If a person is starting a company or thinking about starting one, there is a good chance that they have thought about how much funds they need to get it up and running. Individuals may also realize that they do not have enough capital on their own to get started. So what can they do? The good news is that there are a lot of ways to get outside funding to help companies get started. Funding options usually include one of two concepts.
One is a debenture, loan, or debt, in which the financial institution like a traditional bank, credit union, or lending firm makes its money by clients paying the debenture back plus interest over a term or a certain period. The other is an investment or equity, in which investors are given agreed-upon percentages of ownership (number of shares) in the company in exchange for providing funds for the capital.
In this case, investors are hoping that the company will grow dramatically over time so that their shares in the company will appreciate in value and earn an ROI or Return on Investment. When people write their business plan, they want to keep in mind who their audience is.
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Loans and investments are two very different things, and the ways that lending firms versus investors make money are very different, enough to require various business plans. To help individuals plan accordingly to help pursue the funding they need, here are some differences between a conventional bank and an investor business plan.
ROI or Return on Investment
Suppose an individual is looking for an investor to fund their enterprise. In that case, prospective investors or investors will want to see a Return on Investment scenario that shows current valuations and estimated future valuations of companies. An enterprise determines its current valuation through the investment amount being requested, as well as the percentage of ownership given in exchange for funds.
For instance, a $200,000 investment for 20% ownership means 100% ownership is worth a million dollars valuation using simple math. It is imperative to note that valuations are loosely based on perception when looking for investments, especially for start-ups or small enterprises.
Possible investors may or may not agree with the company’s perceived valuation. While there are certified valuators people can hire to determine precise valuations for them, they can also approximate these things without the help of these professionals.
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The latter is done by taking their Earnings Before Interest, Taxes, Depreciation, and Amortization or EBITDA from a certain year in their income statement and multiplying it by multipliers to find out their future valuation in that year. Although Earnings Before Interest, Taxes, Depreciation, and Amortization times multipliers are the most common way, some industries have multiple recommendations to calculate future valuations.
If organizations are looking at bank debentures, then a Return on Investment scenario is not needed for their business plan. It is because traditional banks make money by having the debenture paid back with good interest. The amount owed is determined by the loan term, the interest rate, and the amount of the debenture. Since none of these things have to do with the company’s performance, the amount owed to the financial institution would be the same whether the business generates $1,000 or a billion dollars.
If an entrepreneur is looking for investor funding, possible investors will want to know all possible scenarios in which they can get out of having financial interests in the enterprise. One option consists of people selling their shares back to the organization at appreciated values in the near future.
Other options include the enterprise failing and shareholders losing their investment or the company being successful in having an IPO or an initial public offering and having shares publicly traded on stock exchanges.
Shareholders’ plan will state every foreseeable possibility to get out of the company. Suppose a person is looking for a bank debenture. In that case, exit strategies are not needed unless they plan to get out of the company before the term on the debenture is up, although a lot of lending firms would be pretty cautious of lending funds under this instance in the first place.
Exit strategies are not needed otherwise, since traditional banks only have vested interests in enterprises in terms of loans. Once terms are up, and debentures are fully paid, banks are no longer concerned about the performances of these companies since it has earned their ROI in full and has departed at this point.
If organizations are looking to get a bank loan or other types of debts, interest expenses should be shown in their income statements. In contrast, their principal debenture payments would be shown in their cash-flow statements. If they are looking for investments or other types of equity financing, interest expenses, as well as principal debenture payments, will be zero.