At some point, the business owner hears about the benefits of debt financing. A loan is non-dilutive, is generally less expensive than equity, and allows you to maintain control. It is also usually available more quickly and can have flexible repayment terms.
At the last minute, the business owner decides to apply for a working capital loan , instead of or in addition to equity financing. It is common for businesses to submit to lenders the pitch prepared for potential investors. This is often where problems arise.
The lender wants to see a solid business case based on detailed and realistic projections.
The lender wants to see proof that their loan will be repaid.
In my work in BDC’s Technology group, I see these types of loan applications all the time. A company has a compelling presentation that talks about an innovative product and optimistic projections for rapid growth.
The problem? It's unlikely that a financial institution will grant a loan based on such a presentation. It will need to be modified a little, because a lender will look at your business very differently than an equity investor.
The lender wants to see a solid business case based on detailed and realistic cash flow forecasts that show how the loan will benefit the business and be repaid.
This is very different from a presentation to private equity investors that emphasizes growth potential.
The surprise of many business owners
An investor wants to acquire shares in a company with high growth potential, ambitious founders, and an inspiring story and pitch. These are the elements that founders present, sometimes with the help of accelerators and incubators.
The lender has different priorities. They want their money back. Sure, growth is good, but what matters most is making sure the business can afford to repay the loan.
It may seem obvious that lenders and investors have different priorities, but many business owners are still surprised when a lender asks for different information than they would to woo an investor.
Business owners should tailor their forecasts to lenders
In my work at BDC as a point of contact for technology companies preparing loan applications, I’ve found that one key document in particular usually requires a second look: their financial projections . Many business owners initially submit overly optimistic projections. Since we use projections to customize loan repayment terms, we want to make sure the projected cash flows are as realistic as possible.
In fact, projections are important not only for applying for a loan, but also for running your business. They show how your cash flow fluctuates and help you predict when you might run out of funds to pay bills or payroll.
Projections prepared for a private equity investor often extend over a five-year horizon and are broken down by year. For loans and internal business operations, projections should be broken down by month and extend over a one- or two-year horizon.
If your projections show 20% month-over-month growth but don't show any investments to back them up, you can expect questions about how you arrived at those numbers.
Differences in presentation to lending entities and that to investing entities
Investors Lenders and lenders
Presentation Must be captivating and showcase growth potential, ambitious founders and an inspiring story Must demonstrate that the business has the means to repay the loan. Must contain detailed and realistic cash flow forecasts, as well as financial statements audited by an accountant or a notice of assessment for the previous year.
Financial projections Often span five years and are broken down by year Should be broken down by month and span one or two years. Should take into account seasonality and various scenarios.
How to Prepare Financial Projections for Lenders
Companies often prepare very optimistic projections for lawyer database presentations to investors to show the market potential. Lenders, for their part, want to see realistic projections. This is especially true if the loan is unsecured and the application is based on historical and projected cash flows .
We look at how the projections fit with past financial statements and with the investments and projects the company tells us it plans to make. The projections should realistically and clearly show how the new funds are expected to impact future cash flows and growth.
What does “realistically” mean? If your projections show 20% month-over-month growth but don’t show any investments to back them up, you can expect questions about how you arrived at those numbers.
Consider seasonality and various scenarios
Often these investments cost more, take longer than expected to materialize, and take time to start paying off. Realistic projections must take these factors into account. They must also reflect when cash inflows and outflows will actually occur, not when a sale is made.
Additionally, many businesses have seasonal characteristics. This element should also be planned for to give lenders an idea of how the business will weather seasonal down periods.
It is also helpful to see different scenarios: one projection with debt and equity financing (if such financing is planned), and a second projection without additional financing. This allows the lender to see how the business will stay afloat.
Projections help structure repayment
With realistic projections, the entrepreneur shows lenders that he or she has done his or her homework and thought about the benefits of debt and what it will bring to his or her business.
Realistic projections are necessary for another key reason: they help the lender structure the loan to match repayment to expected cash flows. An initial interest-only payment period, staggered payments based on expected growth, or a lump sum payment based on an expected venture capital cycle are examples of flexible repayment terms.
Additionally, since lenders are typically long-term partners for a business, there is a good chance that the entrepreneur will come back for another loan in the future. The lender will then review past projections to see if they were realistic. In fact, we like to see that a projection has been exceeded. On the other hand, a failure can impact the credibility of the business and its future financing.
What documents do I need to prepare a loan application?
Cash flow projections are essential for lenders, but they’re not the only documents they need for loans. At BDC, we also require:
financial statements prepared by a chartered professional accountant or a chartered professional accountant for the most recent financial year, or a tax return and notice of assessment from the Canada Revenue Agency;
internally prepared financial statements for the current financial year to date;
a written or verbally presented business plan (depending on financing).
It’s understandable that many growth-oriented business owners are so busy that day-to-day tasks like bookkeeping can get neglected. I know; I was an entrepreneur myself . However, preparing projections and other key business documents can pay off handsomely, helping to improve decision-making, strategic direction and financial strength.
