How to Write the Company and Financing Chapter
The company and finance section of your plan is important, because introducing the management team is critical for both start-ups and established companies alike. Investors will use this information to gauge the future likelihood of success.
Company and Financing Sections
- Company Overview
- Management Team
- Required Funds (optional)
- Exit Strategy (optional)
- Mission Statement (optional)
- Company History (optional)
- Location and Facilities (optional)
1. Company Overview
There are many variations and approaches on how to lay out the various components of a business plan. Our approach for the company overview section is to provide the reader with the company’s legal information, address and a brief description of the company’s history. Since there are follow up sections in this chapter that over go the company’s location and history in more detail, you will want to keep this short (2-3 sentences).
A BRIEF PRIMER ON COMPANY TYPES
The optimal company type is best determined by a credible Attorney. The primer below is meant only to explain the broad differences between the most common company types.
Sole Proprietorship
A sole proprietorship, according to the IRS:
“A sole proprietor is someone who owns an unincorporated business by him or herself.”
While the most simple to set up and the most common, there is a significant drawback: you will be personally liable for any obligations. So for example, if you sell someone a cupcake and they sue you because they found a hair in it, and you lose in court, the creditors can legally go after your personal possessions – such as the roof over your head.
Partnerships
A partnership, according to the IRS:
“A partnership is the relationship existing between two or more persons who join to carry on a trade or business. Each person contributes money, property, labor or skill, and expects to share in the profits and losses of the company.”
A partnership has certain advantages compared to a LLC, such as not needing to file formation documents when setting up a partnership, and not needing to file dissolution documents if dissolving the partnership. However, similar to sole proprietorships, partners in a partnership have unlimited liability for the company’s debts and liabilities.
Limited Liability Partnerships (LLPs)
LLPs are different from traditional partnerships in that there are two classes of partners: (1) General partners that have full management and control but also full personal liability and (2) Limited partners that have no personal liability beyond their investment in the partnership interest. Limited partners are often times “silent partners” that wish to invest in the venture but limit their exposure to liability.
Corporations
A corporation is a separate legal entity owned by shareholders. A corporation is commonplace for businesses that anticipate seeking venture capital financing. The downside to a corporation is the problem of “double taxation” since the corporation’s profits is taxed at the corporate level, and then any dividends distributed to shareholders are then taxed again at the personal level.
S-Corporations
You can elect a special tax status with the IRS to have your corporation not be taxed at the corporate level (instead, it would be taxed as a pass-through entity). Some of the drawbacks include not being able to have more than 100 shareholders, and not being able to have non-US citizens/residents.
Limited Liability Companies (LLCs)
A popular choice among many small businesses, a LLC limits the member’s personal liability and only taxes profits at the individual level (acts as a pass-through entity).
If you have not yet incorporated
Describe the type of company you plan to open, along with the registered name you plan to use.
Explain your rationale – for example, if you are starting a company where you plan on seeking venture capital financing, then you will want to start a C-Corporation as majority of VCs will insist on this legal structure.
If you have a home office/no dedicated business address
Include your current office setup and your future office plans once your company expands, if applicable.
2. Management Team
For start-ups, and especially those seeking financing, the Management Team section is especially critical. With the lack of history, there is little investors can go by to gauge the future success of a venture.
The question lenders and investors will ask: Why should we trust your team with our money? You must demonstrate your team’s ability to execute on the stated goals. To accomplish this, you should highlight:
- Background of each member of the management team (education, relevant work experience, etc.)
- Roles and responsibilities within the company.
Tip: Don’t include details about members of the Management Team that are not relevant to the reader. Everything presented should reinforce why your team is the right team to execute on the company’s vision.
Note: For established businesses
If you have an established business the information you want to present is the same. Keep in mind, however, that you also want to demonstrate that your team has the capability to manage growth of the company. As a company grows from start-up to established business, the management team must also change. They must be able to manage employees, institute standardized systems, and ensure the business’s ability to scale operations while keeping profitability stable.
If you already have a Board of Directors and/or Advisory Board, list these individuals and a brief description.
What is a Board of Directors?
In a publically trading company the Board of Directors is elected by the shareholders and is the highest authority in the management of the company. For our purposes (context of a private company that is most likely a startup or small but growing business), a Board of Directors is comprised of investor(s), founder(s), CEO and independent board member(s) who have substantial business and industry experience.
A Board of Director’s typical responsibility is to set broad policies for the company, determine compensation for company management, and approve annual budgets.
What is an Advisory Board?
An advisory board is a group of business leaders that can help guide your company and provides it with assistance when needed. Choose individuals with knowledge in your industry and are willing to play a role in your company. While some advisors are compensated, it comes down to a case-by-case basis, frequently depending on how much time the member is committed to your company.
Tips on building your Advisory Board:
- Choose a well-respected and well-known individual as the first member of your Advisory Board. This will help you to recruit other members of the Board.
- Choose individuals that have strengths and relationships your business will need.
