Preparing Your Business Plan
To establish a solid financial base when starting a business, most entrepreneurs must look to lenders and investors for external funds. However, it is not always easy to convince people to invest their money in another’s business. The entrepreneur first must convince potential lenders and investors that her business idea is promising, the market accessible, the firm’s management capable, and the return on investment attractive. To accomplish these objectives, the entrepreneur should develop an attractive business plan. Often, the presence or absence of such a plan is the critical factor in a lender’s or investor’s decision to invest or not to invest in a small business.
In addition, a business plan is a valuable managerial tool, helping the entrepreneur focus on developing a course for the business in the future. In fact, the primary purpose of building a business plan is to improve managerial control over the company and to avoid the pitfalls commonly leading to business failure. Unfortunately, most small business owners never create business plans, and the result often is failure. According to one business consultant, “One of the reasons we feel business failure is as great as it is, is businesses are so concerned with meeting a payroll each week, they never take the time to make a business plan. ”This lack of planning starts a vicious cycle that is extremely difficult for owners to break: Failure to plan leads to business crises, which drive planning out of the owner’s schedule, which leads to more crises, which I see a direct relationship between the absence of a business plan and the failure of a business,” says one consultant.
Building a plan forces management to consider the long-term aspects of the company in a comprehensive fashion; using it to raise money is secondary. One business development consultant emphasizes, “When I speak of business plans, raising money is the last thing I talk about.” When prepared properly the business planning process helps managers establish checkpoints for key activities and view the big picture. Creating a plan forces the entrepreneur to evaluate every segment of her company (proposed or existing) and to develop a series of strategies for coping with an uncertain environment. In addition to the what-if scenarios the plan forces the entrepreneur to consider, there are other benefits.
1) a systematic, realistic evaluation of the company’s chances for success in the market
2) a way to determine the primary risks confronting the business
3) a game plan for managing the business successfully
4) a tool for comparing actual results against targeted performance
5) a primary tool for attracting money in the challenging hunt for capital
This chapter focuses on preparing and using this vital business document; it will build a business plan on the foundation laid in the first ten chapters of this book.
I. THE BUSINESS PLAN
The business plan is a written summary of the entrepreneur’s proposed venture, its operational and financial details, its marketing opportunities and strategy, and its managers’ skills and abilities. There is no substitute for a well-prepared business plan, and there are no shortcuts to creating it. “Your business plan is like a road map,” says one small business consultant. “It describes the direction the company is going in, what its goals are, where it wants to be, and how it’s going to get there.” Tile plan is written proof that the entrepreneur has performed the necessary research and has studied the business opportunity adequately. In short, it is the entrepreneur’s best insurance against launching a business destined to fail or mismanaging a potentially successful company.
The business Plan serves two essential functions. First—and most important—it guides the operation of the company by charting its future course and devising a strategy for following it. It provides a battery of tools—a mission, goals, objectives, budgets, financial forecasts, target markets, strategies, and others—that managers can draw on to lead the company successfully. A business plan gives managers and employees a sense of direction, but only if everyone is involved in creating, updating, or altering it. As more team members become committed to making the plan work, it takes on special meaning. It gives everyone targets to shoot for; and it is an effective tool for measuring actual performance, especially in the startup phase. A chairman of a highly successful family business that is international in scope, relies heavily on business plans to manage his company’s diverse holdings. He points to an extraordinary number of computer-generated spreadsheets lining the walls of his bedroom and explains, “This is what is supposed to happen.” The sheets are filled with forecasted cash flow statements, income statements, balance sheets, price analyses, and other information. “Below,” he says pointing to empty charts waiting to be filled in with actual results “is what will happen.” Then, he jokingly adds, “This is the only potential problem in my life.” Below are 10 pitfalls that offer advice on how the business owner can put the plan to work for the company.
TEN PLANNING PITFALLS AND HOW TO AVOID THEM
It’s true: The process of preparing a business plan is itself valuable. But, it doesn’t make sense to develop such a comprehensive document and then to forget about it. The following is a list of the ten most common mistakes business owners make in using their plans—and the remedies for them.
1. Single-purpose use. Entrepreneurs typically prepare a plan to raise money and seldom give thought to actually using it.
