Finding the funds to start your business is usually one of the most challenging things the budding entrepreneur will face. Whether yours is a small, home based business or a large venture that requires six or seven figure funding, the good news is that money is available. The bad news is that it is sometimes harder to secure than you may anticipate.
But look around. Every one of those businesses that you see as you drive down the street began as someone’s dream and, somehow, those entrepreneurs found the money to open their doors. If they did, so can you.
New businesses normally have a difficult time securing money for a variety of reasons. Conventional financing may be difficult because a new business is a risk to banks—there is no track record or assets to go on. For this reason, almost 75 percent of all start up businesses are funded through other means. In this chapter, those other options are examined.
Money and the New Business
The very first thing required of you is to accurately estimate the amount of money you need. Taking a cold, hard look at your money requirements will help you know your business better and help ensure your success. Once you know how much capital your business will require, it will be incumbent on you to get it. Having a cash crunch from the start is a sure way to go out of business fast.
How Much Money Do You Need?
If you have created a business plan, you should have a pretty good idea how much money you will need to get started. If you haven’t figured it out yet, this section will help you. The money you will need can be divided into three categories: onetime costs, working capital, and ongoing costs.
Onetime costs are things that you will need to spend money on to start your business but will unlikely see again, such as:
- Legal and accounting costs. You may need to hire a lawyer to help you negotiate contracts, incorporate, or perform other legal services. An accountant may be needed to set up your books.
- Licenses and permits
- Furniture and fixtures
- Decorating and remodeling costs
- Initial inventory
- Security deposits
- Equipment purchases
- Supplies
- Payroll and owner’s draw until cash flow is positive
Working capital is the money you will need to keep your business going until you start to make a profit. The old adage “it takes money to make money” is true and real. It is critical to have enough working capital on hand to cover the following costs:
- Debt payments. If you will be borrowing money to get started, you will want to begin repaying it right away.
- Inventory and replacement inventory. Service businesses have little, if any, inventory, but retail and wholesale companies often spend large sums in this area.
- Bills (utilities, suppliers, etc.)
- Advertising and marketing costs (e.g., flyers, sales letters, radio buys, signs, brochures)
- Office supplies, other supplies, cleaning service, etc.
- Ongoing payroll
So how much working capital do you actually need? A rule of thumb is that you have enough money in the bank when you get started to get things going and to feed, clothe, and house you and your family for six months. But a rule of thumb is only that. You can come up with some actual numbers by answering the following three questions and doing the accompanying exercises:
- How much money do you have?
- How much money will you need to start your business?
- How much money will you need to stay in business?
As you calculate these numbers, remember that one of the smartest things you can do is to keep your overhead low. Don’t by brand new office furniture if you do not need to. If you have a computer that works, use that.
How Much Money Do You Have?
| Assets | Liabilities | ||
| Cash on hand | ________ | Accounts payable ________ | |
| Savings accounts | ________ | Notes payable | ________ |
| Stocks and bonds | ________ | Contracts | ________ |
| Securities | ________ | Taxes | ________ |
| Accounts receivable | ________ | Student loans | ________ |
| Real estate | ________ | Real estate loans | ________ |
| Life insurance (cash value) ________ | Credit cards | ________ | |
| Automobiles | ________ | Auto loans | ________ |
| Other assets | ________ | Other liabilities | ________ |
| Total Assets | ________ | Total Liabilities | ________ |
| Net Worth (Assets minus Liabilities) _____________________ | |||
When you start to turn a profit, then you can indulge a bit. But right now, be conservative. You will be glad you did.
What do you do with all of this information? Begin by multiplying the last number on the expenses worksheet by six. This is the amount of cash you
How Much Money Will You Need to Start Your Business?
| Furniture | $______________________ |
| Computer hardware and software | ______________________ |
| Services and supplies | ______________________ |
| Equipment | ______________________ |
| Beginning inventory costs | ______________________ |
| Real estate improvements | ______________________ |
| Legal and accounting fees | ______________________ |
| Other professional services | ______________________ |
| Licenses and permits | ______________________ |
| Telephone and utility deposits | ______________________ |
| Insurance | ______________________ |
| Signs | ______________________ |
| Marketing | ______________________ |
| Advertising | ______________________ |
| Labor | ______________________ |
| Internet | ______________________ |
| Emergency fund | ______________________ |
| Other | ______________________ |
| Total StartUp Costs: | $______________________ |
How Much Money Will You Need to Stay in Business?
