Navigating through the complex terrains of finance for startups could one of the toughest stages in developing a business idea. While commercial institutions, family and friends donations as well as personal savings may one of the toughest nuts you have to crack, raising capital to start a business is generally a tall order. How much then is enough to start up your business?
To properly determine what type of funding you should commit into your startups, it is important you first ask the following questions, according to Bob Adams:
- How much cash will I have at risk?
- How much time will it consume?
- How much energy will it take?
- Do I currently have other obligations that will prevent me from giving the business 100 percent?
- Would there be a much better time for me to start a business other than now?
- What are my alternatives if I don’t start a business now?
- What are the chances of success?
- Am I looking at starting a business from a position of relative strength — feeling good about myself and feel I am relatively well off — or am I looking at starting a business from a position of relative weakness — recently laid off from a job and being behind on my bills?
- Can I test-run the business part-time before quitting my job?
- Should I choose between a higher-risk or lower-risk business?
- Suppose my business provides less income than I expected. How long should I stick with it?
- If the business doesn’t work out, how easily will I be able to pick myself up and move along to the next endeavor?
These questions are important because nobody would want to stop halfway into the journey when funding has been made and time spent. That said, deciding on how much is enough to get your new business started would be considered under the following questions.
What Type of Business Do You Plan Going Into?
The U.S.’s Small Business Administration, says microbusinesses cost around $3,000, while most home-based franchises cost $2,000 to $5,000 to start. This may vary according to countries, depending on the value of their currencies and the per capita income of the citizens.
The 10 most profitable small business industries by net profit margin (NPM) are:
- Accounting, Tax Preparation, Bookkeeping, and Payroll Services: 18.4 percent NPM
- Lessors of Real Estate: 17.9 percent NPM
- Legal Services: 17.4 percent NPM
- Management of Companies and Enterprises: 16 percent NPM
- Activities Related to Real Estate: 14.9 percent NPM
- Offices of Dentists: 14.8 percent NPM
- Offices of Real Estate Agents and Brokers: 14.3 percent NPM
- Nonmetallic Mineral Mining and Quarrying: 13.2% NPM
- Offices of Other Health Practitioners: 13 percent NPM
- Medical and Diagnostic Laboratories: 12.1 percent NPM
The 10 least profitable industries in the US by net profit margin (NPM) are:
- Oil and Gas Extraction: -6.9 percent NPM
- Software Publishers: -5.1 percent NPM
- Beverage Manufacturing: -3.7 percent NPM
- Semiconductor and Other Electronic Component Manufacturing: -0.3 percent NPM
- Forging and Stamping: 0.4 percent NPM
- Farm Product Raw Material Merchant Wholesalers: 0.9 percent NPM
- Beer, Wine, and Distilled Alcoholic Beverage Merchant Wholesalers: 2.1 percent NPM
- Petroleum and Petroleum Products Merchant Wholesalers: 2.8 percent NPM
- Grocery Stores: 2.2 percent NPM
- Bakeries and Tortilla Manufacturing: 2.3 percent NPM
On deciding which type of business to go into and its cost implication, Founder and Chairman of Litmus Branding Pvt. Ltd. BrKapil Vaishnani advises that:
‘‘If it is a manufacturing unit you can choose a location that can let you save money on electricity, water, taxes, and transportation. Look for a place where manpower is easily available and raw materials can be sourced easily. You can even look for a location that can get you rebates and subsidies from the government.
If yours is a niche product or a service, you may have to look for a single location where all your competitors are. For instance, if it is a software company you want to start, you may have to look for a software belt where all other software companies have set their shops. Similarly, the ideal location for a gold vendor / jeweler would be a gold mart that has housed many such shops.
Offices can be set up in any place that is accessible and offers good facilities such as parking spaces, refreshments, transportation, and so on.
Make sure the location fits well within your budget and offers scope for expansion. An ideal location would be one that complements your business in the best possible way.
Considering the above is so important that entrepreneur Drew Gerber, who started a technology company, a publicity firm and a financial planning company noted that:
“One of the main reasons most small businesses fail is that they simply run out of cash. Writing a business plan without basing your forecasts on reality often leads to an unfortunate, and often unnecessary, business failure. Without the benefit of experience or actual historical financials, it’s easy to overestimate a new company’s revenue and underestimate costs.”’
He estimated that an entrepreneur will need six months’ worth of fixed costs on hand at startup.
“Have a plan to cover your expenses in the first month,” he said. “Identify your customers before you open the door so you can have a way to start covering those expenses.”