Remedy: Stress implementation. The plan must include specific objectives for key managers and a plan to accomplish them.
2. One-person commitment. If one person writes the entire plan (e.g., the company president), key managers are unlikely to be committed fully to it.
Remedy: Involve all members of the management team in preparing the plan. Have each member write a section of the plan.
3. Benign neglect. Once completed, the business plan sits on the shelf and collects dust. Out of sight, out of mind.
Remedy: Make following up the plan easy. Schedule regular meetings to discuss the plan and the progress made in accomplishing the goals and objectives established.
4. Unworkable document. Managers create a plan that is so huge and complex that it discourages everyone from actually using it.
Remedy: Give the plan life by developing one-page action summaries for each department. Ask managers to update progress on their responsibilities at periodic meetings.
5. Unbalanced application. Sometimes, managers give a disproportionate amount of attention to one portion of the plan—marketing or finance, for example.
Remedy: Get balanced participation from key managers and employees in all areas of the company. Plus, focus 90 percent of management attention within the next year.
6. Disillusionment. Managers get disillusioned when the scenario laid out in the plan fails to develop.
Remedy: Develop contingency plans—both positive and negative. What happens if.
7. Too action-oriented. Action-oriented managers tend to forget about the plan once it is completed. They want to get back to the real world of business.
Remedy: Use their action-orientation to encourage these managers to develop plans for their areas of responsibility.
8. No performance standard. Too often, managers fail to establish measurable standards in the plan.
Remedy: Encourage managers to establish specific, measurable objectives in their respective areas.
9. Poor progress control. Implementing the plan is without control because progress reports are lost in the jumble of everyday business.
Remedy: Hold regular meetings to discuss progress on the plan and nothing else.
10. Early consumption. The plan becomes outdated because no one bothers to update it.
Remedy: Update the plan every six months. That way you never run out of plans.
The second vital function of the business plan is to attract lenders and investors. Too often small business owners approach potential lenders and investors unprepared to sell themselves and their business concept. Simply scribbling a few rough figures on a note pad to support a loan application is not enough. Applying for loans or attempting to attract investors without a business plan rarely produces the desired results. The best way to secure the necessary capital is to prepare a sound business plan. The entrepreneur must develop it with great attention to detail because it is a key factor in her sales presentation to potential lenders and investors. In most cases, the quality of the firm’s business plan will weigh heavily in the decision to lend or to invest funds. The quality of the plan determines the first impression the potential lenders and investors have of the company and its managers. Therefore, the finished product should be highly polished and professional in both form and content.
A plan is a reflection of its creator. It should demonstrate that the entrepreneur has thought seriously about the venture and what will make it succeed. Preparing a solid plan demonstrates that the entrepreneur has taken the time to commit her idea to paper. Susan Garber, a Small Business Development Center (SBDC) director, advises, “To take the step of starting a business without thinking it through is a big mistake.” Still, too many entrepreneurs do just that. Garber claims that, of the clients she sees, “only one in a hundred has a reasonable business plan." The main reason is impatience. Another business adviser says, “They want to get on with building the business; they don’t have time to write a business plan.’
Building a plan also forces the entrepreneur to consider both the positive and the negative aspects of the business. Explains one venture capital manager, The first thing venture capitalists react to is the business plan because it shows that the individuals have done the necessary spade work to show that they are serious. I want to see that management has had the discipline to put the plan down on paper which means that they have a half-way decent chance of building a business. If they don’t do this exercise, they probably won’t have the discipline to build a business. “
An entrepreneur cannot allow others to prepare the business plan for him. Outsiders cannot understand the business nor envision the proposed company as well as the entrepreneur can. Also, because he will make the presentation to potential lenders and investors, the owner must understand the details of the entire business plan. If the entrepreneur lacks a complete understanding of the plan, he will receive a negative evaluation, and in most cases, the result will be rejected by the financial institution or investor. Alice Medrich, cofounder of Cocolat, a manufacturer of specialty candies and desserts, recalls her first attempt at raising capital.
First of all, I went to the bank, and I was so ill-prepared and so insecure about what I was asking about. . . I was extremely insecure with a banker. I didn’t know how to describe what I was doing with any confidence. I did not know how to present a business plan. And, he was condescending to me. Looking back on it, I can understand why: I wasn’t prepared. . . . We didn’t get the loan.
