What a bank needs to see in your start-up business plan
Editor's note: this article originally appeared in the August 2019 edition of the Chamber's Business University newsletter.
The post-recession downward trend in new business activity is showing continued signs of reversal according to the 2017 Kauffman Index of Entrepreneurs.
Most start-up businesses will require at least some funding from a bank or other financial institution. As a result, we are often asked what banks and other lenders look for in order to agree to offer a business loan to a start-up. As entrepreneurs prepare to enter the marketplace here are some of the most important factors that financial institutions want to see in your business plan in order to “green light” your loan application.
Financial institutions rely on business plans to not only make decisions on lending, but to determine the best mix of banking products and services that will most appropriately benefit their business customers.
Having a business plan is critical for both the business owner and the financial institution. Not only does a business plan provide a road map for research, it drastically increases the chance for success, including consistent growth and investment. For startup companies, a business plan allows entrepreneurs to create a blueprint that includes creation, operation, promotion and success of the company in specific details.
A business plan that extensively states the vision, strategy and future of the company is more likely to sell a lender on the idea. Within the plan, lenders look for additional details outside of the financials such as a prospective company’s industry analysis to determine if the mission aligns with the needs of the area and whether there is enough available market share to be profitable.
Entrepreneurs should also undertake comprehensive market analysis that includes demographics of prospective customers and their spending habits, as well as key competitors in the same space. Equally important is to clearly explain the point of difference the planned company offers in comparison to its competitors and how that distinction will influence purchases.
Realistic financial projections are a critical point that lenders will review. Do they compare with industry standards and are they in line with the current performance of similar businesses? One of the biggest mistakes entrepreneurs make in preparing their business plan is to inflate financials beyond industry averages. Lenders recognize this stretch and, more often than not, will see it as an area of concern.
In addition to profit and loss projections, lenders review anticipated cash flow for the next three to five years. Business owners typically think about costs and expenses compared to sales, but timing and delays play a big role in managing cash. Loan officers look closely at accounts receivable and inventory turnover ratios, which are other indicators of good cash flow cycles. Higher turnover ratios are desirable as they indicate management does not hold onto excess inventories and inventories are highly marketable.
The Arkansas Small Business and Technology Development Center (ASBTDC) at the University of Arkansas at Little Rock is a valuable resource for business owners in the creation, management and operation of a company. The ASBTDC provides free services to business owners at any stage of development or operation of their business, including market research and consulting that strengthen any business plan.
Proof that stakeholders know their business or have a record of success helps a plan stand out when it is under review. Applicants should include extensive profiles of the business partners, management team, investors and any other key players involved in the business endeavor. Collaboration or partnerships with individuals who have a history of business acumen bodes well for budding and seasoned entrepreneurs alike.
Financial institutions prefer proof of a secondary source of repayment in the event a business struggles. Those sources include cash savings, a strong guarantor with liquid assets, excess collateral, etc. Banks must protect depositors with every loan, so proof of alternate sources for repayment is critical for loan applicants.
A banker’s best advice for prospective business owners is to “Do your homework.” Simply put - know the industry, create a point of difference, outline a solid and realistic balance sheet and assemble a reputable and experienced team. Lenders want to help small businesses succeed and the legwork done in the planning stages can be a strong indicator of the success that may follow.
Addison Johnston, NMLS# 497574, is the business banking manager for Arvest Bank in Oklahoma City. Email him at email@example.com. Arvest Bank is a Member FDIC and Equal Housing Lender.