Having a business idea is more than just a lightbulb moment. The smile that stretches across your face is a result of finding direction in your career as well as realizing a potentially life-changing venture. Your heart races and your mind pounds because of the excitement.
“This idea must become a reality before someone beats me to it.”
Then comes the realization that you need money to fund your business idea. After reviewing your financial position, the excitement is all but dead. It doesn’t mean that your small business idea has to die completely.
There are more ways to finance a small business than just relying on savings, income, and bank loans.
How Much Money Do You Need To Finance Your Small Business?
In order to turn a business idea into an operating business, you need money. Many great ideas fall by the wayside or end up on the backburner because the entrepreneur didn’t have the means to finance a small business.
Don’t give up on your business idea because financing might appear tight.
Yes, reaching into your pockets is a great option but if they aren’t deep enough, you might be in trouble before your business gains traction. Not even Sir Richard Branson hit a home run when he stepped up to the plate for the first time.
It takes time for a business to succeed. According to StartUp.com, on average, a small business finds sustainable success after four years.
Before you look for funding, the first step is to find out how much money you need to finance your small business.
Step 1: Have a Business Plan
Think of the business plan as the detailed version of your business idea. It summarizes key information such as:
- The type of business you plan to run
- Your goals and objectives
- Strengths and weaknesses of the business
- Challenges for the business
- Summary of proposed products and services
- Courses of action that will help you attain your goals and objectives
The information contained in the business plan will be the backbone of your strategies in developing the business. It will help you identify and organize everything you need to spend on in order to turn your dream into a reality.
Every time you run into problems while starting out your business, the business plan can provide you with the answers you need.
Step 2: Come Up With Detailed Financial Projections
A popular saying in business is “Strategy follows business, not the other way around.”
With the business plan in place, it’s time to crunch the numbers! Find out how much you need to finance these 3 initial concerns of running a small business:
1. Business Registration/Start-up Costs
- Fees for registering your business with the SEC and other regulatory agencies
- Local business permits
- Trademarks and licenses
- Rental fees
- Advanced deposits
- Security deposits
- Other mandated permits and licenses
- Cost of recruitment and hiring
2. Capital Expenditures
- Website design
- Computers
- Software programs
- Office equipment
- Office furniture
- Initial office inventory
- Other company assets
3. Working Capital
- Rent
- Dues
- Salaries
- Employee Benefits
- Marketing and Promotion
- Utilities
- Insurance
- Taxes
To be more assured we recommend calculating working capital for up to 2 years.
Step 3: What Are the Worst-Case Scenarios?
An entrepreneur often views his business from an unfiltered lens. It’s hard to imagine anything can go wrong if you’re emotionally invested in your business. But the harsh reality is the number of businesses that fail outnumber the businesses that succeed every year particularly post-pandemic.
To prepare in the event business outcomes aren’t what was expected, identify the worse case scenarios.
- Go back to your business plan and review the challenges to your business
- Identify these challenges and analyze how they can affect your financial position
- Reflect these risks in a Projected Income Statement and Projected Cash Flow Statement.
Come up with as many worse-case scenarios as possible and create financial projections for each one.
We recommend that you hire an accountant or an experienced market researcher to prepare the Business Plan and financial projections. You save time, money, and results or projections of the studies won’t be biased.
6 Ways To Finance Your Small Business
Now that you have an idea of how much money you need to finance your business, the next question is:
“Where will I get the funding?”
Before you take a dive to check how deep your pockets are, release that single breath, relax, and learn other ways to finance your small business.
1. Bootstrapping
The first place the entrepreneur looks into as his initial source of business funding is his bank account. If he has investments, he might want to consider selling a few assets as possible sources of funding if he feels uncertain about his current level of savings.
Then, he reviews his cash flow.
“Is my stream of income enough to sustain my daily needs and cover my monthly obligations if I use part of my savings and investments to fund my business for the next 2 years?”
Bootstrapping is also known as self-funding. Ideally, we want to fund our business with internally-generated sources to minimize the risks associated with borrowings. Also, you have complete control over your business.
However, bootstrapping can be a risky proposition because you can get emotionally tied up with your business. You want to keep fighting and funding even though the numbers show you’re navigating a sinking ship.
If you decide to bootstrap your business, commit to an amount of money that you’re willing to spend – and lose. Think of it as disposable cash – if you lose it, the amount won’t significantly change the course of your life because you have the means to recover it.
2. Friends and Family
Some financial advisers consider borrowing from family and friends as bootstrapping. We feel this isn’t accurate because not all family and friends would want to consider the loan money as “disposable”.
Likewise, the family member or friend you borrowed money from might ask to have a measure of involvement in the business. You won’t have 100% control over your enterprise.
When you borrow money from people whom you have relationships with, you put those relationships at risk. That’s a reality you have to accept before deciding on this financing option.
