This chapter helps your writing process because it gives you an idea of what lenders and investors want to see in a finished plan. Your ability to understand your financiers’ motives can mean the difference between getting a loan or investment and coming up empty-handed. If you already have financial backing, you can skip this chapter.
Many people and institutions are looking for sound loans and investments. From their side of the fence, it can often seem extremely difficult to find a good one. Many potential financiers have been frightened by news stories about small business financial problems, con artists selling phony tax shelters, business bankruptcies, and so on.
Ways to Raise Money
Before you can sensibly plan to raise money, you need to know how it’s commonly done.
Someone gives you money in exchange for your promise to pay it back. The lender could be a bank, friend, family member, or anyone else willing to lend you money. The lender will almost always charge interest, which compensates the lender for the risk that you won’t pay back the loan. Usually, the lender has you sign some papers (called a note and loan agreement) spelling out the details of your loan agreement.
Lenders often protect themselves by taking a security interest in something valuable that you own, called collateral. If you pledge collateral, the lender will hold title to your house, your inventory, accounts receivable, or other valuable property until the loan is paid off. Loans with collateral are called secured loans.
If you don’t repay a secured loan, the lender sells your collateral and pockets the unpaid balance of your loan, plus any costs of sale. Not surprisingly, if you have valuable property to secure a loan, a lender will be much more willing to advance you money. But you also risk losing your house or other collateral if you can’t pay back the loan.
An equity investor buys a portion of your business and becomes part owner. The equity investor shares in your profits when you succeed. Depending on the legal form of ownership, she only shares in your losses up to the amount of her initial investment. Put another way, most equity investors’ risk is limited to the money they put up, which can be lost if the business fails.
Investors expect you to think of their money as a tool; you will use their tool for a while, and then you will give it back. Your business plan should include a forecast of when and how that will happen. Failing to discuss a repayment strategy in your plan can cause a potential investor to wonder about your motives.
To understand a little more about your potential backers, let’s look at the dilemma they face when they consider investing in a small business like yours. On one extreme are the very safe investments that produce a low profit. At the other extreme lie investments that promise a very high profit but that also carry a high risk of losing the entire investment.