This is the first in a continuing series of articles from Ron’s newest book, Getting to Yes with Your Banker, which includes 93 secrets you likely didn’t know about dealing with your banker. In a Click and Clack format, from an entrepreneur’s and a lender’s perspective, the book is co-authored by Ron Sturgeon, a serial entrepreneur, and Greg Morse, founder and president of Worthington National Bank, a community bank with four locations throughout Tarrant County.
The book is packed with tips and advice about how to choose and get along with a banker, what your banker wants to see, and other valuable tips for both start ups and existing business persons from a banker’s and entrepreneur’s perspective. Today’s article discusses how putting a hockey stick in your business plan can make it DOA at your bank.
Preparing for (and Projecting) Growth
Ron: One of the things a banker doesn’t want to see in a business plan is unrealistic growth rates.
Greg: Absolutely. You can kill yourself by growing too fast, and most people don’t realize that.
Ron: It’s called a hockey stick. It’s an unrealistic change in the numbers, usually growing too fast. Borrowers actually think big growth will impress a lender and increase their chance of getting a loan. Nothing could be farther from the truth.
Greg: Right. And if a business’ revenue is going up too fast, the owners have to bring in more inventory to meet demand, so their receivables are increasing — there’s not a chance for them to repay that loan in the short run.
Ron: Revenue going up is not the same as profit going up. People need to understand the cash flow and where the money goes. If receivables double, the company needs the cash to fund that. That means if receivables went from $100,000 to $200,000, the company needs an additional $100,000. And there are three ways to get that:
One, they can write a check to the company, which would likely be capital (It can also be structured for tax reasons as a note payable to the shareholder, but the bank may want it subordinated to the bank’s debt.); two, they can get a loan for $100,000; or three, they can produce $100,000 worth of profit that isn’t needed elsewhere to fund the growth. In the case of a startup, being able to fund from uncommitted profit is the most unlikely of the three.
Too often, people don’t understand cash flow, so they don’t understand that issue. But the bottom line is bankers don’t want to see hockey sticks in business plans. And your loan request is going to be DOA if you don’t anticipate and plan for the required amount of cash needed, whether from debt, profits, or equity.
Greg: There’s a huge difference between revenue and income. Revenue is the dollars coming in; income is what’s left after all the expenses. A lot of people refer to revenue as income.
Ron: So from a banker’s point of view, what is a quantifiable number that people can look at in a business plan when talking about growth?
Greg: If they have projected anything over a 10 percent growth rate, they’re going to need to explain it. Twenty-five percent growth will often kill a company.
Ron: That’s for a mature business, right? Because for a start-up, it’s easy to double $10,000 sales to $20,000. Our peer benchmarking group participants often vet growth ideas, as usually someone else in the meeting has good ideas on what to do or not do, which is so valuable. And don’t ask your banker for ideas, or to vet your ideas.
Greg: Sure, it’s easy for a start-up business to show rapid growth in the beginning, because of where it’s starting out. But that kind of growth most likely won’t continue. And a business plan shouldn’t project that a start-up will continue growing at an exorbitant pace. But even in start ups, I want to believe that the growth is founded in good metrics. When a loan request shows doubling of sales and production, I want to know where the doubled rent is for the warehouse. I hope the answer is faster inventory turns, if the prospect didn’t show increased rent.
What Bankers Want
One important component in creating a business plan is knowing what bankers want, and don’t want, to see in one. Knowing those expectations not only helps you prepare a better business plan, but also makes the meeting easier for both you and your banker. Next time we will cover some of the items that should be included in a business plan to maximize your chances of getting to yes with your banker.
Ron Sturgeon, business owner, consultant and peer bench marketing leader, combines over 35 years of entrepreneurship with an extensive resume in consulting, speaking and business writing. Ron can be reached at 5940 Eden, Haltom City, TX 76117, 817-834-3625 or by email at rons@MrMissonPossible.com.