Understanding the Best Source of Funding for Your New Business
Need to get a better handle on what it will actually cost to realize the future plans you have in mind for your new business? Also, how you can fund these costs, especially if your plans involve future expansion of your business?
Even if you only jotted down your ideas on the back of an envelope, you probably have a general idea of the business plan for your young business. Now, you need to develop a more complete plan, when and how you plan to get your business up and operating. For instance, your plan might revolve around the objective to have your line of skin care products in national distribution within five years.
As a next step, it’s important to decide on a business structure and develop a capitalization strategy. This is the financial projections section of the business plan, and includes your estimates of revenue, expenses and profit over the near future. Once in place, it provides you with two invaluable roadmaps: a long-term funding plan to take your business national within five years and a short-term spending plan to help you better allocate your cash outlay along the way and reduce the risk that your business will burn through capital before you reach your five-year goal.
Creating a capitalization strategy requires an understanding of the business activities your company will need to finance the growth and expansion you’ve planned, including estimates of how much these activities will cost, and how to best appropriate sources of financing.
Running the Numbers
Once you understand the business activities you need to finance, you can develop an annual budget and estimate your capital requirements for at least the next two years. Many experts recommend a three-pronged approach to planning: worst-case, realistic, and best-case scenarios. This can help decrease the likelihood of underestimating your capital requirements, which could cause you to run out of money or pass up potential opportunities. You may want to consult outside sources, such as your accountant or banker, to ensure your budget is as accurate as possible. Your local chamber of commerce or a regional business association can help you estimate expenses such as utilities and payroll that tend to vary regionally. A professional association that represents your industry may have information about standard costs, margins, and financial ratios.
Sources of Capital
After researching your capital needs, you're ready to consider potential sources of funding. The table below lists several sources that entrepreneurs frequently use and the advantages and disadvantages of each.
| Source | Advantages | Disadvantages |
|---|---|---|
| Company profits | Allows owner maximum control of business. | Not feasible for start-up or early-stage company. Near term profits may be inadequate to finance significant long-term expansion. |
| Business owner's personal resources | Owner maintains control. | Might require business owner to increase personal debt or jeopardize long-term goals. |
| Family and friends | Might provide flexible terms. | Risks include lack of business expertise and potentially negative impact on personal relationships. |
| Loan from bank or commercial finance company | Frequent source of short-term financing. Loan officers might have broad business experience and provide assistance with financial issues. | Might be reluctant to provide long-term loan or to finance a start-up company. Requires collateral or personal guarantees to secure a loan commitment. |
| Loan guaranteed by U.S. Small Business Administration or a business development program sponsored by state government | Might provide capital for businesses that would not qualify for loans through other economic channels. | Guaranty requirements may change in response to federal fiscal policy and current conditions. |
| "Angel" investor who finance small businesses | Often a former entrepreneur or executive, an investor may possess considerable management expertise and be able to provide access to business associates and other investors. | Might desire active involvement in the business, including ownership, resulting in less control for the entrepreneur. |
| Venture capitalist | Does not require additional debt, providing the business owner with financial flexibility. | Often requires a higher rate of return than lenders because there is no commitment to make additional payments. |
Special Considerations for Start-Ups
If you are estimating capital needs for a start-up business, plan on maintaining sufficient funding to cover anticipated expenses for at least six months. Most start-up businesses are not profitable and typically operate six months or longer before generating capital internally. Also, the type of business you manage will influence your capital requirements. For example, a retail business requires inventory that must be financed before taking delivery. Many service businesses typically wait between 30 and 90 days before receiving payment from customers, which might require additional capital to pay interim expenses.
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This information is not intended as legal or tax advice and should not be treated as such. You should contact your estate planning and/or tax professional to discuss your personal situation.
Wealth planning strategies have legal, tax, accounting and other implications. Prior to implementing any wealth planning strategy, clients should consult their legal, tax, accounting and other advisers.