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How do investors evaluate a business plan?

This article examines how investors analyze a business plan.

To understand how investors look at business plans, you need to put yourself in their shoes and understand what their earning opportunities are and what risks they are exposed to.

The situation of the investor is very different depending on whether he invests in the debt or in the capital of the company. Let us take a look at the structure of the company for a moment in order to understand the challenges.

Debt, equity and their challenges

A business is a collection of assets financed by debt and equity. These assets generate cash flows which are then distributed among the various providers of capital.

The main difference between debt and equity is the contractual nature of debt. A loan is a contract between a company and a lender: the lender advances a sum of money to the company, which in exchange agrees to repay it and pay it interest according to a schedule defined in advance.

As the cash flows that the lender will receive is guaranteed by a contract, the only risk to which the lender is exposed is the risk of bankruptcy of the business. In addition, during a bankruptcy, the lender benefits from a privileged creditor position compared to other providers of capital such as shareholders.

Thus the lender’s position is relatively comfortable (cash flow guaranteed by contract, privileged position in the event of bankruptcy) but offers in return only a limited earning potential (nothing more than the cash flows provided for by the contract). . The position of equity investors is the exact opposite.

Equity investors can benefit from unlimited gains: they receive their share of each dividend paid by the company and can realize a considerable capital gain on the resale of their shares in the event of the sale or going public. business.

However, there can be no assurance that the company will be able to pay dividends or that the value of their shares will be greater than their purchase price in the event of resale. And, in the event of bankruptcy, they are the last to get something back.

As you can see there is therefore a major difference between the opportunities for gain and the risks of loss associated with each type of capital provider. This difference is reflected in the view that a banker will have on your business plan compared to an equity investor.