Funding your start-up business
Written by Scott Edmonds CA
“How do I fund the start up of a business?” and “How much do I need?” The answers that leap to mind are "With great difficulty” and “As much money as possible!"
Too often we see business start-ups that begin their journey undercapitalized from day 1. This can have the effect of holding them back and not being able to grow as fast as they want. How can you grow without cash? And in harsh economic times that we are starting to see, customers are holding back on their payments for as long as possible which makes it hard.
Hence the increasing importance of getting your working capital requirements right in the first place; unless of course you are in the luxury position of having an unlimited supply of bank or personal funding.
Funding Options
Unfortunately the banks do not like most start-up businesses. They typically like to see 3 years worth of financial figures with strong profitability before they will lend you money. And this has recently tightened further given the current credit crunch and changes in our financial markets.
Banks are more willing to lend to well established franchises and will lend up to 70% of the purchase price for a franchise business that is on their approved list such as a Gloria Jeans Coffee store. And they will help you fit out your new store by taking the equipment as security for the loan. That’s great, but you still need to come up with the balance, which could be around $150,000 plus sufficient working capital.
For those who are familiar with the term “equity mate” , then you will know that the main way start-ups are funded is by personal borrowings via a Line of Credit or redraw facility against the equity in their house. This is typically the cheapest option as well because you are borrowing at the home loan rate as opposed to a more expensive business loan rate which is typically up to 2% more.
What do you do if the bank won’t lend you traditional finance and you do not have enough equity in your property – especially at present with some States such as Sydney being in a market slump?
I have seen people use credit cards and personal loans to get started and slowly build up their business one step at a time. This can work if you have a great business model and when cash flow is strong enough to pay the debt back as quickly as possible. A vending machine operator client of ours used this credit card strategy to successfully fund his start up business from scratch. He recently sold the business for $1.6m after 5 years in operation. Not bad considering he started out with no money and just a credit card! Note the nature of this business. It spat out cash from day one – unlike most businesses.
Another equity option, if your business plan is good enough, is to consider bringing in a “business angel” or investor/s. The good thing is that these ‘business angels’ help start-ups with more than just finance. They are usually people who do not want the burden of running a business but are interested in providing equity for a stake in your business and prefer to get involved in the big picture issues. The added benefits of having a business mentor and added support can help you and the business reach their true potential. The angel or mentor can bring considerable knowledge and experience “to the table” and not just finance which you can leverage from.
Funding from family and friends is another option. This has to be done properly to avoid grief for all concerned. If you are going to do this then see a lawyer and get appropriate documents drawn up such as loan agreements. Or if you provide them with equity then get a proper shareholder’s agreement in place and make sure your vision of the business is matching.
At least with equity finance, you do not have to pay a loan back. This can substantially help cash flow and hence growth of any business. 50% of something that has the potential to be bigger is better than 100% of nothing or something small.
Another common form of finance when buying an existing business is vendor financing. This is where the existing owner allows you to pay them for the business over a period of time. This can work well and can enable you to get through the first couple of years until the bank will consider lending to you given that you have been in business for a while and are hopefully making a profit.
Apart from how to finance your business, it is equally as important to carefully consider how much money you will need to start-up your business. This will include determining your Initial start-up cost and working capital requirement.
Determining your initial start-up costs
“How much money do you need to start-up a business?" can be a leading question. Taking out a loan to start-up a business is a very important process and the amount applied for should be arrived at only after careful consideration. The amount you wish to borrow may well be the largest sum you have applied for in your life and there are a number of important factors to bear in mind. The most important being the more you borrow, the more you will have to pay back.
Consequently, calculate the amount you need to borrow carefully, deciding which portion is for initial set-up costs and how much you will reserve for on-going costs. And then make sure you keep careful track of this. Remember, the more money you have at your disposal, the more you will be tempted to spend on "wants" rather than on "needs."
Calculating business start up costs is an involved process requiring you to calculate the cost of every factor involved in getting your business to the stage where you can open your doors and start selling your products to your customers.
These are mainly the expenses you will usually only have to meet once and could include:
Your working capital requirements
Working capital is the money used in a business as part of its normal operations. It helps ensure the smooth running of your business and helps it generate business and as a result, income for you. Your working capital, therefore, works to create money and if used correctly, can increase its cash value.
It is critical you have sufficient money available to meet your expenses in your start-up period. Very few new businesses open their doors and are immediately profitable. On the other hand, every year a large number of new businesses fail because they underestimated the time it would take for them to break-even and start making money.
Many of these businesses would have gone on to become successful enterprises if they could have survived this initial period. If you do not have enough cash to pay your debts and expenses as they fall due, your business will undoubtedly fail.
Please contact SWE Chartered Accountants on (02) 4648 4718 for further information specific to your circumstances.
By Scott Edmonds CA