Careful, thoughtful preparation can make the difference between success and failure when shopping the capital market. As one successful applicant who used professional assistance stated, “I had never borrowed a lot of money before, hut I felt comfortable talking with bankers because I had a proposition I believed in and had the necessary information.”
Although each company’s business plan should emphasize the unique personality of the venture, every plan should follow certain guidelines. This section highlights the major elements of an effective business plan.
II. THE ELEMENTS OF A BUSINESS PLAN
This section outlines the primary components of a solid business plan, but every small business owner must recognize that such a plan should he tailor-made, emphasizing the company’s strengths. Many small business managers employ the professional assistance of attorneys and accountants in preparing their business plans. For those owners who are unfamiliar or uncomfortable with business planning, hiring such professionals to organize and polish the plan may be wise. But, the proliferation of standardized planning formats has resulted in a trend toward mass-produced business plans that fail to produce results. The entrepreneur should beware of this cookie-cutter approach because it neglects to sell the unique strengths of a proposed business venture.
Remember: No one can create your plan for you.
Parts of the Business Plan
The Executive Summary. To summarize the presentation to each potential financial institution or investor, the entrepreneur should develop an executive summary. It should he concise—a maximum of two pages—and should summarize all of the relevant points of the proposed deal. The summary should explain the purpose of the financial request, the dollar amount requested, how the funds will be used, and how any loans will be repaid. It is designed to capture the reader’s attention. If it misses, the chances of the remainder of the plan being read are minimal. A well-developed, coherent summary introducing the financial proposal will establish a favorable first impression of the owners and the business, and can go a long way toward obtaining financing. Although the executive summary is the first part of the business plan, it should be the last section written.
Company History. The manager of an existing small business should prepare a brief history of tile operation, highlighting the significant financial and operational events in the company’s life. This section should focus on the successful accomplishment of past objectives and should indicate the firm’s image.
Business Profile. To familiarize lenders and investors with the nature of the business, the owner should incorporate into the business plan a general description of its operation. This section should begin with a statement of the company’s general business goals and a narrower definition of its immediate objectives. Together, they define what the business plans to accomplish, how, when, and who will do it. Goals are long-range, broad statements of what the company plans to accomplish in the distant future. They are aspirations that guide the overall direction of the company and express the company’s raison d’ętre. In other words, they answer the question, “Why am I in business?” Answering such a basic question appears to be obvious, but many entrepreneurs cannot define the basic purpose of their businesses. The director of an entrepreneurial boot camp says, It’s amazing what a tortuous experience [defining the business’ purpose] can be. It’s hard for them to distill their ideas . . . Many people don’t know what business they are in.”
The owner of a small chain of baby products stores has clearly defined his company’s mission.
To serve best the needs of customers who are retail stores offering an incomparable combination of selection, quality, and service at competitive prices.
Objectives, on the other hand, are short-term, specific targets that are attainable, measurable, and controllable. Every objective should reflect some general business goal and include a technique for measuring progress toward its accomplishment. To be meaningful, an objective must have a time frame for achievement.
In summarizing the small company’s background, the owner should describe the present state of the art in the industry and identify the key factors needed for success in the market segment she will compete in. She should describe the current applications of the product/service in the market and include projections for future applications. For example, a manufacturer of silicon chips could discuss the key role his product plays in computer technology and could project increased demand by robot manufacturers. In addition, the owner should incorporate into the plan general long-term growth trends for the entire industry, including stability for product demand and emerging trends affecting demand. This section also should describe the influence of government regulation and legislation in the business operation.
Business Strategy. An even more important part of the business plan is the owner’s view of the strategy needed to meet the competition. It should comment on how the owner plans to achieve business objectives in the face of competition and government regulation. One investment adviser states, “Many business plans give fancy, impressive financial projections, but don’t sufficiently tell you how the company is going to reach these projections." The manager also must describe the firm’s desired character—the image the business will try to project.
For example, a clothing store could project several images: a high quality, classic merchandise shop; a trendy, high fashion store; or an economy-oriented discount outlet. This segment of the business plan should outline the methods the company can use to meet the key requirements for success identified earlier. If, for example, a strong, well-trained sales force is considered a critical element for success, the owner must develop a plan of action for assembling one. This section should highlight basic strategic elements.
