In this series of articles, I will post ten simple ideas from chapters in The Ernst & Young Business Plan Guide (3rd edition). This second post in the series brings out ten simple ideas from Chapter 2, Who Reads the Business Plan?.
Introduction
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Image Source: pixabay.com
License: CC0, Public Domain
The Ernst & Young Business Plan Guide (3rd edition) discusses business plan creation from the perspective of the entrepreneur. As we learned in yesterday's post, [Ten Simple Ideas] The Ernst & Young Business Plan Guide: Chapter by Chapter - Series Overview and Chapter 1, the business plan has a triple purpose that should undergo near continuous revision. It is used as a planning tool, as a yardstick for measuring past performance, and for raising funds.
In today's post, we will talk about the target audience of the business plan. In general, from inside the enterprise the target audience includes top-level managers and members of the board of directors. Externally, readers may include advisers and funding sources.
Borrowing from the Ten Simple Rules series of articles at PLOS, the remainder of this post will include ten simple ideas about a business plan's target audience.
Ten Simple Ideas from Chapter 2, The Busines Plan
1.) The business plan has an internal audience and an external audience.
The internal audience for the business plan includes high level management and the board of directors. As discussed in chapter one, this audience uses the business plan for three purposes, forward-looking project selection; backwards looking performance evaluation; and pursuing funding.
The external audience includes potential sources of funding or advice.
2.) There are numerous potential sources of funding to be considered.
Potential funding sources in the chapter include private lenders, government loans and grants, venture capital funds, angel investors, as well as "self, family, and friends". Most of these will be covered in more detail in the remainder of this post. Of course, when the book was written in 2007, crowdfunding was a nascent phenomenon, so the modern entrepreneur also needs to consider crowdfunding resources like gofundme.com or fundition.io.
3.) Private lenders look for the "four Cs"
The "four Cs" are character, cash flow, collateral, and contribution. These are discussed in detail in the book, so I recommend reading the chapter. In an article of this format, discussion here must be brief.
Character: To the lender, this means credit score + intangibles. The lender will look for someone with a good credit score and other intangible characteristics like talent, reliability, and honesty.
Cash flow: The business plan needs to convince the lender that cash flow will be sufficient to cover the interest and principal payments on the debt. Some lenders may be willing to defer principal payments for up to a year, but interest payments begin immediately, and a missed interest payment triggers a default.
Collateral: Collateral alone is usually not enough to secure a business loan, but it does help to persuade the lender. In general, lenders will look for as much collateral as they can get to secure the loan. The authors also point out that lenders normally require the entrepreneur's signature, so the LLC does not protect individuals from the risk of defaulting on a loan.
Contribution: Lenders typically require a substantial contribution from the entrepreneur in terms of time and money. This helps to protect their investment by ensuring that the entrepreneur's well-being is closely tied to the success of the venture.
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License: CC0, Public Domain
Image Source: pixabay.com
License: CC0, Public Domain
4.) The private lender is relatively risk averse
In general, the length of the loan depends upon the useful life of the assets being financed and the interest rate is variable rate, tied to the prime lending rate. Both of these trends shift loan risk from the lender to the borrower. Lenders may exhibit some minimal flexibility, but they are generally going to structure the loans in a way that maximizes their chances to recoup their investments.
5.) Private financing is generally faster than securing venture capital.
A private loan can be secured in as little as two to three months. In contrast, an entrepreneur can expect venture funding to take up to six months or more. After spending 4 to 6 weeks creating a business plan, the authors give the following generic timeline for securing venture funding:
Weeks 1-2: Initial contact with potential funding sources
Week 3: Mail executive summary and/or complete plan
Weeks 4-6: Initial meetings with potential funders.
Weeks 7-18: Follow-up communications with potential funders.
Weeks 19-26: Offer made, negotiate terms.
Week 26: Deal closing.
6.) Venture capital funds are seeking big wins: Returns of 25-50% APR and investments that become liquid in a short period of time. To achieve this they seek three qualities:
- An entrepreneur with maturity, experience, and a successful track record.
- A fully balanced and staffed organization.
- Proprietary characteristics like patents, trademarks, or licenses.
The authors note that the venture funds will often insist on having a seat on the board. They don't want to get involved in day to day operations, but they will if their investment starts to go south.
7.) Funding can be obtained in multiple rounds.
The book mentions that venture capital funds normally have high minimum investments, over $100,000 or even $1,000,000. It also notes that some venture firms prefer to get involved with second or third rounds of funding, after a firm has established a track record.
8.) According to this chapter, most initial investments do not come from venture capitalists. Rather, it comes from people who are "at less than arm's length." This can include one's self, friends, family and colleagues.
Some entrepreneurs put start-up costs on high interest credit cards (not recommended). Others sell assets, use equity in a home or other investment, obtain small business loans, or obtain funding from family and associates.
One point for consideration with the last group is that a failed business can put strains on family relationships and friendships.
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License: CC0, Public Domain
Image Source: pixabay.com
License: CC0, Public Domain
9.) The "Angel Investor", corporate venture capitalists, and ad-hoc venture pools occupy the landscape between self-funding and venture funds.
Angel investors: As noted above, venture firms typically start their funding between $100,000 and $1,000,000. If the entrepreneur needs less than that, but more than is available through self-funding, "angel investors" may fill the gap. These are private individuals who are seeking high returns on investment.
As with venture funds, angel investors may focus upon a specific market niche. A benefit to working with angel investors is that the deal can be structured in any fashion that can be negotiated. The chapter recommends finding them through venture capital clubs, breakfast clubs, or through professional contacts.
Corporate venture capitalists: Some corporations launch venture capital initiatives in order to spur development that is helpful for their particular market niche.
Ad-hoc venture pools: This may be a predecessor of crowd-funding. Groups of people sometimes self-organize into investment groups or investment pools. These include small business investment corporations (SBICs), economic development groups, private foundations, and even some mutual funds.
10.) Vendors may be the most overlooked resource for financing.
An entrepreneur can sometimes negotiate an extra 30 or 60 days of credit on accounts payable in order to minimize capital requirements and ease cash crunches
Conclusion
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License: CC0, Public Domain
Image Source: pixabay.com
License: CC0, Public Domain
Despite the three-fold purpose of the business plan, this chapter focused mostly on financial factors. It should be noted that dollar values are from 2007 and they may have changed. Another important change in the landscape since 2007 has been the emergence of crowdfunding.
The key ideas from this chapter include the fact that the business plan is written for internal and external audiences, and that there is a large landscape to consider when seeking funding. The entrepreneur may even want (or be forced) to organize funding efforts into several rounds of funding.
Check back tomorrow for ten simple ideas from chapter 3, Legal Forms of a Business in The Ernst & Young Business Plan Guide (3rd edition).
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