Finding Your Funding
Launching a new business usually requires borrowing the money needed for start-up costs. Here's how to find the right amount of money from the right lenders.
The thing about clichés is that they are often true. This is certainly the case with the old chestnut, "You have to spend money to make money." It is one of the hard truths of the world that no matter how wonderful your business concept is, no matter how solid your business plan may be, no matter how good you are at the work you want to do; without funding for your new business, you will not get anywhere. The issue is not simply getting money. The issue is finding the right amount of money from the right sources at the right time. Failure to do this is actually one of the reasons half of all new small businesses fail within the first four years.
To find start-up funding for your company, you must consider both the details and the big picture. You need to determine how urgently you need capital, or start-up funding. How much do you need to launch and run your business and how soon do you need it? You must also decide how much of your own resources you're willing to invest as well as how much financing you plan to pursue. You have to know if potential lenders and investors can realistically be compensated for the amount of risk they would assume by putting money into your business. Is your business steady or seasonal? Will potential investors be confident in your management team's ability to run the business? You also need to determine the developmental stage your business has reached and the funding sources and amounts that are most appropriate for that stage.
Determining Costs, Needs and Resources
According to the Small Business Administration (SBA), start-up costs include all the expenses you'll incur while getting your business' doors open. They include both one-time and recurring expenses. A one-time expense could be for equipment or signage, while recurring expenses include things like rent and utilities. Specific start-up costs depend on the type of business you're opening, but there are some common categories—some necessary and others optional—that cross most business types. They include:
Space to run your business (office, storefront, manufacturing, warehousing)
Office equipment and supplies
Utilities (electricity, heat, water)
Communications (phone, Internet, mobile)
Marketing and advertising
Payroll (all the individuals it will take to run your business)
Raw materials/packaging materials
Legal, accounting and insurance services
Cash Flow Needs
Cash is the liquid funds available for obligations such as payroll and supplier bills. Cash flow is the movement of cash in and out of your business and it is something you need to plan for. In basic terms: Being cash flow negative, means that you lack the cash required to pay your bills, while being cash flow positive means you have money left over after paying your expenses. As the owner, it is your job to make sure that your business' cash flow remains positive. Cash flow is usually divided into three components:
Operating cash flow, or working capital, is the money generated and spent from within your business.
Financing cash flow is money received from external sources, such as bank loans or outside investments, as well as the money you pay out to those sources.
Investing cash flow is money from non-operating activities such as funds in an interest-earning money market account. The interest earned would be part of your investing cash flow. Money spent for a one-time purchase of a large fixed asset might also be considered investing cash flow.
Investing in Your Own Business
The one thing all potential investors and lenders want to see is your own financial investment in your business. It shows your willingness to take the same risks that you are asking of them. To determine how much you will personally invest, you have to consider two competing issues: First, the more you invest, the easier it is to get financing; and second, the more you invest, the more personal risk you assume. Investors and lenders like to see you investing your own funds, and it is common for them to require that you personally supply at least 25 percent of the funds required to start your business. On the other hand, when it's your money getting invested, you could stand to lose a lot of it. Remember, you are the only person who can decide how much of your own money you're comfortable investing.
The Right Kind of Financing for You: Debt vs. Equity
It is one thing to determine how much you need and quite another to figure out what kind of financing you want to use to get it. Essentially, there are two basic types of financing: debt and equity financing. According to the SBA:
Debt capital is represented by funds borrowed by a business 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.
Equity capital is represented by funds that are raised by a business, in exchange for a share of ownership in the company. 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. (sba.gov)
This problematic situation—having to sell a piece of your business—may be a real benefit for you. By sharing ownership and the risk of your venture, your investors have a vested interest in your success. In addition, these people are usually business veterans with a great deal of practical experience and insight. Because of this, they are often a great source of input, advice, and assistance in launching and operating your business. Giving up some control and a percent of future profits is usually a cheap price to pay for the kind of help these industry pros can offer. (For more on the differences between debt and equity financing, see "Funding Your Small Business: Debt vs. Equity" on page 51.)
Determining Which Way to Go
To determine whether you want to go the debt or equity route, there are some questions you will need to ask yourself about your business, your situation today, and how you see your business tomorrow:
Can the business be self-financed?
Will the business generate enough cash flow to cover the repayment of your debts?
Can you provide the guarantees required to secure debt funding in the first place?
Are you interested in spreading the risks and rewards of your business?
Is your company already in a lot of debt?
Making it Happen
At the end of the day, getting the money you need to start and grow your business comes down to three basic things: the right amount of money, the right sources of money and acting at the right time. Make sure that you have a solid business plan (see page 40 of this issue to learn how to write one) and don't be afraid to get the help and advice of a good broker or business attorney. They can be helpful in finding contacts and preparing you to meet with them, but their advice is vital before entering into any agreements. Finally, understand that this process will take time. Depending on the sources you are trying to tap, it could take months. Be patient and check out the great information and programs available at the Small Business Administration, sba.gov.