Starting Your Own Business: Financing your Start Up

You need money to make money!

ROIAs mentioned before in some of the other articles in our Entrepreneur series, one of the basic business principles is the concept of ROI (Return On Investment), and one that many startup and established business forget on their quest to follow their dreams. ROI starts with “I”nvestment, and getting that investment part is one of the biggest challenges for any type of business. From the “FFF” friends and family financing option of startups, to the “BBB” big banks backing used by established enterprises and multinational corporations, every single business large and small needs to invest some money in order to start the process to generate their profits.

How much money do I need?

From the local lemonade stand (it needs the lemons, sugar, water, cups, table), to the Boeing conglomerate (making planes requires a lot of investment in people, factories, transportation, etc, etc, etc), every business needs to understand their financing needs, and to make the necessary plans to generate them. While there are no fixed rules about how much money you need, you can almost bet that there is a common answer for that question

More

No really, how much money do I need?

That’s a question that only you can answer (or at least that your accountant, strategic business consultant, or financial consultant, can answer), and you should not start your business until you have answered this question. While the answer as indicated before its either “More” or “Depends”, you must have a basic understanding of how much money you may need, and where will it come from. In order to estimate your startup costs, there are two basic categories that need to be taken into consideration:

Fixed Costs:

Fixed costs are all the expenses that will not change regardless of how good or bad your business is doing. Your business related car payments, your business related rent payment, your business related insurance, phone, electricity, etc. While it is true that your electrical bill or cell phone bill may go up or down depending on the month, the reality is that there is a minimum that you will need to pay to keep the services going and those expenses will not change regardless of how many customers or sales you have on a month.

Variable Costs:

Variable costs are all the costs directly associated with the sale of your product or service. From inventory, shipping and receiving, to sales costs and discounts, there are many costs that you will not have unless you have a sale. You need to understand what are these different costs and consider them as part of your pricing strategy. If it costs you a $.50 +3% of the sale cost to process that credit card payment, and the cost of your product is $.30 ,you may not want to sell it for $1 via a credit card payment even if initially gives you a 300% return since your real return will be barely 50% on this case (before all other fixed expenses). On the other hand if you can sell a million of them that’s another case, and if you can sell a million then you already have the financing part covered somehow ūüôā

Product Cost: .30

CC Fixed:        .50

CC Variable:   .03

Total Cost:      .83

Sale Price:   1.00

Profit:               .17

In addition to the fixed and variable costs you need to consider your specific financing needs including:

  • What do you need the money for (paying bills or growth)?
  • How fast do you need the money (6 months or tomorrow)?
  • How risky is your business (hoping to win the lottery to make it, or you are just having a slow season)?
  • How is your industry doing (if you were on the home construction business in 2011 you probably were not doing too well..)?
  • How strong is your management team (can you manage the money once you get it, or are you going to lose it again and will need to ask for more)?

So where do I get the money for my business?

startup_financingOnce you know how much money you need (find out your fixed costs, and your variable costs for at least 6 months to a year of operations), then you need to decide how to secure the necessary funds. While people tell you that there are many methods of funding for your business including Bootstrapping, Crowdfunding, Venture Capital, Borrowing, and others, all of them boil down to two simple ways:

Using Personal Finances

Starting a business can be a tremendous strain on your personal finances, and it can create a stress for your family life. It takes time before your new venture turns a profit and provides financial support for you and your family, and you may find out that the initial support quickly changes once the family needs are not met (school, medical, vacations, etc). Before starting a business, it is important to get your finances in order. To get started, write a monthly household budget that accounts for your income and your household expenses. Be as conservative as possible (add everything you remember including vacations, dining out, going to the movies, family trips, family events and gifts) because maintaining your household expenses is vital to the success of your business. Any strain on your personal budget can cause a financial risk to your business. Then you need to be sure that you have enough money saved to pay for those expenses for 6 months to a 1 year period, in addition to the fixed business expenses. That will help you focus on your business without having to worry about the family financial situation while your business grows.

Borrowing Money

Borrowing money is one of the most common sources of funding for a small business, but obtaining a loan isn’t always easy. Before you approach a lender for a loan, you will need to understand the factors the lender or investor will use to evaluate your application. There are two primary types of financing strategies used by lenders and borrowers regardless if they are friends and family, banks, or venture capitalists:

Courtesy of (pbworks.com/)

Courtesy of (pbworks.com/)

Equity Financing: Equity financing  is money raised by a company in exchange for a share of ownership in the business. Ownership accounts for owning shares of stock outright or having the right to convert other financial instruments into stock. Equity financing allows a business to obtain funds without incurring debt, or without having to repay a specific amount of money at a particular time. Equity often comes from investors such as friends, relatives, employees, customers, or industry colleagues. The most common source of equity funding comes from venture capitalists who are institutional risk takers and may be groups of wealthy individuals, government-assisted sources, or major financial institutions. Equity financing could be considered one of the most costly financing strategies since it involves giving away a portion of your future earnings forever. Of course you need to consider if being 10% owner of Facebook, Google, or Apple, is better than 100% owner of (….. an unknown little business), since sometimes equity investors also bring in their expertise and network contacts because of their vested interest in making the business succeed.

Debt Financing:¬†Debt financing means borrowing money that must be repaid over a period of time, usually with interest. Debt financing can be either short-term, with full repayment due in less than one year, or long-term, with repayment due over a period greater than one year. The lender does not gain an ownership interest in the business, and debt obligations are typically limited to repaying the loan with interest. Loans are often secured by some or all of the assets of the company. In addition, lenders commonly require the borrower’s personal guarantee in case of default. This ensures that the borrower has a sufficient personal interest at stake in the business. You can get debt financing from multiple sources including banks, credit unions, state and local governments, and even friends and family. The primary issue with debt financing for startups is the lack of an established credit history, and the potential need for personal guarantees for the loan. On the other hand it may be the less costly of the options on the long term since you will retain ownership of the company and of the future income.

Now that you know how much money you need, and where to get it, you’re on your way to start the process of launching and operating your business. In our future articles we will talk about outsourcing, supply chain, import-export, and many other topics that can help you develop your business and grow your customer base. If you are ready to launch your business but need help with your business plan, financial plan, or just getting it of the ground, feel free to contact us at your convenience. We look forward to be able to help you succeed.

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