Having sufficient financial resources to support your business may make the difference between success and failure for your enterprise. It is critical that you realistically analyze the financial needs of your business and the options you have to fill those needs. Few mistakes are more dangerous to a new business than making unrealistic assumptions about finances and financing. A simple analytical process may save both your business and your sanity as your business begins to grow.
Write a Business Plan
A well researched business is crucial to soliciting financing of any kind. Please see our summary of business plan requirements at the Business Plan page.
Identify Your Cash Requirements
You need to identify all potential expenses your business will incur as you establish it. Some of these expenses will be one -time "start-up" costs, such as the cost of filing for incorporation or your business license. Some will be ongoing such as the cost of utilities, inventory and so on. Additional cash will be required for working capital if you will be carrying accounts receivable and you require inventory to be stocked ahead of sales. It is critical that you identify those expenses and cash requirements which are essential and those which are "nice to have" but not essential. Identifying these essential expenses establishes your basic financial needs in starting this business.
Analyze Your Ongoing Expenses
In looking at your essential expenses, it can be useful to divide them into two categories: those related to a resource your business will need to operate (often called "fixed expenses" for "overhead") and those related to a specific (projected) sale (generally called "variable" expenses). Examples of the former would be administrative costs, utility costs and insurance costs. Examples of the latter include inventory associated with a particular sale, and travel costs associated with servicing a particular customer. This type of analysis is useful for two reasons: you can use it to determine a break-even point, and your fixed expenses don't go away even when your sales do. You must therefore be able to cover these expenses even if your initial sales are not generated as quickly as you anticipate. This type of analysis is generally accomplished by completing a month-by-month cash flow projection.
Identify Your Financing Options
You have now identified how much you need to invest in your business ("start-up costs") and how much money you will need to generate on a monthly basis for your business to survive. You next must identify the sources of funds available to fill these needs. One of the most important steps in this process is to identify all your financing options - don't cripple your business before it starts because you have planned to use one source of financing and then are unable to access that particular source. Always have a contingency plan in case your initial assumptions are not realized.
This is probably the most common type of financing used when starting a business. These resources may be yours, or may be those of friends or relatives. Other options in this category include equity in other assets which you personally borrow against or sell (such as a mortgage on your home), personal savings, or personal loans.
Some businesses finance start-up costs through private investors. This type of financing can take many forms, including loans or shares in the business.
Under certain circumstances, banks and other financial institutions provide financing for start-ups, but they are not the most common source of financing. This is because loans to start-up businesses frequently pose a high risk, and financial institutions are low risk lenders. Financial institutions must maintain a low risk approach to lending because the money they lend belongs to their depositors, not the institution itself.
SBA lenders have multiple programs that can meet the needs of small businesses. These include programs such as the following:
- Microloans: Up to $35,000 for working capital and equipment purchases without collateral
- 7(A) Loans: Up to $5,000,000 for working capital and equipment purchases (as of the end of 2010) -- requires collateral
504(A) Loans: Up to $5 million for purchase of real estate with 10-20% down
To consider financial institutions as a source of capital, you should generally have a good credit history and experience in the industry of your business plan.
Venture capitalists invest in your business and become co-owners with you. They will frequently take an active part in the management of your company and they usually ask for a controlling interest in your business. Venture capitalists look for a high return on their investment (generally several hundred percent) over a relatively short time period (usually three to five years). After this period of time they normally expect to sell their interest to other investors. Minimum investments vary. This type of financing is most appropriate for businesses that can reach sales in the hundreds of millions of dollars.
For assistance in exploring the various financing options available to you, contact the Alameda County SBDC at (510) 208-0410.