How to Write a World-Class Business Plan to Attract World-Class Financing

How to Write a World-Class Business Plan for World-Class Financing

This upcoming year is going to be a big one for so many of you. According to Vistage membership polls, over 50% of members are looking to acquire and/or merge with another business in 2007. Over 75% are looking at globalization as an opportunity for growth. And the vast majority don't plan on selling the business until the distant future, if at all.

What does this mean? It's up to you to grow the business to its full potential. And regardless of whether you are an early stage or fully established company, this means you'll need capital.

So blow the dust off that ol' strategic business plan and send it to … wait. What are lenders looking for in a business plan these days? Are there ways to sharpen your plan to ensure you are not only attracting world-class lenders, but also the right types of lenders?

According to Vistage speaker David Barnitt, member Karen Rands, and speaker Gordon Tunstall, all experts in raising capital, the answer is a resounding YES.

Overall, what do lenders look for in a business plan?

Ideally, you should develop a 5-year 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, according to Barnitt, is to generate high levels of lender or investor enthusiasm for your deal -- in just a few minutes of reading. Here are his six tips that will help your 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 specialized. 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 backup your specialization and underlying processes.

Tie together the numbers and the narrative. The financial metrics and the narrative description 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 plan, the more open it will be to lend a higher loan amount, at a lower rate, with a lower amortization schedule. "Banks are hard asset oriented, Barnitt says. "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.

According to Tunstall, bank lenders have a theory of lending based on the 3 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: Amount of free cash available to amortize debt based on historical results. Ratios typically are 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.

"Banks do not like risk," Rands says. "However, if it's a Small Business Administration (SBA)-backed loan, then they will reduce the amount of collateral needed because the government guarantees 80% of the value of the loan, but the existing debt capability of the borrower must be able to sustain the remaining 20%."

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 buy-out 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. Barnitt says, “In today’s market, many mezzanine lenders are looking to fund growth versus fund a cash-out. They end up owning a small piece (generally less than 5%) of equity.

In a buy-out scenario, Rands says, "Mezzanine is used as the fill-in money between a company with a pending VC 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," Barnitt says, "which include long terms (up to 7 years) and interest-only periods (up to 5 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," Barnitt continues, "and make their money through the capital appreciation of their warrants."

"Just remember mezzanine lenders are interested in the same criteria as banks," Tunstall says, "but are looking for a growth potential because, not only do they typically require a second lien on the assets but also warrant position in the company."

What do VCs look for in a business plan?

Our experts explain what venture capitalist investors are looking for 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. Rands says, " VCs want to know how your company will scale to 100 times its size so they can get 10 to 20 times return on their money."

Intellectual property can help secure VC financing. Barnitt adds, "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," Tunstall advises, "is to always negotiate an equity earn-back. This will return the equity you gave up in the beginning based on the VC’s skeptical 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 skepticism." Tunstall says he has saved hundreds of millions of dollars based on this concept.

If you have an early stage company, what should you do differently?

Lenders and investors will be looking for different types of information in an early stage business plan compared to a plan from a more well-established company, our experts note. 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 plan must give significantly more product detail and empirical research than is needed in the advanced stage plan," Barnitt stresses.

"If you have an early stage company," Rands says, "focus on how you plan to acquire market share and how you are going to educate customers on the benefits of your product."

Tunstall adds, "Early stage 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, Barnitt says, is "the background of the founders. They are important to highlight in an early stage plan."

What common mistakes can CEOs avoid in their business plans?

Our experts have reviewed a lot of business plans, and have collected this list of the most common, avoidable mistakes:

Overaggressive 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 the 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, business plan bloopers do abound. Tunstall warns:

Never to include letters from customers. This makes the plan look cheap and over selling.
Never to include a term sheet. If you indicate the terms are that you will give up 30% of the company, no one will offer less even though they might have without the term sheet.
Never to change the plan to fit the bank's criteria.
Not to speculate on exit strategies as to future valuation.
Not to supply weaknesses as information.

The number 1 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 are deemed credible and verifiable by lenders?

Barnitt explains that "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." He continues, "Historical actual numbers, independent third party data, and management estimates are all utilized in shaping the business story. If done properly, the business plan not only establishes a compelling business model and growth story, but also educates the lender as to what is important to analyze 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 with the numbers being presented. The audit should be performed by an independent third party.

Follow these fundamentals and you are sure to create a business plan that is more likely to attract not only the best financing deals, but also the right ones for your product.