Funding a new business is one of the most misunderstood and hotly debated topics within the entrepreneurial community. It seems like almost any rule is accompanied by an exception. One school of thought is that you need a ton of cash upfront. On the other hand, given the failure rate of new businesses, startup dollars are frequently spent with nothing to show for them. Others believe a shoestring budget is all that is needed if done properly. The Lean Startup approach has gained popularity in recent years. The key to deciphering this puzzle is understanding how much you need – not how much you want to spend, how much you currently have or can raise, or even how much you think you need. The second most common reason businesses fail is by running out of money before reaching sustainability. Once you determine how much you actually need, your chances of success greatly improve.
The type of business you are seeking to launch will play a role in determining how much money you need to get started. A business that produces physical products or owns inventory will need a lot more upfront capital than a consultant or pure service business for example. Start by determining what the fixed costs of your business are going to be; a good plan is to have cash on hand to cover at least six-months of your fixed costs.
Getting costs right is important. Be conservative with your projections. If you underestimate or leave out certain costs in your calculations, you’ll can end up burning through your reserve faster than expected and run out of cash before the business reaches sustainability.
Once you have a handle on your projected fixed costs, turn your attention to other cost categories. There are one-time costs, such as initial fees for licensing, equipment costs, and incorporation costs. There are on-going costs such as rent, insurance, and (my favorite) legal fees. There are some costs that are unavoidable such as utilities, licensure fees, and supplies. Give serious thought as to whether you need a super fancy turbocharged computer and an Eames desk chair. In some cases the big spend is smart or necessary; question your assumptions in this regard to avoid overspending.
Just as you need to forecast the money going out, you should also get an idea of the money you expect to have coming in. I recommend running best, middle, and worst case scenarios. Make sure you have a realistic understanding of the market for your product or services based on objective evidence. Overestimating demand is a common mistake entrepreneurs make. Another factor to consider is what financing you will have, the terms under which you are going to be required to pay it back, and other potential sources should your original sources dry up.
Once you have your numbers together, add up all of your various conservatively estimated costs, compare it against your worst case revenue projection, and come up with the total amount of money you think it will take to get your business to sustainability. Then – and this is the best free advice you will get today I promise you – double it. Trust me – that is likely close to the amount you actually need. This number is likely to be higher than you anticipated, but my experience has taught me that the amount needed is typically 2-3 times a founder’s initial estimate. Consider cutting back on non-essential costs or finding additional financing, but don’t pretend my doubled number is too high. Do not revise estimates of costs downward unless you are absolutely certain you over-estimated (and even then, you are cutting out some cushion).
If you are thinking of launching your own business and would like to understand your options for financing, insurance, or incorporation, contact Chris Clark who can help you answer these questions and get your business started today.