| Expenses, per month | |
| Your personal living expenses | $______________________ |
| Advertising | ______________________ |
| Marketing | ______________________ |
| Inventory | ______________________ |
| Supplies | ______________________ |
| Utilities | ______________________ |
| Telephone and Internet | ______________________ |
| Insurance | ______________________ |
| Taxes | ______________________ |
| Maintenance and upkeep | ______________________ |
| Delivery/transportation | ______________________ |
| Lease payments | ______________________ |
| Dues and subscriptions | ______________________ |
| Debt repayment | ______________________ |
| Payroll, other than owner | ______________________ |
| Your salary | ______________________ |
| Sales tax | ______________________ |
| Rent or mortgage | ______________________ |
| Storage and shipping | ______________________ |
| Transportation and delivery | ______________________ |
| Miscellaneous | ______________________ |
| Total Expenses | $______________________ |
will need to cover operating expenses for six months, and six months is the minimum amount you will need to get started. You absolutely must have this amount available before opening your business. This money will ensure that you will be able to continue in business during the crucial early stages.
Next, you must add this number to the total in the start up costs worksheet. By adding the total start up costs to the total expenses for six months, you can learn what the estimated costs will be to start and operate your business for six months. By subtracting this total from your cash available (the amount in the first worksheet), you can determine the amount of additional financing you will need.
Business Loans
As indicated, because the new business presents a risk to banks, conventional loans are not always easy to get. The U.S. government knows this, yet it wants to encourage entrepreneurship. As a result, the U.S. Small Business Administration (SBA) can be one of the best friends your new business can have.
Although the SBA does not make loans, it guarantees them. A bank might be far more inclined to loan your new business money if the SBA guarantees the loan. The SBA works with about 150 approved lenders nationwide that actually make the loans. The SBA’s intermediary lenders have experience making and servicing loans and providing technical assistance to the borrowers. That means that not only can a new business get a loan, but the lenders also can offer business guidance in the process.
The SBA has created many different types of loans that it offers through its member banks. For example, the SBA Microloan Program lends a maximum of $35,000 to entrepreneurs in any stage of business. Other loans go up to $1 million. To learn more about SBA loans and to find a list of intermediary lenders in your area, go to <www.sba.gov>, or call 800UASKSBA (8008275722).
The Four Cs
Whether you work with an SBA lender or not, you will still need to qualify for the loan. While it is basically true that a loan is a loan, lenders have different criteria for making a small business loan. You must understand what the bank is looking for so that you can meet those conditions.
- Character. What is the character and integrity of the borrower? To smaller, independent banks, character means a lot, whereas credit scoring dominates the approval process in many larger banks. If you work with a smaller bank, character can be the critical factor between approval and denial. Because your character is so important in the loan approval process, it cannot be underestimated. Character is determined by your past credit history, payment history, letters of reference, and so on.
- Capacity. What is the ability of your business to repay the loan? When it comes to lending, banks are most concerned with cash flow. Many bankers feel that a small business’s cash flow statement is the single most important financial document to consider in a loan request, because in it the bank can see if the borrower has the capacity to repay the loan. Make sure you can show your banker that your cash flow picture will work, even with the principal and interest payments included.
- Capital. How much money are you asking for and is the dollar amount requested justified by your supporting documentation? The more money you ask for, the more people will review your loan and the more scrutiny your request will get. Smaller loans are easier to get. If you are unsure how your capital requirement fits with your proposal and with your banker, then it is a good idea to have a preliminary meeting to talk about this to make sure that your request fits all requirements.
- Collateral. Do you have something to pledge to the bank as a security? A small business can offer many different types of collateral—a mortgage on real estate or inventory and accounts receivable, for example. Collateral makes bankers’ jobs easier, helps them sleep, and allows them to say yes to loan requests.
If you need capital, think like a banker and understand these four concepts before you apply.
Other Loan Options
If a conventional loan is out of the question, it might help to know that banks make other sorts of loans as well. This is especially true if your business is already generating some money or if you already have clients or assets. Other loans include:
- Accounts receivable financing. This revolving line of credit is based on your accounts receivable. A typical program enables you to borrow a predetermined percentage of accounts receivable, usually 80 percent.
- Purchase order financing. Say that you have a purchase order for $50,000 worth of widgets, or you sign a $50,000 contract. Using this method of financing, you can obtain advances on contracts that can be repaid directly by your customer.
- Fixed asset loans. These loans are based on fixed assets (such as machinery you own).