Description of Firm’s Product/Service. The business owner should describe the company’s overall product line, giving an overview of how the goods/ services are used. Drawings, diagrams, and illustrations may be required if the product is highly technical. It is best to write product and service descriptions so that laypeople can understand them. A statement of the goods’ position in the product life cycle might also he helpful. The manager should include a summary of any patents, trademarks, or copyrights protecting the product or service from infringement by competitors. Finally, the owner should provide an honest comparison of the company’s product or service with those of competitors, citing specific advantages or improvements that make her goods or services unique and indicating plans for developing next generation goods and services that evolve from the present product line.
Manufacturers should provide a description of the production process employed, strategic raw materials required, and sources of supply used. In addition, they should summarize the method of production and illustrate the plant layout.
Marketing Strategy. One of the most crucial Concerns of potential lenders and investors is whether there is a real market for the proposed good or service. Every small business owner seeking funds must incorporate into the business plan a description of the company’s target market and its characteristics. Defining the target market and its potential is one of the most important and most difficult parts of a business plan. It must show how the entrepreneur plans to turn the idea into a product or service customers will want to buy. For example, the owner of a small chain of baby products stores identified his firm’s typical customer as an expectant mother 18 to 34 years old (an average of 26.3 years) in the fifth to eighth month of pregnancy, most often shopping with her mother. One venture capitalist claims that the investor “needs to believe that the company has targeted an attractive market and has developed a plan to capture an unfair share of it.”
Proving that a profitable market exists involves two steps:
1. Showing Marketplace Interest. The entrepreneur must be able to prove that customers in the marketplace have a need for the good or service and are willing to pay for it. This phase is relatively straightforward for a company with an existing product or service, but can he quite difficult for one with only an idea or a prototype. In this case, the entrepreneur might offer the prototype to several potential customers to get written testimonials and evaluations to show investors. Or, the owner could sell the product to several customers at a significant discount. This would prove that there are potential customers for the product and would allow demonstrations of the product in operation.
2. Documenting market claims. Too many business plans rely on vague generalizations like, “This market is so huge that if we get just 1 percent of it, we will break even in eight months.” Such statements are not backed by facts and may not be realistic. Says one venture specialist, “I’m really not interested in having a 2-percent market share of an $8-billion business because I know that you can’t get that kind of market share with a new venture.”
Claims of market size and growth rates should be supported by facts. Results of market surveys, customer questionnaires, and demographic studies lend credibility to an entrepreneur’s frequently optimistic sales projections. Quantitative market data are important because they form the basis for all of the company’s financial projections in the business plan.
One entrepreneur set out to prove that there was a sufficient market for his business idea: a convenience food restaurant offering complete take-out meals for professionals who lack the time to cook. He collected volumes of data on customer buying habits and developed a demographic profile of the customer most likely to patronize his restaurant: two-income families and single heads of households. From surveys, he discovered that price is not the primary consideration; quality and convenience outweigh price concerns.
The essential goal of this section of the plan is to identify the basics for the financial forecasts that follow. Sales, profit, and cash forecasts must be founded in more than wishful thinking. An effective market analysis should identify the following.
Target market—Who are the primary customers? What are their characteristics? What do they buy? Why do they buy? What expectations do they have about the product or service?
Market size and trends—How large is the potential market? Is it growing or shrinking? Why? Are customer needs changing? Are sales seasonal? Is demand tied to another product or service?
Pricing—What price tiers exist in the market? How sensitive are customers to price changes? Can the planned price produce a profit?
Advertising—Which media are most effective in reading the target market? How will they be used?
Distribution—How will the product or service he distributed? What is the average sale? How many sales calls does it take to close a sale? What incentives exist for sales people?
This portion of the plan also should describe the channels of distribution the small business will employ (mail, in-house sales force, sales agents, retailers). Also, the owner should summarize the firm’s overall pricing policies as well as its promotion policies, including the advertising budget, media used, and publicity efforts. The company’s warranties and guarantees for its products and services should be addressed.
This portion of the plan must emphasize the entrepreneur’s understanding of her target customers. One private investor advises entrepreneurs writing business plans as follows.
