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Business Plan Tips - Job Advice

Just as manuscripts are screened by assistants before reaching an editor, business plans submitted to financial institutions and venture capitalists are almost always screened by someone like me, a professional analyst who gets paid to "manage risk," which is MBA-speak for finding legitimate reasons not to fund your project. In this article I provide tips on getting your business plan past me and on to the people who sign checks. That's easier said than done, as research consistently shows that only a tiny fraction of business plans ever result in financing.

Before I delve into specific recommendations, let's briefly review the purposes of a preparing a business plan.

In practice, a business plan has three purposes and three purposes only: (1) to demonstrate the validity of your business model (including the existence of a market); (2) to establish the qualification of your team to execute your business model; and (3) to convince investors/lenders that the only thing you're missing is capital. That's it. Anything else you try to make it will detract from these goals.

If you want your business plan to make it to the Loan or Investment Committee, consider following these 8 recommendations:

1. Present the Right Type of Plan to the Correct Audience

Generally speaking, there are three types of business plans: Loan-Targeted; Equity-Targeted and Operating-Only. Do not send an equity investor a loan request and do not send a lender a request for an equity investment. Operating-only plans do not seek to raise capital and thus are not discussed in this article.

Loan-targeted and Equity-targeted business plans are quite different. Lenders are principally concerned with collateral and cash flow. They tend to give a lot of weight to the debt coverage ratio. Equity investors focus on the Return on Equity generated from anticipated liquidity events like a lucrative acquisition or initial public offering. There are other differences. For example, if you're trying to raise equity, then your business plan will likely be known as a Private Placement Memorandum. This terminology comes from Regulation D of the Securities Act of 1933, a federal law which applies to your business plan if you're attempting to raise private equity across state lines. This document has a specific format that investors are accustomed to. Failure to follow this format is a sure sign of a novice.

2. Abide by the 50/50 Rule

Your business plan should be no longer than 50 pages and no more than 50% of its content should be quantitative in nature.

There are two compelling reasons to keep your page-count under 50 pages:

First, whether your business plan is 20 pages or 200 pages, in most cases an analyst will reduce it to a 10-page summary called an Internal Credit Memorandum. The ICM is the only thing the decision-makers will ever see. Save the trees and save your time.

Second, people with money to invest or lend are among the busiest people on earth. None of them have time during the business day to sit and read more than 50 pages. The ideal length of a business plan is 20-30 pages, which is more than long enough to concisely state everything you need to. In my experience, every business plan longer than 50 pages contains unnecessary filler. Filler is bad. No matter what you read in that business plan book, your business plan does NOT need to include patent applications, folded-up blue prints, job descriptions, research studies, brochures, or pictures of your children. If and when I need any of these items, I will request them from you during the due diligence phase.

The reason you should limit your quantitative content to no more than half is because your business plan should tell a persuasive story that your numbers support. The numbers themselves are not the story.

3. Your Narrative Must Match Your Numbers

In many cases, the person who writes the narrative portion of a business plan is not the same person who prepares the financial portion. This often leads to inconsistencies, usually because your plan was not proofread or because one section gets updated without updating the other. A common example is where the Narrative lists executive salaries that amount to one figure but the Income Statement calculates salaries as a percentage of revenue, resulting in an entirely different figure. In addition to appearing sloppy, the problem with such inconsistencies is that they force the person analyzing your business plan to decide which of the two figures to accept. When I'm that person, I always pick the more conservative figure. That's usually bad for the applicant.

4. Show Them the Money

An entrepreneur once famously remarked, "If I succeed, everyone wins. If I fail, the bank loses." Your investors have heard this one too, but they're not amused. Investors and lenders are much more favorably inclined towards projects where the sponsor will be sharing the risk of the venture by co-investing some of its own capital along side theirs. They also saw the movie "Other People's Money," which may be why they instruct their analysts to discard business plans that include no sponsor equity.

5. Pass the Acid Test

One of the first things most analysts do with a new business plan is go straight to the Balance Sheet and check if Cash plus Cash Equivalents is greater than Current Liabilities. It's called the Acid Test. A ratio of less than 1 is a danger sign. Without getting too deep into financial theory, it's a warning that you have (or will have) a liquidity problem, or worse, a solvency problem. There are several acceptable methods of calculating this ratio. Pick the most favorable method. For most businesses, the most favorable method is to include the value of accounts receivable in the numerator.

6. Pass the Common Sense Test

No one wants to invest money in a profit-making enterprise that doesn't make any profits. Don't submit a business plan that projects a loss in the first few years but great profits thereafter or one where your product loses money on each sale but claims profit will be made "on volume." Even if you honestly believe that either of these scenarios will actually happen (which, statistically speaking, they won't), you will be much better off simply projecting break-even or a very small profit. The difference in dollars is negligible, but the difference in perception is critical. The main reason to avoid this is that most lenders and investors have policies against intentionally "funding losses."

7. Real Men (and Women) Don't Use Templates

If you're going to use business plan software to produce your business plan, then at least spend the time to make it unique and credible. Every month, without fail, I get several business plans produced by one particular software package. The reason I know this is because every one of them, regardless of the business model or industry, contains the EXACT boilerplate language and the EXACT default figures from the program. Because this demonstrates a lack of diligence and effort, those plans usually go straight in the trash bin. A coffee shop and a multinational defense contractor should not have the same financials. The only number these two businesses really have in common is the $99 they paid for the software.

8. Avoid Common Financial Mistakes

There are so many potential mistakes to be made in this area that it deserves its own article. However, here are some basics:

  • The Income Statement, Balance Sheet and Statement of Cash Flow must agree with each other.
  • Most Limited Liability Companies (LLCs) do not pay corporate income taxes. I see this one all the time. Over 80% of LLCs are setup to pass tax liability through to members, yet most business plan spreadsheets include a line-item for taxes that people fill-in anyway. When you do this, you underestimate your Operating Income by the amount of the tax. Because Operating Income is an important metric to most analysts, it's not a good idea to artificially decrease it.
  • Don't Forget the Notes. For an analyst, financial statements without explanatory notes are almost useless. The notes will contain essential information like the company's fiscal year, basis of accounting (cash or accrual), definition of inventory and the details of liabilities (interest rates, maturities, etc.). To illustrate my point, consider the simple case of revenue recognition. Suppose you receive an income statement that claims a company will earn $1,000,000 in revenues this year. Does that figure refer to cash received or the value of sales contracts? Only the notes will tell. Anybody remember Enron?
  • Tell Them How Much You're Asking For. Another common mistake is not including a Statement of Sources and Uses (sometimes called a Funding Plan). This statement expressly sets forth how much funding you are requesting and what you will do with the proceeds. I can't tell you how many

    business plans I've reviewed that tell you everything but how much money is being requested.

Extra Credit

If you want to earn goodwill points with the person who will decide if your business plan ever makes it to the investment or loan committee, consider these optional steps:

  1. In addition to a hardcopy, email an electronic copy of your business plan in PDF format.
  2. Include the NAICS code for your industry. The NAICS code is the successor to the well known SIC code. It's what an analyst uses to look up information about your industry at commercial data sources like Dun & Bradstreet and RMA.
  3. Don't use a ring binder.
  4. Include a ratio analysis with your financial projections.
  5. Don't misspell names.

There you have it. Following these tips may not be enough to get your business plan funded, but they will get it taken seriously. The rest is up to you.