The best way to mitigate the risks of borrowing from friends and family is to put the lending arrangement in a well-detailed contract that’s signed by both parties. If things aren’t going well, having the conditions of the loan articulated clearly in the contract can help achieve faster resolution of conflicts.
3. Small Business Loan
Getting a small business loan is the usual course of action for budding entrepreneurs who don’t want to reach into their savings and investments.
The benefit of a small business loan is that your cash flow won’t be impeded for the first few months or years depending on the provisions of the lending agreement.
A common arrangement is to pay only the interest for the first year of the loan and the principal amount beginning Year #2.
To apply for a small business loan, banks will generally require the submission of the following documents:
- Business Plan
- Financial Statements
- Feasibility Study
- Income Tax Returns
- Credit Report
- Legal documents – articles of incorporation, franchise agreement, and lease contract.
Depending on the type of loan that you’re applying for, the bank might ask you for collateral. The type of collateral a bank will ask to cover the loan will depend on its risk assessment of your business.
For this reason, it pays to have your business plan backed up by solid financial statements and an air-tight feasibility study. Having a good track record in business, particularly a healthy credit score, will also help you secure the loan.
The risk is that you might lose the collateral and potentially everything that you invested into the business.
Before deciding on getting a small business loan, sit down with your accountant or financial advisor and review your projected income statement and cash flow. Establish the risk level, come up with exit strategies, and identify the maximum tolerance point where you won’t lose the shirt off your back.
4. Venture Capital
Reality shows have glorified venture capitalists but they might not be for you. Venture capitalists look for business opportunities that have the potential to be game-changers in the industry. The feasibility study presents the high possibility of a secure financial future and high returns on the venture capitalist’s investment.
Thus, there is a high level of risk involved. To manage risk, a Venture Capitalist will require an equity stake in your business – many will propose a percentage that allows them to have significant control over operations and decision-making.
For example, if the financial reports show that your current processes aren’t delivering the expected results, the Venture Capitalist will demand a change in management.
He might bring in his own people to run key areas of your business. In addition, the Venture Capitalist might impose changes in processes that will make your business unrecognizable to you.
The reason for these strong-armed tactics is that the Venture Capitalist doesn’t want to lose.
Before considering Venture Capital as an option, think about the possibility of losing control over your business and if the money will be worth it.
5. Angel Investors
Angel Investors are often confused with venture capitalists.
The differences are that Angel Investors are usually retired businessmen or executives who have accumulated great wealth and are looking for investment opportunities and the amount of investment involved isn’t as high as those of a Venture Capitalist.
It can be said that compared to venture capitalists, Angel Investors feel they have a social responsibility to help small businesses get started by providing funds with fewer strings attached and to succeed by contributing their knowledge and experience.
Hence, the word “Angel” in Angel Investor – they are there to guide your business to succeed.
While the Venture Capital might require a majority stake, an Angel Investor might ask for participation in management decisions and/or a seat on the Board of Directors.
Venture capitalists set up corporations to organize and run their services. In comparison, Angel Investors prefer to remain incognito. You have to know the right people who can get you a private meeting with them.
6. Business Incubators
Business Incubators or accelerators are companies that give you free access to their facilities in order for you to test products, services, and processes. They will also provide you with other types of support – technical, administrative, and logistical.
Usually, businesses that are engaged in technology and science look for business incubators.
To be clear, the services aren’t exactly free of charge. There are ways that a Business Incubator is compensated for opening its door to a small business startup:
- The Business Incubator is funded by the government and the entrepreneur is able to qualify for the use of the facilities and services.
- The Business Incubator receives a percentage from the sales of your product or service.
- The Business Incubator is paid by the investors in your business.
The Business Incubator might also just charge you a fixed fee for the use of its facilities. However, the fees won’t be due or demandable until after 6 months or 1-2 years depending on the arrangement.
Conclusion
Which type of business financing is for you?
It’s possible to finance your business by combining some of the options we discussed in this article.
After you’ve determined the amount of capital you need to start and sustain your business for 2 years, review your personal finances. How much can you risk? Whatever the amount is, deduct it from the total required business capital.
Next, review your projected cash flow. How much can you afford to pay out as recurring monthly payments without negatively impacting business operations?
Calculate the number of loan payments you can accommodate and determine the small business loan payable in 2 years. Deduct the amount of the small business loan from the balance of the required business capital.
Review your processes and see if you can reduce the amount of the required business capital by using a Business Incubator. Using a Business Incubator might improve your cash flow and make it easier to accommodate a small business loan.
Depending on the final balance, you should be able to decide on whether to get a loan from friends and family or from an Angel Investor. We can count out Venture Capital if the balance is small. Venture Capitalists invest money that reaches millions of dollars.
Financing is like a tank of oxygen. It allows you to breathe when oxygen is hard to come by. However, the quantity of oxygen is limited and you have to return to the surface before time expires.
Securing the funds needed for your business is one thing. Managing it wisely is another.
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