Be market-driven, not product-driven. Show a well-researched understanding of what customers really want. Highlight the benefits to a customer purchasing the product or service. Wherever possible, quantify benefits in terms of cost savings or revenue generation. Show who and where customers are. Quantify the market in terms of units or dollars or both.
Competitor Analysis. The entrepreneur also should describe the competition the company faces. Failure to provide a realistic assessment of competitors makes the owner appear to he poorly prepared, naive, or dishonest. Gathering information on competitors’ market shares, products, and strategies usually is not difficult. Trade associations, customers, industry journals, marketing representatives, and sales literature are valuable sources of data. The focus of this section should be to demonstrate how the entrepreneur’s company has an advantage over its competitors. What distinguishes her products or service from others already on the market and how will these differences produce a competitive edge? According to one financial expert, “The most successful small companies are those that begin with a marketing approach which determines what the market wants and then invents it”
Officers’/Owners’ Resumes. The most important factor in the success of a business venture is its management. Financial officers and investors weigh heavily the ability and experience of the firm’s managers in financing decisions. Explains the owner of an executive search firm, “Entrepreneurs must recognize what they do well and what they don’t do well, and then create a management team with complementary skills to get the job done. People are the most important part of making a new venture work.” The plan should include the resumes of business officers, key directors, and any person with at least 20 percent ownership in the company. Remember: Lenders and investors prefer experienced managers.
A resume should summarize the individual’s education, work history emphasizing managerial responsibilities and duties), and relevant business experience. When compiling a personal profile, the owner should review the primary reasons for small business failure and show how the team will use its skills and experience to avoid them. Lenders and investors will look for the experience, talent, and integrity of the people who will breathe life into the plan. This portion of the plan should show that the company has the right people organized in the right fashion for success, One experienced private investor advises entrepreneurs to remember the following.
Ideas and products don’t succeed; people do. Show the strength of’ your management team. A top-notch management team with a variety of proven skills is crucial Show the strength of key employees and how you will retain them. A Board of Directors or advisers consisting of industry experts lends credibility and can enhance the value of the management team.
Plan of Operation. To complete the description of the business, the owner must construct a functional organizational chart which identifies key positions and the personnel occupying them. Assembling a management team with the right stuff is difficult, but keeping it together until the company gets established may be harder. Thus, the entrepreneur should describe briefly the steps taken to encourage key officers to remain with the company. Employment contracts, shares of ownership, and perks are commonly used to keep and motivate key employees.
Finally, a description of the form of ownership (partnership, joint venture, S corporation) and of any leases, contracts, and other relevant agreements pertaining to the operation is also helpful.
Financial Data. One of the most important sections in the business plan is a detailed outline of the loan or investment package—the dollars and cents of the proposed deal, Lenders and investors use past financial statements to judge the health of the small company and its ability to repay loans or generate adequate returns. The owner should supply copies of the firm’s major financial statements from the past three years. These statements should be audited by a certified public accountant, because financial institutions prefer that extra reliability. However, a financial review of the statements by an accountant may satisfy some requirements.
The manager must carefully prepare monthly projected (or pro forma) financial statements for the operation for the next two to three years (and possibly for two more years by quarters) using past operating data, published statistics, and judgment to derive three sets of forecasts of the income statement, balance sheet, cash budget, and schedule of planned capital expenditures. She should include forecasts under pessimistic, most likely, and optimistic conditions to reflect the uncertainty of the future. One consultant says that the most common mistake entrepreneurs make when building a business plan is failing to plan for various scenarios. “It’s always important to remember what the risks are,” she says. It is essential that all three sets of forecasts be realistic. Entrepreneurs must avoid the tendency to fudge the numbers to look really impressive. Financial officers will compare these projections against published industry standards and will detect unreasonable forecasts. In fact, some venture capitalists automatically discount an entrepreneur’s financial projections by as much as 50 percent. Once she completes the forecasts, the owner can perform break-even and ratio analysis on the projected figures.
It is also important to include a statement of the assumptions on which these financial projections are based. Potential lenders and investors will want to know how the entrepreneur derived forecasts for sales, cost of goods sold, operating expenses, accounts receivable, collections, inventory, and other key items. Spelling out such assumptions gives a plan more credibility. The table below offers ten ways to enhance the quality of forecasted financial statements.
