Six Business Plan Pitfalls to Avoid When Approaching Funders: Lessons from Healthcare Enterprises in Emerging Markets
Entrepreneurs in emerging markets looking to start or grow their business often rely on outside capital. To attract this capital, they must show funders that they have a good understanding of both the opportunities and the challenges they will face — and that they have the grit to capitalize on these opportunities and address these challenges.
Having a good business plan is a key part of building this credibility with funders. But despite its importance to their enterprise’s success, many entrepreneurs struggle to develop a strong business plan that instills confidence among potential funders.
In our work at the William Davidson Institute and in our previous careers, we have reviewed and participated in the development of business plans for hundreds of enterprises in the healthcare sector. From these experiences, we have identified six common mistakes that undermine both the credibility of a business plan and the funding prospects of the entrepreneur who developed it. We’ll discuss these pitfalls in the context of the healthcare industry, but they apply to many enterprises in other sectors in emerging markets.
Lack of an entrepreneur with skin in the game
If a funder had to choose a single factor that can make or break a business plan, it would be the entrepreneurs proposing the plan. Who will lead the proposed enterprise? Who is investing their time and personal money in it? How much skin do they have in the game?
Investors want to see leadership and commitment in these individuals. They also want to see entrepreneurs who have invested their own money to such a level that they will suffer significant personal financial loss if the business fails. In short, they want to support entrepreneurs who have a strong incentive to make their business succeed — and who will not walk away when the going gets tough, leaving investors with losses.
We have seen multiple examples of business plans put forward by a group of doctors who have been successful in a high-income country to which they migrated. They want to give something back to their country of origin by establishing a high-quality medical facility there, but they don’t plan to move back there to lead it, because they have a lucrative job in their adoptive country. Such business plans are not attractive to investors.
Overly optimistic revenue projections
Business plans often show exaggerated revenues, especially in the first few years. This is because entrepreneurs tend to incorrectly estimate factors like the size of the market, the rate at which a customer base is likely to grow, or the effect of competition.
In the healthcare sector, a useful business plan starts with a careful understanding of who the customers and payers are — and what that means for potential market size — based on a clear understanding of the epidemiology of the diseases the company will address. The plan then recognizes that the business in question will only be able to serve a fraction of that market. Determining a reasonable market size requires the enterprise to assess competition, the ability of patients or insurers to pay, travel costs, the likelihood of disease, and other factors specific to the service offered and the geographic location. The timing of the company’s projected revenues also needs to be realistic. It takes multiple years for revenues to build up, and any business plan of a new healthcare institution that projects significant revenues immediately after commencing operations signals to investors that the planners either don’t have a good grasp of the market — or worse, that they are deliberately exaggerating to deceive potential investors.
In our experience in the healthcare sector, hospitals typically take five to seven years to reach a high level of capacity utilization. Yet in the meantime, there are many fixed costs that must be met — and they start the moment that a hospital begins operation (more on that below). Consequently, it is normal to have losses and negative cash flows in the first two years of operation, with a successful new private hospital only reaching the break-even point in its third or even fourth year.
Business plans that gloss over this reality to paint a rosy picture of fast revenue growth can turn off investors, because such plans underestimate the company’s financing needs, risking a liquidity crisis and failure. They suggest an entrepreneur who is either inexperienced or dishonest. Neither is good.
On the other side of the cost/revenue equation, entrepreneurs in emerging markets tend to ignore or underestimate their costs in a way that completely undermines the financial viability of their business model. An accurate estimate must address several costs that are often overlooked. For instance, it must include not only the cost of equipment, but also the cost of maintenance, repairs and parts for that equipment. It must determine if supplies are readily available locally, or if they must be imported — and if they must be imported, it must cover costs associated with any restrictions or tariffs on those supplies. It must accurately reflect the cost of the time spent by everyone involved in running the business — including the owners themselves, who need to spend a good deal of time on the company and could be earning a salary elsewhere. And it must take into account the cost of buildings and land: These may not be included in accounting costs if the facilities are owned by the entrepreneur, but that doesn’t mean there is no cost to using them. Foregoing the opportunity to rent or sell them is a real cost, and needs to be included in any business plan. Construction costs also need to be benchmarked against other construction projects of equivalent complexity and quality in the same market. The timing of all these costs relative to the enterprise’s revenues is also important: While the revenues will often be delayed, the costs will be incurred immediately. Has the entrepreneur planned for the appropriate cash outflows?
A common mistake we have seen in healthcare startups is to assume that their personnel cost as a percentage of revenues will be equivalent to that of a mature facility. Yet in contrast to established facilities, much of a startup’s staff will work well below capacity in the early years. For example, if a nurse can care for 10 patients, that nurse’s salary must be paid even when s/he is caring for only one or two patients in the first months of operation. We have seen such errors result in loan default and financial loss due to insufficient cash to reach break-even, despite good demand. To an investor, this sort of assumption gives the impression that a management team does not understand the cost structure of their industry — and specifically, that they don’t realize what will be required as the startup grows to scale.