- As your business evolves, so will the members of your Advisory Board. Feel free to shake up the line up over time.
3. Required Funds
In this section you will tell the reader how much money you need to raise, what you are going to use it for, and how you got to the requested amount.
Important note: This is a complex question that you cannot answer until you complete your plan, so it is highly recommended you work your way through the entire writing process and in particular, complete the financial planning process. Only then will you be able to identify the amount of money you will need to raise
There are two primary financing options: equity and debt.
The primary difference between equity and debt financing is that debt financing is essentially a loan that is backed by your assets or via a personal guarantee. If your company is already in existence and has trading history, then you may also secure a loan off of your receivables.
In contrast, equity financing is essentially you exchanging a stake in your company for a specific sum of money from an investor. Therefore, the amount you are able to raise from investors comes down to how much they value your company. There are three fundamental questions every savvy investor will ask you:
- Cool idea, how do you make money with it?
- How much money do you need, and why and when?
- What do you think your company is worth?
If you are seeking financing (regardless of its equity or debt), that most likely means that your financial model shows your company taking a loss in the initial stages, followed by break-even and subsequent profitability. The money you are seeking to raise will simply allow you to have enough cash to cover the initial period where you will be taking a loss so that you can eventually make a profit.
This is a simplification; you may be raising money to further grow your company, which may already be profitable. Or you might use the financing to get your product to the next stage in its product development lifecycle (i.e.; milestone event). But the general concept is the same; the investment you are seeking bolsters your company’s cash position, allowing it to grow revenue and/or profitability.
Cool idea, how do you make money with it? / How much money do you need, and why and when?
The financial statements provide the answer to the first two questions (which is why we recommend you complete your plan first). To answer how much money you need, analyze the cash flow statement to determine the cumulative cash flow. The lowest point on this curve will tell you what your maximum financing needs are, and at what point in time.
What do you think your company is worth?
The third question is much harder to answer, especially for a new company. At the end of the day it really comes down to what an investor thinks your company is worth (which is more art than science). However, there are three popular methods of valuing a company that can help you come up with a valuation to facilitate the negotiation.
Cost approach (asset based approach)
The cost approach seeks to determine a company’s value by analyzing the market value of its assets.
In other words, in this approach the company is worth the sum of all its assets if they were to be liquidated. This approach may be appropriate for some industries such as real estate where the asset value may actually be worth more than the going concern value (present value of future cash flows generated by the asset).
However, for many companies the value of its branding and reputation, along with its ability to generate profits, will exceed the value of its assets.
Market approach
The market approach seeks to determine a company’s value by analyzing recent sales of similar assets, with the theory that valuations of similar companies can serve as a good proxy. This is a common approach in the real estate industry.
Income approach
The income approach seeks to determine a company’s value by using its expected profit over time and then placing a value on that future stream of income in today’s terms. Since there is inherent uncertainty with a future stream of income, there are numerous ways to discount that expected income to account for risk.
Completing the equation
Now you have all the pieces to complete the equation. You have the amount of money you need by looking at cumulative cash flow. You also have an idea of how much money your company will be worth.
Equation to determine how much equity you should offer:
Equity to offer = Company Valuation / Money needed
If raising debt, you are not exchanging equity for cash. Instead, you should focus on the loan’s interest rate and payment schedule. Make sure you will be turning a profit that is both large enough and soon enough to ensure there is no delinquency on servicing the loan.
Putting it all together
For equity financing, answer the following:
- Investment amount needed
- When you need it
- How much time it will buy you / When you expect to turn a profit or get to the next milestone event
- % of equity offered and at what company valuation (you may wish to keep exact figures vague in order to further negotiate)
- Exit strategy
For debt financing, answer the following:
- Loan amount needed
- When you need it
- When you will be able to pay back the loan
- The amount and frequency of loan payments
Breakdown of funds:
In addition to the information above, you should also summarize how you plan to use the funds. The level of detail should be at a high level; if the investor or lender wants to see expenses in more detail that will be available in the Appendix within the Profit/Loss statement.
Example of a Breakdown of Funds:
Construction of new kitchen:
- Kitchen remodeling, March 1, 2014, $25,000
- Kitchen hardware, April 1, 2014, $50,000
- Total Loan Amount: $75,000
What about a Line of Credit?
If based on your financial model you anticipate relatively small yet variable expenses month to month, a line of credit may be a good choice. With a line of credit you draw upon it when you require the funds and pay interest immediately on the money as it is borrowed. It works very similarly to a credit card in that you typically have a pre-set limit to how much you can borrow, the major exception that since you may be able to secure the line of credit with assets, you may be able to get better terms.
4. Exit Strategy
In the Quick Start Guide we briefly went over the different strategies available and how thinking about your company’s eventual exit will help shape your business model. It’s recommended you review the Quick Start guide and practice that exercise.
Depending on your company, there are various exit strategies available, including:
- Selling your business
- Passing it down through the family
- Taking the company public (IPO)
- Liquidation
If you are seeking equity financing, then your investors will pay close attention to this section. Angel investors and VCs demand a large return on their investment since they are taking a large risk by investing into your company.
