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A good business plan should spell out the bottom line

Denver Business JournalOn the Money
From the  March 8, 2002 print edition

Ralph Waldo Emerson said, “Build a better mousetrap and the world will beat a path to your door.” That tenet may still ring true, but will anyone pay for it?

In financial circles, it’s not about the mouse or the trap; it’s about the money.

When raising money, the basics “How much? What are you going to do with it? What do the investors get in return?” must be stated within the first 100 words of any business plan proposal for funding.

Imagine attending a concert where the orchestra is seated and ready to play. The conductor walks onto the stage and launches into a soliloquy on the nature of compositional techniques, the relative worth of this piece as it applies to the vast human aesthetic experience, the subtleties of the acoustics in this particular hall, what everyone in the orchestra is wearing and planning to do after the concert, various alternative forms of transportation to get the audience home after the concert, a tabular statistical summary of child-care alternatives employed by those in attendance — and never plays a note of music.

That’s what it’s like for the financial person who reads a business plan that excludes those key 100 words.

It may sound simple and a little disheartening to the entrepreneur, but without these three simple essentials stated right away, no one will read the plan. Breaking down the critical 100 words looks like this:

1. How much? — Start with one number summarized from cash-flow projections. It should be the amount of money needed over the next three years to carry out the development and expansion of the business. Set this stage quickly to avoid any waste of time. Many investors have specific parameters for how much or how little they are willing to consider.

If you have sophisticated financial help, also indicate the proportion of funds that will come from the sale of stock and bank borrowing. Describe the kind (common stock, convertible debenture, etc.), unit price and total amount of securities to be sold.

2. What are you going to do with it? — For a new business, the cash-flow forecast is more important than any other prediction because it details the amount and timing of expected cash inflows and outflows. This is where the use of the new funds is shown.
Usually the level of net income is insufficient to finance operating cash needs. Moreover, cash inflows never match the outflows on a short-term basis. The cash-flow forecast clarifies these conditions.
Investors want to see specifically where their money is going. They do not want to see the new money replace old debt or liabilities, or give the owners above-average salaries, or pay for dog-and-pony road trip shows that will only raise more money, thereby diluting their position.

Show on the cash-flow statement that this money will operationally grow the business.

Given a level of projected sales and capital expenditures over a specific period, the cash-flow forecast highlights the need and timing of additional financing and shows peak requirements of working capital.

You also may show how this additional financing will be obtained, on what terms and how it is to be repaid. Part of the needed financing may be supplied by the professional venture capitalists, part by bank loans of one to five years and the balance by short-term lines of credit.

All of this information becomes part of the final cash-flow forecast.

3. What does the investor get in return? — This raises the thorny issue of company valuation. A basic bare-bones rate of return is “what you got” divided by “what you gave.” An additional wrinkle is whether the “got” part of the equation is cash or some other form of asset.

You can work a relatively simple equation for this information: Multiply yearly revenue at the end of the third year by 1.5; multiply that by the equity percent held by the investor; divide that by the amount of cash given at the beginning.
This is a very basic return for investment calculation. It is astounding how many business plans neglect to provide even this fundamental inkling of potential return to the potential investor. More sophisticated analysis can be, and probably will be, performed for each potential investor on a case-by-case basis that would also include issues relating to cash, debt vs. equity, preferential payment schedules, dilution and the like.
You probably do have a better mousetrap. Now, use your straight-shooting business plan to get the capital to make your company successful.

© C. Stephen Guyer for American City Business Journals Inc. All rights reserved.