Knowing how to write a business plan is crucial. The aim of this article is to provide entrepreneurs with guidance on how to customise your business plan according to the type of funder that you propose to approach. Including the relevant information when writing a business plan is an important step in launching your new venture or expanding an existing one. A crucial purpose of a business plan is to raise finance. The business plan is possibly the first and only – substantial contact that a potential funder has with you. It is a sort of ticket of admission which gives you the chance to impress prospective sources of finance with the quality of your proposal. For example, more than three-quarters of business angels require a business plan before they will consider investing.
A Business Plan
A business plan has several purposes and target audiences. Therefore, a ‘one size fits all’ approach to writing your business plan would not work for you as an entrepreneur. The audience for a business plan varies and might include suppliers, distributors, major customers, the board of directors, outside consultants, banks and investors.
These various audiences evaluate business plans differently. For example, the way in which bankers, venture capital fund managers (VCFMs) and business angels (BAs) would evaluate business plans, the questions that they ask differ. Therefore, understanding the information which they consider in making lending decisions would help you to customise your business plans accordingly.
APPROACHING THE BANK
When assessing lending decision, the banker is interested in information to assess the entrepreneur’s competence, commitment and business prospect. However, this information is often unclear due to the lack of track record especially for new businesses.
Information Asymmetry problems
Sometimes the information is unavailable, uneconomic to obtain or difficult to interpret. Therefore, the banker could end up lending to businesses which subsequently fail – or not lend to businesses which go on to become successful, or have the potential to do so. Banks are usually interested in minimising these types of risks.
Risk of Moral hazard
They also consider challenges of monitoring entrepreneurs after a loan has been made to ensure that they do not switch to riskier projects – different from the loan approved, that would enrich the entrepreneur at the expense of the bank, or reduce their effort. Therefore, bankers lending decisions will emphasize financial considerations – availability of collaterals, margins, cash flow forecasts, gearing ratios, asset management ratios and financial controls. There is lesser emphasis on the full evaluation of the proposed project and the personal characteristics of the entrepreneur.
Adequate collateral backing
Adequate collateral backing is a necessary condition for any loan. Taking collateral as security – in the form of personal guarantees or personal collateral for new businesses – is attractive to bankers. The entrepreneur’s willingness to offer collateral indicates his/her confidence in their own abilities and in the likely success of the project. The collateral is also thought to align the interests of the entrepreneur with that of the banker.
APPROACHING VENTURE CAPITAL FUND MANAGERS
Like the banker, the Venture Capital Fund Managers also encounter information asymmetry problems when evaluating investment opportunities. However, as equity providers, they adopt very different approach to their funding decision. Venture Capital Fund Managers invest for capital gain and, unlike the banker, they share in the success of the businesses that they invest in. Their investment in an entrepreneurial business is fully exposed if the business fails. Also, their investment will be illiquid if the business does not achieve signiﬁcant growth.
Capability of the management team
Venture Capital Fund Managers tend to place greatest emphasis on the capability of the management team, the product/service and the market. The importance that is placed on the ability of management includes management skill – quality of the entrepreneur influences investment decision, particularly a thorough familiarity with the industry/market, leadership capability and the ability to evaluate and handle risks. Other criteria include characteristics of the management team and the management team’s track record.
Returns – driven
Venture Capital Fund Managers are returns-driven and their primary objective is to deliver high returns to the outside investors (limited partners) whose funds they manage. They are therefore more concerned with market risk – due to unforeseen competitive conditions affecting the size, growth and accessibility to the market. Venture capital fund managers protect themselves from agency risk by using stringent contractual provisions that allow them to replace an underperforming entrepreneur, one guilty of misconduct or who is found to be incompetent.
Approaching Business Angel Investors
The Business Angels approach to investment decision-making though similar to that of Venture Capital Fund Managers – is not identical. Business Angels are more concerned with agency risk – risk that is caused by the separate and possibly divergent interests of entrepreneurs (agents) and investors (principals).
Business angels attach more importance to agency risk because most angels lack comparative data to evaluate market risk. Angels may not have the resources to collect and analyse (costly) market-related information so less due diligence is conducted compared to venture capital fund managers. Business angels tend to keep simple and informal contracts with entrepreneurs which sometimes makes it harder for them to enforce sanctions. Business angels take a more hands-on role in their investee businesses and they place greater importance on the ‘chemistry’ between themselves and the entrepreneur. Skills gaps in the management team does not deter Business angels because they can contribute missing expertise through their own involvement. The opportunity to contribute is part of the ‘return’ Business angels consider in making investments because they think that their involvement can contribute to the success of their investee businesses. They invest their own money, and in addition to capital gain, their consideration also includes satisfaction and enjoyment derived from playing a role in the entrepreneurial process, and, in some cases, altruism.
In conclusion, it is important that entrepreneurs know how to write a business plan. The plan should attempt to engage potential investors by taking these information into consideration. Ensure your financial information is accurate and meaningful if approaching the banker. The numbers are also important to the equity investors in order to assess proﬁtability, amount of funding that is required presently and in the future and what the money will be used for. However, while the VCFMs are mostly interested in the ﬁnancial returns, business angels emphasize personal relationship issues and should be engaged on a more emotional level.
Read “What do Investors Look for in a Business Plan? A Comparison of the Investment Criteria of Bankers, Venture Capitalists and Business Angels” at: http://isb.sagepub.com/cgi/content/abstract/22/3/227
Categories: Business Plan