Ten ways to strengthen internally prepared financial statements.
1. Use a pyramid of reports (i.e., summaries supported by progressive levels of detail).
2. Compare historical statements (actual results) to forecasted statements made in the past. This will help you determine how accurate your forecasting methods have been.
3. Include nonfinancial statistics such as units shipped, inventory turnover, etc. Although this information may be contained elsewhere in your business plan, it helps to explain the big picture.
4. Plot trends in key statistics using graphs. A visual interpretation of the information makes it easier to comprehend the course your business is traveling.
5. Isolate all nonrecurring costs and investments that will pay off in the future. This is one of the most important concerns of potential investors/lenders.
6. Show sales detail (e.g., by units vs. replacement parts, by product lines, by distribution channels). Again, the more detail you can provide, the fewer questions that will arise from investors/lenders.
7. Separate discounts using standard selling prices and codes for various types of discounts. Controlling revenue erosion can be just as important as controlling costs.
8. Analyze costs including incremental (variable), programmed (discretionary) and fixed.
9. Separate operational costs by function (e.g., purchasing, marketing). Investors/lenders will want to see where money has been spent in the past, but groups of similar costs are more meaningful than a multiplicity of accounts.
10. Identify total employee costs by grouping fringe benefit costs along with monetary compensation.
The Loan Proposal. This section of the business plan should state the purpose of the loan, the amount requested, and the plans for repayment. When describing the purpose of the loan, the owner must remember to be specific in explaining the planned use of the funds. General requests for funds using terms such as for modernization, working capital, or expansion are unlikely to win approval.
Instead, descriptions such as to modernize production facilities by purchasing five new, more efficient looms that will boost productivity by 12 percent or to rebuild merchandise inventory for fall sales peak, beginning in early summer should be used. The entrepreneur also must specify the precise amount requested and include relevant backup data, such as vendor estimates of costs or past production levels. The owner should not hesitate to request the amount of money needed, hut should not inflate the amount anticipating the financial officer to talk her down. Lenders and investors are familiar with industry cost structures. One experienced investor says, “Indicate the investment expected. Show how much money the enterprise is seeking, the form of investment sought, how the funds will be used, and what portion of the business the investment will purchase [if equity].”
Another key element of the loan or investment proposal is the repayment schedule or exit strategy. A banker’s primary consideration in granting a loan is the reassurance that the applicant will repay, while an investor’s major concern is earning a satisfactory rate of return. Financial projections must reflect the firm’s ability to repay loans and produce adequate yields. Without this proof, a request for additional funds stands little chance of being accepted. It is critical for the owner to produce tangible evidence showing the ability to repay loans or to generate attractive returns. “Plan an exit for the investor, says the owner of a financial consulting company. “Generally, the equity investor’s objective with early stage funding is to earn a 30 to 50 percent annual return over the life of the investment. To enhance the investor’s interest in your enterprise, show how they can ‘cash out,’ perhaps through a public offering or acquisition.”
Finally, the owner must include a timetable for implementing the proposed plan. He should present a schedule showing the estimated startup date for the project and noting any significant milestones along the way. Entrepreneurs tend to be optimistic, so the owner must be sure his timetable of events is realistic.
Preparing a sound business plan clearly requires time and effort, but the benefits gained greatly exceed the costs of developing a plan. Building the plan forces a potential entrepreneur to look at a business idea in the harsh light of reality. It also requires the owner to assess the venture’s chances of success more objectively. Sometimes, the greatest service this exercise provides is the realization that it just won’t work. In other cases, it brings to light important problems to overcome before launching a company. As one business consultant states, “If you do a really good job of writing your business plan, it’s more than just putting words on paper. You do a lot of research, and you expose a lot of flaws. Each one that you expose and treat, you enhance the chances of your success.”
Lenders and investors are favorably impressed by small business owners who are informed and prepared when making a loan or investment request. Failure to collect, to interpret, and to present relevant financial and operational data with a request for debt or equity funds often leads to rejection.
Honesty is also a critical factor in preparing a business plan. It is not wise to try to fool a financial officer by adjusting figures to portray the business more favorably. They know their business and frown on fraudulent attempts to obtain financing.