Angels
If a bank loan is simply not possible, then consider the angel option. An angel, as the name implies, is someone who has extra money and who is willing to take a risk on a new venture. But they do so for a price. What price, you ask? Ah, well that’s the rub. You will be asked, in all likelihood, not only to give up a big piece of the pie, but also some control. It is not uncommon to give up 30 percent of your business to an angel, as well as a say in how
■ Where to Find Angel Investors Online
• <www.garage.com>
Angels are out there, but you have to look for them. Ask around. Meet with some stockbrokers, real estate firms, and the like to get some names of possible investors. If you are willing to give up some power, equity, and decision making, angels can provide an excellent funding source for the new business.
If finding an angel investor is part of your plan, you will need to prepare your pitch, do your research, contact the angel, and research the deal.
Prepare Your Pitch
An “elevator pitch” is business lingo for a proposal that can be explained in the length of time you might be in an elevator with the investor. Let’s say you found your angel and, for whatever reason, you both got in an elevator on the 29th floor of a building. You would have about 30 seconds of uninterrupted time to pitch yourself, the business, and the idea. So your elevator pitch must be intriguing, make sense, be short and powerful, and motivate someone into wanting to schedule a meeting or learn more. Even if you are never in an elevator with a potential investor, a quick pitch will still be necessary when the time comes.
The “pitch” aspect also requires two written components:
1. The executive summary from your business plan. As you know, it is a compelling overview of your business venture. This may be the first thing the angel will read about your business and why he or she should invest in it. The executive summary should state clearly how much seed capital you need.
2. The business plan itself. If the angel likes the executive summary, he or she will want to see the whole plan.
Do Your Research
By using the online resources listed at the left, you can come up with a list of potential angels and then narrow it down to a few of the most likely. Once you do that, you need to learn about each person.
- Where did they make their money?
- What are their business interests?
- What motivates them?
- What else have they funded?
Contact the Angel
This is when you will need both an oral and written pitch. The important thing is to pique his or her interest and find some common ground. If you were referred to him by someone you both know, tell him. If you are starting a business like the one she started, let her know. Do you like the same ballclub? By creating a sense of common ground with a prospective angel, you increase the chances that your funding proposal will be taken seriously.
| Remember that many angels like being advisers and mentors and may be | |
| willing to use their own contacts to help you find additional funding or | |
| other assistance. All you have to do is ask. | |
| Research the Deal | |
If you are offered money, have your lawyer review all agreements. Also, get some references from the angel for other deals he or she has done. Check the references and make sure the angel is good to work with and legitimate.
Venture Capital
Venture capital (VC) is money tapped for large business start ups—those that need millions of dollars to get going. Venture capitalists pool their money into a joint fund to make these investments. Typically, a venture capitalist will provide early financing to new businesses that show the potential for rapid and profitable growth. In exchange, the venture capital firm will get stock, a say in business matters, and probably a few seats on the board.
• <www.vfinance.com>
• <www.herring.com>
• <www.vcmarketplace.com/vcdirectory.htm>
The OldFashioned Way
For many new businesses, loans, angels, and VC money are simply not an option. What then? Here are some other options that are used often to fund the dream:
- Use your savings. It is not uncommon for entrepreneurs to have to put dreams off for a while until they have saved enough to get started. Even if you plan on getting an outside investor, he or she will still likely want to see that you have your own money on the line too. You can always cash out your life insurance; whole life policies have a cash value that you can either cash out or borrow against. You also can sell your stocks and bonds.
- Tap your retirement. You may have a 401(k) plan or an IRA. Either way, these funds are possible sources of start up capital. Before you decide to tap these funds, make sure it is legal to do so where you live as each state is different.
- Use your credit cards. A common place people get start up funds from is their credit cards. Although entrepreneurs do this all of the time, be cautious. Interest rates of 18 percent can foster unmanageable debt very quickly.
- Borrow. Other people’s money has been a source for new businesses for as long as there have been businesses. The first place to look is your friends and family. Maybe your dad would be willing to give you a loan against a future inheritance or you might have a good friend who believes in you.
- Find a cosigner. You can always ask another person to sign on a loan in order to augment your credit. But remember that a cosigner also is liable for the note. If you fail to pay it, the bank will go after your cosigner.
- Use home equity. Banks are more than happy to lend you money against the equity in your house. Beware, though, because a new business is a risky venture. If it doesn’t work and you are unable to repay the loan, not only will you lose your business but you also could lose your home. For this reason, home equity loans are an option of last resort.
T H E B O T T O M L I N E
To get the money you want, you first need to know how much you will need. After that, you can target various sources, including friends and family, banks, angels, and VCs. No matter who you look to tap to fund your venture, they will want to see that you have a plan for making a profit and paying them back in a timely fashion.