To address these flawed assumptions, experienced investors know they will need to remodel the business plan themselves to have a better estimate of how much money is needed. But not all are prepared to do that. The correct approach is for the entrepreneur to build the model from the bottom up, looking at patient numbers and how many staff are needed to treat them.
Lack of access to expertise
Human capital is another cost, but its importance warrants a separate discussion — especially in a field like healthcare. Human capital challenges begin at the top and can flow through the entire organization.
Does the entrepreneur have the right personnel to manage the institution? Being a good doctor isn’t the same thing as being a good business manager. Is someone with experience managing a facility included in the business plan?
Many healthcare entrepreneurs fail to address these questions: They propose big hospitals, but only have a handful of part-time specialists available to work there. To attract funders, they must show that they have access to staff with the specific skills called for in their business plan — at the quantity necessary to make the business viable. In the case of a hospital startup, they must demonstrate that they can hire not only doctors and nurses, but also technicians capable of operating imaging devices, performing lab work, maintaining equipment and so on.
It’s essential for a business plan to take these staffing needs into account, since shortages of healthcare personnel are pervasive in emerging markets (and also in many developed markets). For example, treating cancer patients with radiotherapy requires a specialist radiation oncologist doctor, a medical physicist and a dosimetrist. Medical physicists usually need a master’s degree in physics, plus a clinical residency in treating cancer. They are in short supply. One planned cancer center business we encountered in Central America had to be shelved when the only fully-trained medical physicist in the country left for Europe after receiving a lucrative job offer. Another example from our work in Latin America shows how far a business may need to go in order to ensure it has staff: The enterprise operates a chain of cancer centers, and has to plan new facilities five years in advance, giving it time to sponsor the training of future staff in radiotherapy and medical physics programs at universities, so it can hire them to work at the facility after they graduate.
There are risks associated with all the factors we’ve discussed. Running a business involves recognizing and addressing those risks. Does the business plan recognize the full range of possibilities on revenues and costs? Does it recognize the possibility that personnel or equipment won’t be available, or that regulatory hurdles might emerge? And does the plan include strategies for mitigating these risks? Investors are well aware of the risks of doing business: They much prefer to support entrepreneurs who have prepared for them.
Investors will be far more impressed by a business plan that thoroughly thinks through the risks that a business will face, than by one that gives these risks limited attention — or worse, that doesn’t mention them at all. One small family-run company we worked with in an Eastern European country was remarkably prepared for its due diligence, which included a good risk analysis. It was clear by the end of the first day that this was a team worth backing. Indeed, the company survived a severe economic downturn just three years later. Today it is the largest private healthcare provider in its home country, has expanded to a second country, and is publicly listed.
A robust business plan will include a clear delineation of responsibility, authority and the right to residuals — i.e., the right to determine what happens with any revenue that exceeds costs, and who has the obligation to figure out how to cover any costs in excess of revenues. The plan will address several key governance questions, like: How is the chief executive chosen, and who has the right to make that decision? How is the board chosen, and who has the right to choose the board members? What is the purview of the CEO versus the board? Does the allocation of responsibilities make sense? Do those with responsibility have the authority to act on that responsibility?
Lack of clear governance decisions at the beginning can undermine the entire business later on, when important decisions have to be made. For instance, one hospital we worked with was a joint venture between two large and successful organizations. However, its governance called for an agreement between the leaders of the two organizations in the event of a disagreement at lower levels. Not surprisingly, an issue eventually came up, and the two organizations disagreed about how to handle it. The lack of clear delineation of authority and responsibility ultimately caused the joint venture to dissolve. In another example, the board was unclear about succession plans, and after significant internal conflict, the hospital lost both its CEO and its CMO. If there had been greater clarity about expectations and timelines, only one or the other would likely have left, but lack of clarity resulted in the departure of both, and the hospital went through a few very difficult years.
Avoiding the six mistakes discussed above can significantly improve an enterprise’s chances of receiving funding. While our focus in this article is on healthcare, these factors will affect the viability of plans in other sectors as well. Some sectors will have other factors that need to be considered, and the emphasis on the factors discussed above might differ for other industries. But they are important to potential investors regardless of the industry.
Paul Clyde is the president of the William Davidson Institute (WDI), the Tom Lantos Professor of Business Administration and the Movses and Maija Kaldjian Collegiate Lecturer of Business Economics and Public Policy at the University of Michigan’s Ross School of Business.
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Note: The William Davidson Institute is NextBillion’s parent organization.