Why the bank wants to see your business plan

A few posts ago I mentioned that a business plan may not be necessary unless you plan to pursue financing.If you do plan to go for a business loan or venture capital, however, you should make sure you’ve done your homework. Here are some of the key components of a business plan lenders will be looking for, and why:

A clear description of your business – You would be surprised how many businesses get started without really defining this. You should discuss your product/service, how you plan to make money from it, where you intend to locate your business, and who you expect to buy from you. Lenders will use this to determine not only how clearly you can describe your business, but how logical or feasible it sounds.

Who are you? – Describe what experience you and/or your partners may have that would help the business be successful. A complete lack of experience is not always a deal-breaker, but certainly showing, for example, 20+ years experience in that particular industry, coupled with a partner with a strong financial background, could go a long way to helping ease a lender’s fears.

A plan for marketing your business – How do you plan to make your customers aware of you? While your marketing plan does not necessarily have to be aggressive, it does need to show cohesiveness with the rest of your plan. For example, if your projections have your business showing a profit in its first month, and yet you have no plans to advertise, it’s likely the bank is not going feel you are a credible business.

Sales projections for a year – You will need to be able to show how much money your business can make its first year. You should probably give some indication as to what those estimates are based on. While a lender will not expect you to be precise–how can anyone know exactly what will happen–they do want to see that you’ve thought through your projections, and they are based on sound reasoning.

Competition analysis – It is important to show that you not only are aware of your competition (and unless you are a true revolutionary, chances are there will be competition), but that you know something about their strengths and weaknesses, and that you have a plan for competing against them.

Startup and Operating Cost Estimates – You should be able to provide at least a fair estimate of how much money you will need to get started in business, and how much you will need to stay in operation for a year. You may have the most credible plan ever up to this point, but if your startup costs alone will exceed the amount of funding you have available (even assuming you get the loan), to say nothing of staying in business long enough to turn a profit, why would the lender take a chance on you? Prove that you have a good idea of the costs–and that you will have enough to cover it–and you’ll have a much better chance of a “yes”.

The oft-quoted statistic is that over half of all businesses fail in their first five years. That makes lending to new businesses a risky proposition at best. Yet banks make their money by accepting some moderate risk and extending loans. If you can show the bank that you have thought things through, know what you’re doing, and are basing your request for funding on solid, logical estimates, your chances of getting funding increase dramatically because the bank sees their chances of getting paid increase dramatically.

When my partners and I started our business we had a private investor helps fund our venture. Still, being no fool, our investor wanted some reassurances that we knew what we were doing. That two of the partners had over 15 years of experience in the industry, and that the third partner had an MBA was a good start. We were also able to show him that we had evaluated all the local competition and identified where we could capitalize on their weaknesses.

Finally, we were able to put together projections showing both our startup costs and our projections for a year and a half. We had based those projections on first-hand data from my partners’ experience. We accounted for the probability that customers would not find us for awhile, and that our inventory would take time to build up. We had three different sets of projections; an optimistic scenario, a pessimistic scenario, and the scenario we felt most probable. We had identified potential trouble-spots and plans for getting around them.

Our investor came away feeling confident that we would not only succeed in our plans, but that his money was in good hands. We got our funding, and our business got under way. I won’t say it’s been a runaway success–we’ve barely been open four months now–but I will say we’ve exceeded “likely” scenario projections every month so far, and while we overran our startup costs a bit, our planning helped us recognize it quickly and compensate accordingly.

In hindsight, while we didn’t draft a formal business plan, the planning we did was invaluable. Even had we been able to finance the entire venture ourselves, the discipline of planning helped us recognize the essential elements of getting our business going and the limitations we were operating under. We had goals in place to help us gauge critical factors early on. I feel the confidence and focus we gained has been the key factor in our success thus far.

So is a business plan necessary? No, but if you want funding you’ll want one. And if you want to succeed in business, you should at least take some time to consider all the key elements in a business plan. You’ll be glad you did.