III. WHAT DOES A BANKER LOOK FOR?
Banks are a common source of debt capital for small businesses. Existing small businesses may need periodic cash infusions, for which they rely on lines of credit from their bankers. To improve the chance of obtaining such loans, the entrepreneur should know what a loan officer looks for in a bankable small business loan. Most bankers consider a loan acceptable if it conforms to the five Cs of credit: capital, capacity, collateral, character, and conditions.
Capital. A small business must have a stable capital base before a bank will grant a loan. Otherwise the bank, in effect, would be making a capital investment in the business. Most banks refuse to make loans that are capital investments because the potential for return on the investment is limited strictly to the interest on the loan, and the potential loss would probably exceed the reward. In fact, the most commonly cited reasons banks give for rejecting small business loan applications are undercapitalization or too much debt. The bank expects the small business to have an equity base of investment by the owner(s) that will help support the venture during times of financial strain.
Capacity. A synonym for capacity is cash flow. The bank must be convinced of the firm’s ability to meet its regular financial obligations and to repay the bank loan, and that takes cash. Many small businesses fail from lack of cash than from lack of profit. It is possible for a company to he showing a profit and still have no cash—that is, to be technically bankrupt. Bankers expect the small business loan applicant to pass the test of liquidity, especially for short-term loans. The bank will study closely the small company’s cash flow position to decide whether it meets the capacity required.
Collateral. Collateral includes any assets the owner pledges to the bank as security for repayment of the loan. If the company defaults on the loan, the bank has the right to sell the collateral and use the proceeds to satisfy the loan. Typically, banks make very few unsecured loans (those not backed by collateral) to business startups. Bankers view the owner’s willingness to pledge collateral (personal or business assets) as an indication of the small business owner’s dedication to making the venture a success. But, a sound business plan can improve a banker’s attitude toward a venture. One business adviser claims, “A banker will require [less] hard collateral if he sees that he can believe in the business plan.”
Character. Before approving a loan to a small business, the banker must be satisfied with the owner’s character. The evaluation of character frequently is based on intangible factors like honesty, competence, polish, determination, intelligence, and ability. Although the qualities judged are abstract, this evaluation plays a critical role in the banker’s decision. One financier explains, “The most exciting thing to the venture capitalist is talking to management one-on-one. To invest, you have to get caught up in the high-energy level, enthusiasm of people, and their ability to impress you that they know their business.”
Loan officers know that most small businesses fail because of incompetent management, and they try to avoid extending loans to high-risk managers. The business plan described in this chapter and a polished presentation by the entrepreneur can go far in convincing the banker of the owner’s capability. As one successful loan candidate who painstakingly prepared a business plan and perfected a presentation technique says, “Many applicants shuffle in with their hands in their pockets and their eyes on their shoes. They don’t quite know how to make a presentation.”
Conditions. The conditions surrounding a loan request also affect the owner’s chance of receiving funds. Banks will consider factors relating to the business operation such as potential growth in the market, competition, location, form of ownership, and loan purpose. Again, the owner should provide this relevant information in an organized format in the business plan. Another important condition influencing the banker’s decision is the shape of the overall economy, including interest rate levels, inflation rate, and demand for money.
The higher a small business scores on these five Cs, the greater its chance of receiving a loan. The wise entrepreneur will keep this in mind when preparing a business plan and presentation.
Although every company’s business plan will be unique, reflecting its individual circumstances, certain elements are universal. The following outline summarizes these components.
I. Executive Summary (not to exceed two typewritten pages)
A. Company name, address and phone number
B. Name(s), addresses, and phone number(s) of all key people
C. Brief description of the business
D. Brief overview of the market for your product
E. Brief overview of the strategic actions you plan to take to make your firm a success
F. Brief description of the managerial and technical experience of your key people
G. Brief statement of what the strategic actions are and what would the money be used for. In addition, income statements and balance sheets for the last three years of operation
II. Detailed Business Plan
A. Background on your business
1. Brief history of the business
2. Current situation
B. Your Business
1. Complete and detailed description of your business
What makes your business unique?
How does it create value for others?
Describe the key factors that will dictate the success of your business (i.e., price competitiveness, quality, durability, dependability, technical features, etc.)
