WHAT BACKERS LOOK OUT FOR

Business plans are written to be read: that in turn means that the readers’ needs, however few or diverse, have to be carefully considered in the preparatory process. Lenders want to be sure their money is safe, investors need to be enticed by the expectation of future profits, and managers, be they running a health service, utility company or a charity, want to be convinced that the proposal is needed and likely to come in on time and on budget.

Almost every new venture needs finance and if you are in competition with others, say with another division of your company or a bank choosing who to lend to, then as well as the operational benefits of preparing a business plan, it is important to examine what financial backers expect from you, if you are to succeed in raising those funds.

It is often said that there is no shortage of money for new proposals – the only scarce commodities are good ideas and people with the ability to exploit them. From the potential entrepreneur’s position this is often hard to believe. One major venture capital firm alone receives several thousand business plans a year. Only 500 or so are examined in any detail, fewer than 25 are pursued to the negotiating stage, and only six of those are invested in. In tough times these figures worsen significantly.

To a great extent the decision whether to proceed beyond an initial reading of the plan will depend on the quality of the business plan used in supporting the proposal. The business plan is the ticket of admission giving the entrepreneur or proposal champion the first and often only chance to impress prospective backers with the quality of the proposal.

It follows from this that to have any chance at all of getting financial and/or managerial support, your business plan must be the best that can be written and it must be professionally packaged.

In our experience at Cranfield the plans that succeed meet all of the following requirements.

Evidence of market orientation and focus

Entrepreneurs must demonstrate that they have recognized the needs of potential customers, rather than simply being infatuated with an innovative idea. Business plans that occupy more space with product descriptions and technical explanations than with explaining how products will be sold and to whom usually get cold-shouldered by financiers. They rightly suspect that these companies are more of an ego trip than an enterprise.

Market orientation is not in itself enough. Backers want to sense that the entrepreneur knows the one or two things their business can do best – and that they are prepared to concentrate on exploiting these opportunities.

Two friends who eventually made it to an enterprise programme – and to founding a successful company – had great difficulty in getting backing at first. They were exceptionally talented designers and makers of clothes. They started out making ballgowns, wedding dresses, children’s clothes – anything the market wanted. Only when they focused on designing and marketing clothes for the mother-to-be that allowed her still to feel fashionably dressed was it obvious they had a winning concept. That strategy built on their strength as designers and their experiences as former mothers-to-be, and exploited a clear market opportunity neglected at that time by the main player in the marketplace – Mothercare.

From that point their company made a quantum leap forward from turning over a couple of hundred thousand pounds a year into the several million pounds league in a few years.

Evidence of customer and user acceptance

Backers like to know that your new product or service will sell and is being used, even if only on a trial or demonstration basis.

The founder of Solicitec, a company selling software to solicitors to enable them to process relatively standard documents such as wills, had little trouble getting support for his house conveyancing package once his product had been tried and approved by a leading building society for its panel of solicitors.

If you are only at the prototype stage, then as well as having to assess your chances of succeeding with technology, financiers have no immediate indication that, once made, your product will appeal to the market. Under these circumstances you have to show that the ‘problem’ your innovation seeks to solve is a substantial one that a large number of people will pay for.

One inventor from the Royal College of Art came up with a revolutionary toilet system design that, as well as being extremely thin, used 30 per cent less water per flush and had half the number of moving parts of a conventional product, all for no increase in price. Although he had only drawings to show, it was clear that with domestic metered water for all households a distinct possibility and a UK market for half a million new units per annum, a sizeable acceptance was reasonably certain.

As well as evidence of customer acceptance, entrepreneurs need to demon-strate that they know how and to whom their new product or service must be sold, and that they have a financially viable means of doing so.

Proprietary position

Exclusive rights to a product through patents, copyright, trademark protection or a licence helps to reduce the apparent riskiness of a venture in the financier’s eyes, as these can limit competition – for a while at least.

One participant on a Cranfield enterprise programme held patents on a revolutionary folding bicycle he had designed at college. While no financial institution was prepared to back him in manufacturing the bicycle, funds were readily available to enable him to make production prototypes and then license manufacture to established bicycle makers throughout the world.

However well protected legally a product is, it is marketability and market-ing know-how generally that outweigh ‘patentability’ in the success equation. A salutary observation made by a US professor of entrepreneurship revealed that fewer than 0.5 per cent of the best ideas contained in the US Patent Gazette in the last five years have returned a dime to the inventors.

Financiers’ needs

Anyone lending money to or investing in a venture will expect the entrepreneur to have given some thought to his or her needs, and to have explained how these can be accommodated in the business plan. This will apply even if the money is coming from an ‘internal’ source such as a parent company, a divisional budget or a government department.

Bankers, and indeed any other sources of debt capital, are looking for asset security to back their loan and the near certainty of getting their money back. They will also charge an interest rate that reflects current market conditions and their view of the risk level of the proposal. Depending on the nature of the business in question and the purpose for which the money is being used, bankers will take a 5- to 15-year view.