Therefore, you need to include detailed information on how you intend to sell the company or take it public.
Demonstrating a large market opportunity
If investors are going to take a big risk, they demand a big return. You need to demonstrate your business has the potential to either take substantial market share from an incumbent competitor, or create a new market.
Being in a hot industry
Investors like to be in hot, growing industries such as biotechnology, mobile e-commerce and healthcare. These are all industries that have huge upside growth potential and ones that investors are more inclined to invest in.
Solving a larger company’s problem
If your exit strategy is to sell your company to a larger company, then identify how your company’s product solves that larger company’s stated problems and/or goals.
For example, Apple’s mapping software is playing catch-up to Google Maps. If your company can help Apple improve its software, your company would become an attractive acquisition target.
5. Mission Statement
The mission statement reflects the core purpose and vision of the company. It’s a statement your employees and customers can get behind.
Some tips on writing a well-crafted mission statement:
- Keep it short. 1-2 sentences max.
- Don’t use “fluff” words. Make the statement mean something.
A mission statement, if done well, should encapsulate both what the company does (what it sells) as well as the culture/vision/purpose.
Examples of Fortune 500 firms that really get it right:
A. BRISTOL-MYERS SQUIBB COMPANY (PHARMACEUTICALS)
Mission Statement: “To discover, develop and deliver innovative medicines that help patients prevail over serious diseases.”
Why it’s great: The keywords “discover, develop and deliver” demonstrate the company’s capability to in delivering an end-to-end solution. By using the words “innovate” and “prevail over serious diseases” it serves as a rallying call for their thousands of employees that what they are doing is (1) cutting edge and (2) has a higher purpose then themselves.
B. CVS CORPORATION
Mission statement: “We will be the easiest pharmacy retailer for customers to use.”
Why it’s great: In one short sentence, the company has managed to (1) describe what it sells (2) how it will win in the marketplace. It is a pharmacy retailer and it will solely focus on making itself easier for the customer to use (that could mean so many things, such as innovating online to fulfill prescriptions to improved customer service within their stores).
Example of poorly written mission statements
A. FORTUNE 500 FOOD AND BEVERAGE COMPANY
Mission statement: “The Company’s primary objective is to maximize long-term stockholder value, while adhering to the laws of the jurisdictions in which it operates and at all times observing the highest ethical standards.”
Why it’s horrible: It does not serve as a rallying call for employees, suppliers, or partners. Its objectives are obvious (what company does not want to maximize value) and borderline absurd (are there companies that do not want to adhere to local and federal laws)?
Lastly, it does not mention what the company actually does.
B. FORTUNE 500 VEHICLE PARTS SUPPLIER
Mission Statement: “We are committed to attracting, developing, and keeping a diverse work force that reflects the nature of our global business.”
Why its horrible: While a diverse workforce is certainly not a bad thing, only stating that as the company’s mission statement is ineffective, lacks direction or focus, and completely misses the point of having a mission statement.
6. Company History
This is predominately for businesses that have previous trading history, but can also be used by new companies that want to highlight relevant history on how the company came to existence, work completed to date, milestones achieved, etc.
Some information you may want to include:
- Start date
- First location
- First product/service
- Significant milestones/events
Reminder: keep in mind that there is no set rule as to the level of detail you want to include. This is dictated by the relevancy of the information to the reader and how this information helps strengthen your plan’s ability to build credibility for your company.
Every company is made of milestones
Milestones for a business are achievements that demonstrate the business is on the right track. They are best when quantifiable and measureable. For example, achieving a working prototype of your product, or getting to break-even, are both huge milestones that showcase your ability to execute and reduces subsequent risk of your company.
Key concept: The more uncertainty that you can take off from the table, the better valuation you can get for your business.
7. Location and Facilities
For businesses that have a retail or manufacturing component, this is an important section of your plan.
Information you may want to include:
- Size (e.g.; in sq. ft.)
- Location/Address
- Other notable facts, such as equipment at the facility
For retail operations
Location is important for a large number of retail businesses, whether you are a restaurant or purveyor of consumer products. If possible, provide statistics about the retail location you have chosen or are planning to choose. Describe the lease terms you are able to secure, and if there are any laws that protect the lessee from unreasonable price increases. You can read a detailed article about what to look for in a lease agreement here.
For manufacturing
Provide detailed information on the manufacturing facilities. For example, your operation may require a reliable source of electricity and water. Describe how the facility provides the business with these resources. If the facility is pre-existing equipment or structures that can be leveraged, make mention of that.
Other
Location can be an important aspect of your business even if you are not in retail or manufacturing.
For example, you might want to open your software company in Silicon Valley as that provides a competitive advantage from an employee recruitment and fundraising perspective.
If you operate out of a home office
Describe your future expansion plans, including expected date of expansion.
Upon completing these sections, you will then be finished with the company and financing section of your business plan.
