Page 143 - Business Plans that Work A Guide for Small Business

134 • Business Plans that Work

that they will get their investment back plus an attractive rate of return. The
rate of return that an investor might expect would be around 20 percent
per year. Why? This investment isn’t risk free. Even though Lazybones has
been successful to date, many companies going through rapid expansion
overextend and end in bankruptcy. For example, Bennigan’s, a casual dining
franchise, went into bankruptcy shortly after the 2008 recession began. A
combination of lots of competition in the casual dining arena (e.g., Chili’s,
Applebees, and so on) along with declining interest in dining out due to the
recession pushed the franchisor over the brink. Could something like this
happen to Lazybones? The probability is low but not zero, and even if the
company is not technically bankrupt, they may not be in a position to fund
the debt service to investors. Thus there is a risk premium associated with
this investment. When an investor puts money into a start-up firm, it is pri-
vately held. That means there is no market for investors to sell their shares.
Thus investors expect to hold their shares for many years until the com-
pany either (1) goes public, (2) is acquired by another firm, or (3) generates
enough cash flow and profit to buy back the investors’ shares. Let’s assume
that investors expect to get their money out of the company in five years:

Investment (i) = $500,000.
Length of investment (n) = five years.
Expected Rate of Return = 20 percent.
We are seeking the future value (FV) of the investment.

n
FV = i(1 + ROR) .
5
FV = $500,000 (1 + .20) .
FV = $1,244,160.

Now that we know the future value of the investment, we need to
determine the future value of the company. We need to estimate the com-
pany’s profit after tax in the future and then multiply that figure by a price
earnings ratio. In this case, I’m just using the projections that Lazybones
presents in its plan for year five.

Lazybones’s profit after tax (PAT) = $2.1 million.
Consumer services price earnings ratio (PE) = 10.
2

2 From Yahoo/Finance for Consumer Services Industry, www.biz.yahoo.com/
p/762conameu.html, accessed August 15, 2010.