When many decide to start a business, there seems to be a big misunderstanding about the worth of their idea. An idea is just that until it is executed and sales are generated.
Over our time in business, my business partner and I have written many business plans and developed proforma financial statements for clients who were starting a business. For the most part, the majority of those we have worked with have a great understanding of their business, its potential, and they themselves made an investment in their business. In those cases, we have been able to develop a business plan where they were able to obtain financing or investment.
There suddenly has been an increase in individuals starting their own business whether because they wanted to be self-employed or out of necessity due to the job market. There are so many misconceptions about what it takes to get a business up, running and funded. It is sad to see that people sometimes get too far down the path before they realize there could be an issue in getting proper funding or investment.
There are three major components to business valuation.
Net realizable assets (all you own minus all you owe), plus
Net present value of future cash flows (past results are a good indication of future results), plus
Synergies; someone believes in you – it is why one person pays more for something versus someone else; it's the person who sees the future in what you are doing – emphasis on "doing.
No assets means Value = 0;
No revenues means Net Present Value = 0;
Synergy, in this case, with no value, what multiples will an excited investor pay?
Grants and Government Loans
There are many grants and loans available for businesses, as long as you understand the requirements and limitations. There are very few start-up grants, and for those that are, most are tied to equipment, real estate, or were created to help stimulate growth in the economy by funding employees such as students or those on unemployment. Where the grants are for "hiring," it means "net new employees," not funding the owner's salary, and there most likely will be audits to ensure you did what you said you were going to do. There is only so much money available, and everyone is going after the same piece of the pie. In many cases, there will be a cap on the number of grants of a particular type. If you are applying later in the year, there is an excellent chance that the program will then be closed for the remainder of the year.
There are small business loans through the government that the banks or credit unions administer that are great for those starting up, as long as you understand they are still a loan. They need to see security for 25% of the loan. The loan will go through the same process as any other loan. The loan needs to be tied to assets of some kind, whether business or personal. If you are buying equipment or a building for your business, that becomes an attachable asset. The bank or credit union are expected to ensure these loans are paid back – even though they are backed by the government. They have a duty of care.
Business Plans and Supporting Financials
Your business plan is your supporting documentation for your proforma financial statements. Your numbers need to make sense, which means you cannot pull numbers out of the air and hope a bank won't look back within your plan to see how they were obtained. Your plan needs to defend the size of your market and how you are going to gain the market share you have stated in order to get to your forecast. Before you spend more time on the cover and making pretty pictures for the bank, know that they only care about the numbers and the validation through the plan. We had one of the bankers we deal with tell us about a client that spent a lot of money on a binder, tabs, and colour copying for their business plan. The plan looked nice, but there was no substance, and they were shocked; they were turned down. If more time had been spent on the content and the financials, they would have had a better chance of obtaining financing for their business.
Investment and Experience
You have to invest in your own business and show that you have some skin in the game. If I heard once, I have heard it a thousand times," but it is my idea, so that is my investment." My favourite line is, "I am giving sweat equity as I am worth more than the salary I am giving myself." Sweat equity means you do not take anything out of your business until you are profitable. No one will fund an owner's salary. You have to account for having enough sales to pay for yourself.
Your idea is worth absolutely nothing to an investor if you are not willing to invest or take the risk in the idea yourself. No financial institution or investor will give you any funding if you have not invested in your own business with either equity (money) or assets, and why should they? What message are you sending to ask someone else to take a risk on you and your idea if you are not willing to take a chance yourself? The lender or investor also wants to know that you have the background and experience to execute on the idea. Have you worked in that industry, in management, in sales, or possess other skills that show there is a good chance of success?
Target Market and Sales
There has to be more than saying your industry is $5B, and you plan to take .5% of it. You have to defend that number based on many factors. How much of the market do your competitors have, and how much is available? How many salespeople or channels will you have and do the numbers make sense based on the number of sales per person/channel for the sales cycle of your product. Our observations have been that the greatest weakness in new plans is supporting/justifying the top line: revenues. It is insufficient to state, "I will take 0.5% of a $5B market; 0.5% should be easy to get – right? So let's just put $25M as our revenue line in year three, and we'll ramp up to that".
Have you invested enough in marketing (aka sales planning & execution) to get to your forecast? Have you priced your product or service appropriately to sell and are you making enough margin to cover the expenses. Does your SWOT analysis have more strengths and opportunities than weaknesses and threats?
Actual Sales and Cash are King
If you have made an investment yourself in your business or have assets to attach and have sales, you are in a position of strength, if the company makes sense. By having sales in hand, this shows that your idea can be executed. It is up to you as the business owner to go out and get the first sales. You cannot wait until the customers come to you. Don't forget; a sale is a gift until it is paid for; make sure you collect from real paying customers.
So before you quit your job to jump into life as an entrepreneur, make sure you are prepared for what lies ahead in starting a business. There is money out there and are resources to help you, but you need to be prepared to do most of the heavy lifting and take the risk, as the old saying is true, "No risk, no reward." An idea is just an idea until it is proven and realized, which means you have someone willing to purchase products and services from you.