C. Market Analysis
1. Who are the potential buyers for your products? (Please be specific.)
2. What is their motivation to buy?
3. How many customers does the market contain? (How large is the market?)
4. What are their potential annual purchases?
5. What is the nature of the buying cycle?
Is this product a durable good that lasts for years or a product that is repurchased on a regular basis?
Is the product likely to be purchased at only seasonal periods during the year?
6. Specific target market—What do you know about the potential customer you are likely to sell to in your geographic area?
If yours is a consumer product:
a. What are the product features that you feel influence the consumer’s buying decision?
b. What, if an\, research Supports your feeling?
c. Does the consumer have a preference in where he or she purchases comparable products? How strong is this preference?
7. External market influence. How might each of the following external forces affect the sale or profitability of your product?
Economic factors such as:
c. high or low unemployment
Social factors such as:
a. age of customers
b. locational demographics
c. income levels
d. size of household
e. specific societal attitudes
D. Competitor Analysis
1. Describe each of the following factors and discuss how these factors will influence your success.
a. Who are they? Please list major known competitors.
b. Why do you believe the potential customers in your target market buy from them now?
Potential firms who might enter the market
a. Who are they and when and why might they enter the market?
b. What would be the impact in your target market segment if they enter?
What are the strengths and weaknesses of each competitor’s business?
E. Strategic Plan for Your Business
1. How do you plan to market your products to the target market you identified above? Please specifically identify your marketing strategy on key factors such as:
product promotion and advertising
2. How will your products match up against those presently in the market?
F. Specifics of Your Organization and Management
1. How is your business organized?
legally (corporation, S corporation, partnership, sole proprietorship)
2. Who are the key people (or will be) in your business? What are their backgrounds and what do they bring to the business that will enhance the chance of success?
G. Financial Plans
1. How much money do you need to make this product and your business a long-term success?
Tie the response to this question to your production and marketing plan.
be realistic and specific
2. Create a cash budget. Show the banker or investor what you need in terms of money, when you need it, and how and when you plan to generate revenues from operations and sales.
3. Have a realistic projection of costs of operations
other (i.e., unique startup costs)
4. Present actual and projected balance sheets and income statements
5. Prepare a break-even analysis
H. Strategic Action Plan
1. Clear mission statement for your business
2. Specific performance goals and objectives
3. Restatement of your production and marketing strategies
4. How these strategies will be converted into operating action plans
5. What control procedures you plan to establish to keep the business on track
Attracting capital to launch a new business or to boost an existing one is not an easy task. The entrepreneur must prove to potential lenders that the business is a good credit risk and must show potential investors that an investment in the business offers the potential for an attractive return. To improve the chance of attracting debt or equity capital, the entrepreneur must prepare a well-organized business plan. This document gives lenders and investors an opportunity to evaluate the firm’s strengths. Developing a sound business plan also provides the entrepreneur with the foundation for preparing a coherent presentation to lenders and investors. Without these preparations, the small business owner greatly reduces the chances of obtaining financing.
Every business plan should contain a simple break-even anal sis. which shows the level of operations at which total revenues equal total costs. Although just a simple screening device, break-even analysis is a useful planning tool for the entrepreneur, and it allows lenders and investors to evaluate the potential success of a small business.
Too often, entrepreneurs approach potential lenders and investors poorly prepared to prove their need for financing and the worth of their businesses. The result is almost always refusal of the loan request. To avoid being rejected, the well-prepared owner will develop a business plan summarizing the relevant operational details of the proposed venture. Most financial officers weigh heavily the quality of the owner’s business plan and its presentation in making a lending or investing decision.
The following should be included in a typical business plan: the cover letter; the owners’ and officers’ resumes; the company history; the general business summary, defining the organization’s primary mission as well as its goals and its objectives; the business strategy; the description of the product or service; the marketing strategy; the plan of operation; the financial plan; and the loan proposal.
Banks are an important source of small business financing. The small business owner seeking additional funds must be aware of the five Cs of credit—capital, capacity, collateral, character, and conditions—and their importance to bankers.
By preparing a thoughtful, coherent business plan and by making a smooth, polished loan request presentation, the entrepreneur can greatly improve the chances of attracting debt and equity funds.
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