If you are in need of capital to fund business growth, a good strategic business plan will attract not only world-class lenders, but also the right types of lenders for your product. Here are some crucial business plan tips, including:
- what to include in a strategic business plan and how to set it out
- what banks look for in a strategic business plan
- what mezzanine lenders look for in a strategic business plan
- what venture capitalists look for in a strategic business plan
- the right sort of strategic business plan for an early-stage company
- avoiding common business plan mistakes.
Overall, what do lenders look for in a business plan?
Ideally, you should develop a five-year strategic business plan that includes pro forma income statements, balance sheets, and cash flow statements on a monthly basis. Annual projections will not show seasonality and working capital fluctuations. The overall goal of a strategic business plan is to generate high levels of lender or investor enthusiasm for your deal – in just a few minutes of reading.
Here are six tips that will help your business plan shine for all types of lenders:
- Use clear and understandable language that
explains the business in terms of its underlying processes.
- Explain why the business is unique and
specialised. This is most effectively articulated by
breaking the business into its functional process components (FPCs)
and highlighting the degree of difficulty of each FPC.
- Be quantifiable and measurable. Use a sound
financial metric foundation, based on historical financial
performance, to back up your specialisation and underlying
processes.
- Tie together the numbers and the narrative.
The financial metrics and the narrative description contained in
your strategic business plan should support each other, and be
easily connected.
- Describe a simple growth story that is tied
into an overall strategic plan so that the reader can see how the
business will get from point A to point C.
- Spell out what the capital will be used for. For example, is it for acceleration of organic growth, to support an acquisition, or to fund a shareholder buy-out?
What else? Let's start with banks.
What do banks look for in a business plan?
Banks want to feel confident in you personally and professionally, in your team and in your ability to pay them back. The more confident a bank is on a borrower's ability to deliver on its business plan, the more open it will be to lending a higher loan amount, at a lower rate, with a lower amortisation schedule.
Banks are hard asset oriented. Their financing structures are not very flexible to fund growth. But a bank might be right for you if you're looking for steady (not steep) growth and less expensive debt.
Bank lenders have a theory of lending based on the three Cs of credit:
- Collateral: The value of assets, personal and
business, pledged by the borrower and based on a liquidation
approach to valuation.
- Cash flow: The amount of free cash available
to amortise debt based on historical results, e.g. from 1.5 to 2
times cash flow to one times liability to the bank.
- Character: The borrower should have a good credit history and be personally reputable in the community.
What do mezzanine lenders look for in a business plan?
Mezzanine debt is used either in conjunction with other layers of capital such as private equity in a buyout or, increasingly, on a standalone basis to fund growth. Mezzanine debt has evolved from its traditional role as the close-gap between equity and debt on the balance sheet. In today's market, many mezzanine lenders are looking to fund growth rather than a cash-out. They end up owning a small piece (generally less than 5%) of equity.
In a buy-out scenario, mezzanine is used as the fill-in money between a company with a pending venture capital closing or an acquisition and the needed funds between the private equity side and the senior debt. Note, however, that mezzanine capital is primarily beyond the collateral base of the company and is based on future cash flow for payment. Not all mezzanine has venture capital below the loan.
Mezzanine lenders provide flexible growth structures that include long terms (up to seven years) and interest-only periods (up to five years). Also, mezzanine lenders are:
- open minded as to pro forma treatment of historical financial results
- looking to finance the growth of niche businesses that have barriers to entry, high margins and sustainable cash flow
- indifferent as to the hard asset value
- looking to the quality of the management team and the growth story to gain a comfort level that the company's future cash flow will repay the mezzanine debt.
They have more of an equity orientation and make their money through the capital appreciation of their warrants.
Just remember that mezzanine lenders are interested in the same criteria as banks but are looking for a growth potential, because they typically require not only a second lien on the assets but also a warrant position in the company.
What do venture capitalists look for in a business plan?
What venture capitalist (VC) investors look for in a strategic business plan can be expressed in just two words: exponential scalability. Your business plan must show specifically how that future growth is going to happen. If you're projecting 20% growth, that's just not enough for most VCs. VCs want to know how your company will scale to 100 times its size so that they can get a 10 to 20 times return on their money.
Intellectual property can help secure VC financing. Venture capitalists are looking for businesses that have a sustainable competitive advantage, primarily based on intellectual property.
One important suggestion for negotiating the final VC transaction is to always negotiate an equity earn-back. This will return the equity you gave up in the beginning based on the VC's sceptical evaluation of your future performance. If they believe you are going to hit half the performance in the business plan and price their transaction return accordingly, and if you then hit your plan, they will have received twice as much return as they expected. This is not fair; they need to return the equity they took based on their scepticism.
If you have an early stage company, what should you do differently in your business plan?
Lenders and investors will be looking for different types of information in an early stage business plan as opposed to a business plan from a more well-established company. Early stage companies must rely more heavily on their unique value proposition, why the market will benefit from it, and why the market is ready to accept it. The early stage business plan must give significantly more product detail and empirical research than is needed in the advanced stage business plan.
If you have an early stage company, focus your strategic business plan on how you plan to acquire market share and how you are going to educate customers on the benefits of your product.
Early stage business plans should include more prospective evidence of customer acceptance and technology capability to validate viability. Sometimes this requires pre-sales confirmation and independent technology verification.
One last item to consider focusing on is the background of the founders. They are important to highlight in an early stage business plan.
What common mistakes can CEOs avoid in their business plans?
We have reviewed a lot of strategic business plans, and have collected this list of the most common, avoidable mistakes:
- Over-aggressive growth rates, unrealistic financial projections, and data that doesn't have real-world historical backup.
- Not presenting the competition completely or from the customer's perspective.
- Narrative filled with jargon and hyperbole.
- Not clearly explaining the unique selling proposition that shows what problem the business is solving.
- More than one projected outcome. Don't supply best and worst case scenarios. Just supply one realistic one.
- Incomplete strategies for implementation, no plan of action for after funds are received.
Aside from the most common ones mentioned above, business plan mistakes do abound so here are some principles to remember:
- Never include letters from customers. This makes the business plan look cheap and over selling.
- Never include a term sheet. If you indicate that you will give up 30% of the company, no one will offer less – even though they might have without the term sheet.
- Never change the business plan to fit the bank's criteria.
- Don't speculate on exit strategies as to future valuation.
- Don't supply weaknesses as information.
The number one mistake is having a shaky financial foundation – a financial forecast that is poorly created and/or documented. Lenders want all your data to be sound, and backed up by credible, verifiable resources.
What resources do lenders deem credible and verifiable?
Lenders, particularly cash flow lenders and mezzanine lenders, are open minded as to what data is used to tell the story, provided it is verifiable. Historical actual numbers, independent third party data, and management estimates are all utilised in shaping the business story. If done properly, the strategic business plan not only establishes a compelling business model and growth story, but also educates the lender as to what is important to analyse from a risk standpoint in the company.
The most important word there is "historical". These numbers should be based on reality, not your high aspirations and optimism. Including audited financial statements, if available, would make the potential lender more confident in the numbers being presented. The audit should be performed by an independent third party.
Follow these fundamentals and you are sure to create a strategic business plan that is more likely to attract not only the best financing deals, but also the right financing deals for your product.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.