What's wrong with writing a business plan for investors?

I've recently been involved in writing a business plan. Whilst it was a worthwhile experience, it has also prompted me to question whether writing a business plan for investors - rather than for internal use - is in anyone's interest.

We were writing for a biotech business plan competition. The winning team was to get £100,000 ($150,000) and free lab or office space in a biotech incubator. The judges of the competition consisted of venture capitalists (VCs) and other investors, as well as other organizations that are involved in early-stage startups. The selection process was quite similar to that used by VCs when they decide which businesses to invest in.

In principle, there are sound reasons for writing a business plan. It forces the startup to envisage its future and to think through the details of what it will do. Ideally, this process will uncover potential threats and opportunities, strengths and weaknesses.

This is however not what happens in reality. In my experience, people starting a business already tend to be overoptimistic. Unfortunately, I doubt that writing a business plan for potential investors encourages honest and self-critical assessment of how to maximise the startup's chances of success. 

Instead, it becomes an exercise in trying to convince potential investors. When there are several estimates of the market size, the temptation is to pick the biggest one. When there are potential non-obvious threats, the temptation is to either not mention them at all or to explain why they are not going to be a problem, rather than actually thinking them through. Et cetera. Some investors even encourage this by explicitly demanding to be "sold" the idea.

You may think that this is not a big deal. After all, investors are aware that startups will inflate their chances of success and will discount for this: You're hyping, I know that you're hyping, and you know that I know that you're hyping.

The problem with this is that apart from money, time is the most limited resource for startups. Writing a business plan takes time, and the one the startup writes for investors is probably going to be the only one. Writing a second, more realistic one for internal use would be a waste of resources.

A solution would be for investors to stop asking for a business plans and instead relying exclusively on their own due diligence - in close collaboration with the startup of course. The initial communication between the startup and the investor would focus on the science, covering the market and the business model only in general terms. The advantage for startups would be that they could write their business plan without having to keep in mind what the investors want to hear, instead using their resources on planning that actually matters to the business.

If you have any experience of investing in early-stage startups, or if you have ever written a business plan yourself, I'd love to hear what you think about this.