‘‘When planning your costs, don’t underestimate the expenses, and remember that they can rise as the business grows,’’ Gerber said. ‘‘It’s easy to overlook costs when you’re thinking about the big picture, but you should be more precise when planning for your fixed expenses.’’
What Costs Are Necessary To Get The Business Running?
After considering what type of business you plan going into, it is best to consider what costs are necessary to get the business running.
The American Small Business Administration says that there are various types of expenses to consider when starting your business.
‘‘It’s important to differentiate these types of costs to properly manage your business’s cash flow for the short and long term,” said Eyal Shinar, CEO of Fundbox, a cash flow management company.
Business owners usually face these types of costs when they plan to start their businesses:
- One-time vs. ongoing costs: One-time expenses will be necessary in most cases in the startup process, such as the expenses for incorporating a company.
If there’s a month when you must make a one-time equipment purchase, your money going out will likely be greater than the money coming in, Shinar said. This means your cash flow will be disrupted that month, and you will need to make up for it the following month.
Ongoing costs, on its own, are incurred on a regular basis. Examples include expenses such as utilities. These generally do not fluctuate as much from month to month.
2. Essential vs. optional costs: Essential costs are expenses that are absolutely necessary for the company’s growth and development. Optional purchases should be made only if the budget allows.
“If you have an optional and nonurgent cost, it may be best to wait until you have enough cash reserves for that purchase,” Shinar said.
3. Fixed vs. variable costs: Fixed expenses, such as rent, are consistent from month to month, whereas variable expenses depend on the direct sale of products or services.
‘‘Fixed costs may eat up a high percentage of revenue in the early days, but as you scale up, their relative burden becomes negligible,’’ Shinar said
Below are some of the estimates of both fixed and variable costs, although these depend on the nature of the business you are running
- Equipment: (One-time; essential)
- Incorporation fees: (one-time; essential)Under $300
- Office space: (On-going; essential) $100-$1,000 per employee per month
- Inventory: (On-going; essential)17–25% of the total budget
- Marketing: (On-going; essential) 0–10% of the total budget
- Website: (On-going; depends) About $25 per month
- Office furniture and supplies: (On-going; essential) 10% of the total budget
- Utilities: (On-going; essential) About $2 per square foot of office space
- Payroll: (On-going; depends) 25–50% of the total budget
- Professional consultants: (On-going;optional) $1,000 to $5,000 per year
- Insurance: (On-going; essential) An average of $1,200 per year
- Taxes: (On-going; depends) Variable
- Travel: (On-going; depends)Variable
- Shipping: (On-going; depends) Variable
Are There Ways You Can Track Your Spending To Ensure That You Stick To Your Budget?
Important here is the need to keep track of your expenses by calculating these costs from time to time. This will give you a clearer picture of the amount needed to keep your business viable.
Bill Brigham, director of the New York State Small Business Development Center in Albany, New York, advised new business owners to project their cash flows for at least the first three months of the business’s life. He advised startup owners to add up not only fixed costs but also the estimated costs of goods and best- and worst-case revenues.
‘‘If you borrow money, make sure you know not only how much you borrowed but also the interest you owe. Calculating these costs puts a floor on the revenues needed to keep the business viable and provides a good picture of the cash necessary to start it up,’’ Brigham said.
Shinar advised that once you get your business going, you can use QuickBooks or FreshBooks. These tools can connect directly to your bank account. They will also help you to track expenses throughout each month and during tax season.
For Brigham, while starting, it is wise not to resort to borrowing as an option.
‘‘Borrowing puts a lot of pressure on any business and its owners, as it leaves less room for error,’’ he said.
Click here to download a cash flow template to be able to track your monthly cash flow.
How Do You Raise Money To Get Started?
There are several ways to raise funds and get started. A third of small businesses got started with less than $5,000 and 58 percent got started with less than $25,000 in 2018. In the same year, the most popular small business financing methods were:
- Personal funds 77 percent;
- Bank loan 34 percent;
- Borrowing from family/friends 16 percent;
- Other funding 11 percent;
- Donations from family/friends 9 percent;
- Online lender 4 percent;
- Angel investor 3 percent;
- Venture capital 3 percent;
- Crowdfunding 2 percent
Follow this link to find out how you can attract investors to your startup.
Charles Rapulu Udoh
Charles Rapulu Udoh is a Lagos-based Lawyer with special focus on Business Law, Intellectual Property Rights, Entertainment and Technology Law. He is also an award-winning writer. Working for notable organizations so far has exposed him to some of industry best practices in business, finance strategies, law, dispute resolution, and data analytics both in Nigeria and across the world.