Maryland that looked at how venture capitalists chose to invest, the article quotes numerous investors who say that business plans and five year projections simply don’t matter much in their decision process.

Personally, I’m not a big fan of business plans either.  Especially those that are little more than marketing documents that repurpose research performed by a variety of sources that will print whatever you pay them to print.  The pro forma five year financials that accompany most plans aren’t of much value either, but that’s not because its difficult to predict the future.  The plans and pro forma financials alike simply lack rigor.

Market validation studies and operating plans are of much more use when deciding to start a business.  I am a big believer that businesses fail for two primary reasons: 1) People dynamics; and, 2) Markets. 

Most investors will admit that they spend a good deal of their due diligence hours assessing the team - its market knowledge, ability to work together, past performance.  The remainder of time is spent assessing and validating the market size, growth potential, competitive dynamics, etc.  If markets take too long to develop, or if competitive response is not anticipated guess what, you burn more cash. 

Figuring out whether an idea is an opportunity should be where any entrepreneur invests a good deal of time before even approaching an investor.  The process of digging for data, speaking with industry experts and creating one’s own view of the market and how it will evolve is time well spent.  Simply regurgitating an analyst’s view of the market is a signal to me that the would be entrepreneur is intellectually lazy.  Building a product or service is only half the battle.  Knowing and understanding who will be there to purchase it, at what price and volume is the other half.  This knowledge can only be gained by wading through the data, forming a hypothesis and testing it on many potential customers and industry experts.  Only then can you confidently build an operating plan that more accurately estimates financial need, the amount of time to first sale, pricing, distribution, working capital needs, and believable estimates of cash flow break even.  Perhaps a reason that many investors ignore business plans is that they sell too hard, are produced in a vacuum with little customer validation, and the numbers reflect dexterity with spreadsheets rather than being driven by estimates backed up by accepted yardsticks and fundamental analysis.

It would be wrong for any would be entrepreneur to interpret this study’s conclusions to mean that business planning doesn’t matter.  Having an operating plan with financial benchmarks is certainly useful even if the numbers change over time.  The knowledge and understanding gained in the creation of the plan can be the difference between adjusting the numbers after you’ve burned through the cash, or being able to anticipate the market and making changes that extend the runway and avoid the need to raise money at an inopportune time.