Chapter 1
The bank has turned you down. Now what?
Lending institutions are naturally the first place to look for the capital to start or expand your business. If you're just starting out, you're very likely to be turned down if you can't demonstrate at least one previously or currently successful venture, or participation in a successful one with others. If you're looking for expansion capital, you're likely to be turned down if your revenues and earnings history are mediocre or weak—for whatever reason which can be entirely legitimate.
The plain fact is that banks work with public money—not their own. By law they cannot finance risky ventures, even if the product or service seems promising up-front. Unless your start-up or expansion shows solid evidence to support probable success, such as substantial orders or a good earnings history, the bank sees you as an unacceptable risk. And you get turned down. For the record, few start-ups can demonstrate any substantial orders and are almost always turned down by banks because of the high failure rate of new businesses. Somebody like Microsoft Chairman Bill Gates could get money from any bank for a start-up, but don't you try it. Gates' track record speaks for itself.
If you're a startup, your best bet is not to bother wasting valuable time with a bank unless you have enough orders to cover the value of the loan. And they must be confirmed orders—not just letters of interest. Expansions, on the other hand, must demonstrate a revenue history sufficient to justify the market projections for the project.
Whether you're starting up or expanding, and whether you're looking for a loan or private capital, you must have a business plan. This is absolutely vital. A business plan is a 15 or 20-page document that describes your company, or proposed company, in detail—background, management team, product description, company structure, industry overview, market analysis, marketing strategy and potential, and the list goes on. You might think of it as a resume for your company and project. Chapter 3 will give you the particulars of this important document. If it's convincing, the loan officer is as likely as not to turn that former no into a yes for your expansion. Again, if yours is a startup, don't bother with the bank unless you have more than enough confirmed orders to cover the loan. Even then, your lack of a market history will likely lead to a turn-down if the bank maintains highly conservative lending policies.
If yours is an expansion and the bank still turns you down despite a good business plan, it's usually because the amount of money you're asking for is too high. In fact, the loan officer may tell you as much and may suggest a safer amount. If you honestly believe you can't accomplish your goals with the lesser amount, you're not out of luck even now. Chapter 2 will explain.
Case in point for a good business plan:
Entrepreneur John B. had only $7500 in personal assets to secure a loan. He'd had unsteady income for several years from consulting work in his field, and his wife absolutely refused to consent to a second mortgage or home equity loan to finance the business he wanted. Yet his bank extended a $15,000 line of credit for his startup business! Can you believe that? How did he do it? Along with an excellent credit history that he and his wife had, he presented a very convincing business plan with his loan application. And he was asking for a very modest amount of capital.
He had even failed once before as an entrepreneur, and had struggled to build a consulting business after that. At face value, the bank had every reason to turn him down flat. But his particular bank was an SBA (Small Business Administration) lender, and did not look at his application strictly at face value. Along with facts and figures, SBA lenders also look at the entrepreneur's experience and quality of business plan, and decide accordingly. Even though the SBA backed part of the loan, it must be understood that John B. is the glaring exception.
He averted a probable turndown by preparing a business plan that demonstrated a solid aptitude for management, a working knowledge of marketing, a good understanding of finance, and well-defined business goals. What was more, his business plan was built around a new industry product he had developed. He demonstrated himself to be not only a good businessman, but also an idea man. And he got his money!
You could get the same results, even with the adverse circumstances that John B. faced, if you're willing to put in the time and effort to develop a good business plan and make your presentation professional enough to convince the bank that you know what you're doing. However, because the kind of success John B. had is so rare, startup entrepreneurs are generally advised to avoid wasting time with the bank, and focus on private capital.
Unless you're confident that you're a good writer, hire a professional to write your plan. John B. was fortunate enough to have exceptional writing skills. Professional talent to write a business plan can cost you from two to ten thousand dollars, depending on the experience, credentials and reputation of the writer. Between the writing, editing and client changes—meaning yours—the project is likely to take a month if not two, even with the speed of faxing and e-mail. And any experienced and skilled writer will charge you $40 to $50 per hour. You must regard this as an investment in your future. Either you're serious about your business or you aren't. You're going to have to spend at least a small five-figure sum on your capital search unless you can find people willing to work for a small percentage of the capital proceeds. Don't hold your breath!
