Starting A Small Business: Financing Your Business
- Electronic equipment: computer, printer, scanner, fax machine, photocopier, etc.
- Furniture and fixtures: desk, lamps, bookshelves
- Office supplies
- Reference books
- Manufacturing machinery and equipment
- Advertising: domain name, domain hosting, mailers, website design, etc.
- Operating Space
- Corporation fees
- Legal fees
- Security deposit for renting a business location
What you need to buy can also depend on the degree to which you want to separate your business from your personal life. Many people will use their personal vehicle, cell phone and a room in their home to meet these needs inexpensively. Incorporating to separate your business assets and liabilities from your personal ones also costs money, but it offers an extra layer of protection if your business fails.
You should also consider operating costs that you'll pay regularly in the course of running your business. Some of these may be required before you set up shop and on an ongoing basis thereafter, like insurance, membership fees and dues, loan payments and employee wages.
Sources of Startup Capital
How much money you can afford to risk on your business from your personal savings and how much money you need to open for business will determine whether you need to look elsewhere to raise startup capital. Let's consider the pros and cons of each potential money source.
Personal savings are commonly used by business owners to help pay for startup costs. You won't incur any interest expense when you use your own money to finance your business. You also won't have any creditors to pay back, and no one will come after you for money if your business fails or isn't successful right away. On the other hand, most people have already earmarked their personal savings for other uses, like retirement and a rainy day fund. Unless you already have plenty of extra money lying around, you might want to start setting aside some of your savings each month to put toward your business. You might also be able to tap your home equity, but it's a big risk to tie the success of your business up with having a place to live.
Banks provide business loans to finance vehicles, equipment, real estate and other expenses. These loans are generally for a short term, such as six to seven years, but the duration can often vary based on the type of financing required. Some type of collateral generally must be used to secure the loan - usually the vehicle, equipment or real estate being purchased with the loan, or a blanket lien on other assets. Expect to pay a loan origination fee and, of course, interest. Business loans can offer the security of a fixed monthly payment and a fixed interest rate, although variable rate loans may also be available. (Not sure what sort of loan you should get? Read Which is better, a fixed or variable rate loan?)
Some banks may only offer loans on large amounts; if you need to borrow less than the minimum requirement, seek other financial institutions to provide a more accommodating loan or dip into your personal finances. You might also want to finance your equipment and vehicle needs with a line of credit or a conditional sales agreement.
If you plan to seek a loan from a bank, be prepared to provide a detailed explanation of how much money you need and for what purposes, as well as a detailed explanation of how you will be able to repay the loan. The bank may want to see recent personal income tax returns, bank statements, credit history and other personal financial information.
Small Business Administration Loans
Small Business Administration (SBA) loans are an option if you don't qualify for a regular business loan. Your business must be owner-operated, for profit, organized as a sole proprietorship, corporation or professional partnership, and fall within the size guidelines set by the SBA. Because these loans are guaranteed by the government, they can be easier to qualify for than conventional business loans. They also allow you to make lower payments over a longer period of time. Although SBA loans are provided through regular banks, the government simply acts as the guarantor. Special SBA loans are available for veterans, active duty military, reservists, National Guard members and the spouses of people in these groups.
You can always use a business and/or personal credit card to pay your business startup costs, assuming you already have or can qualify for a credit card. However, unless you have a card with the required limit and a low interest rate that you will be able to make regular payments on, credit card financing can quickly get you in trouble. You don't want to borrow money for your business at a 20% interest rate because the balance will grow each month and it can become very difficult to pay off the debt. Sometimes it is possible to get a card with an introductory interest rate as low as 0%. If you take advantage of an offer like this, make sure you have a plan for paying off the money you borrow before the card's interest rate goes up. (To learn more, see The Pros And Cons Of Small Business Credit Cards.)
Business Line of Credit
A business line of credit should have less rigorous qualification requirements than a business loan. It is similar to a business credit card in that it is an unsecured loan and you can use it as you need rather than borrowing a lump sum all at once. It can be used to refinance debt as well as to finance working capital, payroll and all the same types of expenses as a credit card financing. It is typically designed to be a short-term loan and may have a variable interest rate and an annual fee. Some banks may only offer large business lines of credit, such as $25,000 and up, so this may not be the right option for you if you only need access to a small amount of credit.
Family and Friends
Are you willing to risk your personal relationships by mingling them with money? Only you know the nature of your relationships with friends and family, and whether any of these people are a viable source of financing. But if your business goes under, would you rather have to explain to a stranger or to your best friend that you're not sure when you'll be able to pay them back? Mixing friends and family with finances adds yet another risk to your business endeavor - the risk that you'll ruin a close relationship. (For more on mixing your personal and business relationships, see 8 Ways To Help Family Members In Financial Trouble.)
Nothing can strain a relationship like money. Merely asking for it can be enough to introduce awkwardness into an otherwise sound relationship. If your dad won't lend you startup capital, you might find yourself thinking, "How can my own father not believe that I have what it takes to succeed?" It's much easier to be rejected for a loan by someone who doesn't know you because you'll know it's purely a business decision, not a personal one.
Pursuing venture capital means bringing someone else, generally a stranger, into your business as a partial owner. If retaining control of your business is important, you shouldn't consider this financing option. Usually, you will not receive any profit yourself until your investors have profited from your business. Additionally, this type of financing limits the entrepreneur's upside potential since venture capitalists will often require majority ownership of the business. On the other hand, the majority of the downside risks are also assumed by the lending party. (For more insight, read When Your Business Needs Money: Angel Investors.)
How Much Capital Do You Need?
There is no one-size-fits-all method for determining startup capital needs because each business has unique requirements. Basically, you need to make a list of the startup items specific to your business and research each one to determine its cost. It's important to actually do the research, and not just guess - especially if you are doing this for the first time. If you rely on hunches, you may grossly under- or overestimate your expenses. Also, if you're seeking financing, the lender will be hesitant and may not take you seriously if your numbers aren't realistic and well-researched.
When you're starting a business, there are a couple of ways to get carried away with spending money. First, you may be overemphasizing about the tax deductibility of business expenses. While tax breaks will reduce your costs, they won't make your purchases free. You'll still be paying for the bulk of everything yourself, so you shouldn't buy it if it isn't necessary. Second, you may be so excited about starting a business that you have trouble differentiating necessary expenses from optional ones. Do you really need a brand-new, solid wood desk, or will that card table in the garage get the job done just as well?
Remember, initially the most important thing is keeping your business afloat so you can earn a profit. Every purchase you make should be directly related to this goal. Minimizing what you need to buy and how much each item costs will help you meet this goal. You want to get by on as little startup capital as possible. (Don't overlook the details when starting up a business. It's the small expenses that have the potential to make or break a great idea. For more information, refer to Business Startup Costs: It's In The Details.)
Next, we'll talk about protecting your business by choosing a legal structure and purchasing insurance.
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