One of the major purposes of a business plan is to attract funds from potential lenders and investors. A good business plan is supposed to give clear projections and hope that when an investor invests his or her money, they are going to get a return on their investment.
The truth is that investors usually provide large sums of capital for ownership (equity) in a startup business and expect to cash out within 5 to 7 years. This is the reason why they often place more emphasis on the entrepreneur’s character.
Investors also demand high rates of return and will thus focus on the market and financial projections when they go through your business plan. Having said that, if you are looking toward attracting lenders and investors, then the following points will guide you on how potential lenders and investors evaluate a business plan before involving their money.
How Potential Lenders and Investors Evaluate a Business Plan
One of the key factors potential lenders and investors look out for from a business plan before lending or investing their money is the financial projection aspect of the business plan. Financial projections are estimated financial data to forecast your business’s future income and expenses.
Financial projections should include forecasting the income statement, the balance sheet, and the cash flow statement. Projections are made by the month for the first year and then by the year for the next two years. They often include different scenarios so you can see how changes to one aspect of your finances (such as higher sales or lower operating expenses) might affect your profitability.
The truth is that no investor or lender will take your business plan seriously if you don’t have well-captured financial projections for the business. The financial projections must be real and acceptable.
Another very key part of your business plan document that potential investors and lenders would want to evaluate before releasing their money to your business is your cash flow. Investors would want to see a minimum of three cash flow scenarios from your business plan: one with conservative sales, one with realistic sales, and one with aggressive projections.
The truth is that over 90% of declined loan applications are because the cash flow projections don’t convince the lender that the business will make enough to repay the loan. Cash flow measures how much money is moving into and out of your business during a specific period.
Businesses bring in money through sales, and returns on investments. Please note that it is important to include cash flow projections for each month over one year in the financial section of your business plan.
You will agree that no investor or lender would want to release their money to a new business without conducting a risk assessment. A risk assessment enables the organization to identify risks, and the severity of each risk, and to explore solutions to reduce the impact of risks.
Conducting a risk assessment will help you ensure that the benefits of the project merit the risk incurred. Your business plan must be able to tell the potential lender or investor how you are going to handle the risk that no one will buy your product or service.
A potential investor or lender needs to see a contingency plan of how you would pay back the loan if your sales don’t meet expectations or if your expenses are higher than anticipated. A well-developed business plan will show that you have thought through different scenarios and changing circumstances, which will give the potential investor or lender significant confidence in your business.
The Collateral or Tangible Assets Being Secured
Collateral is an item of value used to secure a loan. Collateral minimizes the risk for lenders. If a borrower defaults on the loan, the lender can seize the collateral and sell it to recoup its losses. Mortgages and car loans are two types of collateralized loans.
The least you can do when trying to attract potential investors or lenders is to show that you have what can give them the confidence they need to release their monies to you. That is where you need collaterals or some tangible assets – you can list them in a section of your business plan.
Your Equity Contribution
Another very important aspect of your business plan document that potential investors and lenders will evaluate before releasing their money to you is your equity contribution or the amount of personal equity that has been invested in the business.
If you are looking for investors to invest their money in your business, you should be able to at least show them that you believe in the business by first contributing your own equity to the business.
Your Board of Directors and Management Team
Lastly, another key aspect that potential investors and lenders evaluate before lending business money is the board of directors and management team of the business.
The truth is that if you have a highly competent management team and a trustworthy board of directors, it will be easier for you to attract money from lenders and investors for your new business.
Please note that aside from the points stated above, potential lenders also look at your ability to meet debt and interest payments (cash flow), and the entrepreneur’s credit history or character. Please note that there are different types of credit scores, but most fall within a range of between 300 and 850.
In many cases, lenders consider a score of between 300 and 579 as very poor or bad. Anything above that falls into the fair, good, very good, or exceptional range.