The upside of the cost of your business plan and capital search is that you'll get all your money back at the settlement table if your capital comes from a deal with investors, along with all your other capital-search costs. With private capital, your business plan and other capital-search costs are known as offering expenses. If you've spent, say, $15,000 on your search, that's your offering expense and you get it back when the investor writes you a check for the number of shares he or she is buying. For a small business, few investors will object to offering expenses as high as $25,000 to $50,000. Experienced investors know how expensive a capital search can be.
Now if you happen to know a good writer, you're in great luck. If not, look in the Yellow Pages under Management or Business Consultants or key either of these terms into a quality search engine like Google. And don't feel shy about asking for the writer's credentials, and experience with business plans.
Your plan must include several financial statements—cash flow, profit/loss, and balance sheets. However, there is divided opinion about balance sheets for a startup. This author’s opinion is that a balance sheet is a projection on top of two other projections, and is just another exercise in hypothesis. But if an investor prospect still demands to see balance sheets, play the game and have your accountant draft one for three years based on your financial forecasts.
If you're looking for start-up capital, these statements must be three to five-year projections. If you're looking to expand, these statements will show your earnings history and assets to-date. Even if you've been losing money, these statements will still tell the bank or the investor why, and you may still get your money. Don't try to do these yourself unless you have a business mentor skilled in financial statements. Our example, John B., had access to such an individual. Have your accountant prepare them. If you don't have one, then hire one!
CHAPTER 2
THE INVESTMENT COMMUNITY
A business or home-equity loan is always the easiest way to get financing for an existing business that's generating revenues. But for a startup, the chances of getting bank financing are little short of zero—too risky, as we've already said. Well, a proposed startup is not out of luck by a country mile!
If you're a startup entrepreneur, your only realistic option is the investment community. You have to target a group of professional investors known as venture capitalists. These people, virtually unknown to the general public, are risk investors—that is, they invest in business deals that are too risky for banks or conservative investors to touch. Unlike a bank, they work with their own money, and will invest in any deal—based on the quality of the business plan and management experience—that meets their criteria and they feel shows promise.
Venture capitalists, typically, are professional investors who customarily look for a new enterprise that could be the next Microsoft, the next Intel, the next AOL. These people routinely invest in deals worth anywhere from $250,000 to billions, depending upon the pool of cash they have to work with from their network of other investors.
The downside of this is that if you're a start-up entrepreneur needing between $50,000 and $250,000, your chances of landing a deal with a venture capitalist are very unlikely. You're "small potatoes" for them. Yet this is the amount you need! So, what do you do?
You must look to a secretive group of wealthy people known as angel investors—also known as business angels. The term came from New York City's Broadway. Years ago, wealthy investors financed Broadway productions that they felt were exceptionally entertaining and could probably make a bundle. A Chorus Line was such an example. That production made millions. These investors were guardian angels to the successful productions they financed. Hence the term, angel.
Then these investors decided that instead of just investing in theater productions, why not back less risky enterprises like startups and young companies in industry? There were tens of thousands across the country to choose from at any given time. And so, the angel investment community was born.
Most angels invest typically from $25,000 to $100,000. Yet the wealthiest of the breed will invest up to $1,000,000—but only if the entrepreneur presents a very convincing business plan and that plan clearly demonstrates his or her ability to run a small business.
So, where can you find these people? You can't. Not on your own. Angels are notorious for maintaining low profiles, and angel networks are only now becoming better organized. You can only find them through experienced professionals who know where to look. Capital-search companies like ours have access to a number of angel sources.
The typical approach to these people is to have a capital-search professional represent you with a letter of introduction along with a copy of your executive summary. Where the summary is your primary sales tool, the letter is your opening pitch. And if you don't see where your search for capital is a marketing job, think again! Your letter should never be more than a single page, and it should be on your business stationery! In fact a half page, at best, is better. And never whine about the problems you've had looking for capital. These people are businessmen, not Samaritans, and they've heard it all before. If your project interests them, their sole concern is how much the venture will cost them, what the results will be versus expectations, and how soon they can expect to profit from their participation in your business. If your executive summary interests a prospect, he or she will ask for the full business plan.
Caution! When dealing with conventional venture capitalists versus angels, you're as likely as not to be asked to surrender a controlling interest for a time as part of the deal. This is part and parcel with the risk the investor is assuming. Just make sure your contract with that party includes a provision for a buyback on your part to regain control after a specified number of years. You certainly want this, and it gives your investor the option to cash out and invest in something new and different. Talk to your attorney about such contractual arrangements unless you have a working knowledge of contract law! This is not a job for an amateur.