As with a mortgage repayment, bankers will usually expect a business to start repaying both the loan and the interest on a monthly or quarterly basis immediately the loan has been granted. In some cases a capital ‘holiday’ for up to two years can be negotiated, but in the early stage of any loan the interest charges make up the lion’s share of payments.

Bankers hope the business will succeed so that they can lend more money in the future and provide more banking services such as insurance, tax advice, etc to a loyal customer. It follows from this appreciation of a lender’s needs that lenders are less interested in rapid growth and the consequent capital gain than they are in a steady stream of earnings almost from the outset.

As new or fast-growing businesses generally do not make immediate profits, money for such enterprises must come from elsewhere. Risk or equity capital, as other types of funds are called, comes from venture capital houses, as well as being put in by founders, their families and friends.

Because the inherent risks involved in investing in new and young ventures are greater than for investing in established companies, venture capital fund managers have to offer their investors the chance of larger overall returns. To do that, fund managers must not only keep failures to a minimum; they have to pick some big winners too – ventures with annual compound growth rates above 50 per cent – to offset the inevitable mediocre performers.

Typically, a fund manager would expect, from any 10 investments, one star, seven also-rans and two flops. It is important to remember that despite this outcome, venture capital fund managers are only looking for winners, so unless you are projecting high capital growth, the chances of getting venture capital are against you.

Not only are venture capitalists looking for winners, they are also looking for a substantial shareholding in your business. There are no simple rules for what constitutes a fair split, but industry experience suggested the following starting point:

• for the idea	33 per cent;
• for the management	33 per cent;
• for the money	34 per cent.

It all comes down to how much you need the money, how risky the venture is, how much money could be made – and your skills as a negotiator. However, it is salutary to remember that 100 per cent of nothing is still nothing. So, all parties to the deal have to be satisfied if it is to succeed.

Venture capital firms may also want to put a non-executive director on the board of your company to look after their interests. You will have at your disposal a talented financial brain, so be prepared to make use of him or her, as these services won’t be free – either you’ll pay up front in the fee for raising the capital, or you’ll pay an annual management charge.

As fast-growing companies typically have no cash available to pay dividends, investors can only profit by selling their holdings. With this in mind, the venture capitalist needs to have an exit route such as the Stock Exchange or a potential corporate buyer in view at the outset.

Unlike many entrepreneurs (and some lending bankers) who see their ventures as lifelong commitments to success and growth, venture capitalists have a relatively short time horizon. Typically, they are looking to liquidate small-company investments within three to seven years, allowing them to pay out to individual investors and to have funds available for tomorrow’s winners.

So, to be successful your business must be targeted at the needs of these two sources of finance, and in particular at the balance between the two. Lending bankers ideally look for a ratio of £1 (US$1.61/€1.13) of debt to £1 of equity capital, but have been known to go up to £4–5. Venture capital providers will almost always encourage entrepreneurs to take on new debt capital to match the level of equity funding.

If you plan to raise money from friends and relatives their needs must also be taken into account in your business plan. Their funds can be in the form of debt equity, but they may also seek some management role for themselves. Unless they have an important contribution to make, by virtue of being an accountant or marketing expert or respected public figure, for example, it is always best to confine their role to that of a shareholder. In that capacity they can ‘give’ you advice or pass on their contacts and so enhance the worth of their (and your) shareholding, but they won’t hold down a post that would be better filled by someone else. Alternatively, make them non-executive directors, which may flatter them and can’t harm your business. Clearly, you must use common sense in this area.

One final point on the needs of financial institutions: they will expect your business plan to include a description of how performance will be monitored and controlled.

One budding entrepreneur blew an otherwise impeccable performance at a bankers’ panel by replying when asked how he would control his venture: ‘I’m only concerned with raising finance and getting my business started at the moment – once that’s over I’ll think about “bean counting”.’ He had clearly forgotten who owned the beans!

Believable forecasts

Entrepreneurs are naturally ebullient when explaining the future prospects for their business. They frequently believe that ‘the sky’s the limit’ when it comes to growth, and money (or rather the lack of it) is the only thing that stands between them and their success.

It is true that if you are looking for venture capital, then the providers are also looking for rapid growth. However, it’s as well to remember that financiers are dealing with thousands of investment proposals each year, and already have money tied up in hundreds of business sectors. It follows, therefore, that they already have a perception of what the accepted financial results and marketing approaches currently are for any sector. Any new company’s business plan showing projections that are outside the ranges perceived as realistic within an industry will raise questions in the investor’s mind.

Make your growth forecasts believable; support them with hard facts where possible. If they are on the low side, then approach the more cautious lending banker, rather than venture capitalists. The former often see a modest forecast as a virtue, lending credibility to the business proposal as a whole. But if you believe in your vision and have patience and resilience take your proposal to institutions that are up for big risks in return for the chance of big rewards.