Bankers and others providing debt financing

When lenders review a business plan they are concerned with three mains issues:

1.       If the loan is only one element of the financing necessary to fund the business plan fully, are the other sources of finance in place and secure?

2.       Will sufficient cash be generated by the business to meet interest payments on the loan and to repay the principal?

3.       Are there physical assets, or other forms of collateral, within the business against which a loan can be secured so that, were the business to fail, the lender would be able to get all or some of its money back?

Bankers will look closely at the financial forecasts contained within the business and the underlying assumptions on which those forecasts rely. They will wish to satisfy themselves that they are credible. As part of their financial analysis of the business plan they will look closely at the balance Sheet to assess its strength and the liquidity of the Business. They will examine the gearing, the ratio of debt to equity within the business, to ensure that the business does not become too heavily geared towards debt, which will increase the possibility of default on the loan. They may also examine ratios such as interest cover which is described in more detail. If the loan agreement contains financial covenants, certain levels of performance the business must meet, then the financial forecast must include the measures associated with any covenants and demonstrate sufficient headroom so that the lenders can be confident the covenants will not be breached.

Providers of equity funding:

There are many organizations and individuals who might provide equity funding to support a business plan. Family and friends is often the first port of call for smaller business ventures. The providers of more substantial levels of equity or Share capital for new business ventures include Venture capitalists and private equity houses, who have a shorter investment time horizon compared with, say, institutional investors. Pension funds and other institutional investors may already be investors in an existing business and will be among the first to be approached when additional capital is required. Another source of equity funding may be a business considering some form of merger or partnership, which it may achieve through an equity injection into the business. The appropriate sources of funding for different business plans are discussed in detail. As providers of equity finance or share capital are last in the line of Creditors to be paid when a firm goes bust, their concerns are different from those of bankers:

1.       What are the funds to be used for?

2.       Is the business proposition a strong one and is there an identifiable source of sustainable competitive advantage that will allow the Business to outperform the market in the long Term?

3.       What is the expected return on equity? How experienced and capable is the management team?

4.       Is the business plan fully funded and what are the risks that more equity capital will be needed, leading to a dilution of the equity stakes of those who invest first?

5.       What are the growth prospects for the business and the potential for capital appreciation and/or a strong dividend stream? What returns have been achieved on any previous equity injections into the business?

6.       How will the providers of equity be able to exit from the business and realise the gain on their investment?

The providers of equity will look closely at the Credibility of the financial statements and the level of gearing (the ratio of debt to equity within the balance sheet). The more highly geared the business, the greater is the level of financial risk faced by the equity providers. These themes are explored in more detail.