Often, the hardest work in opening a business is securing start-up financing. People who don’t plan properly learn there’s no “fun” in funding, and they increase the risks that are part of any business venture, ranging from slow starts to failure.
When a business does not succeed, the gap between cash available after liquidating assets and liabilities taken on by the business ultimately becomes the responsibility of the owners. To close the gap, owners have to be realistic about the risks and the underlying costs of starting a business and be prepared to put some “skin in the game.”
Smart Business spoke with John Bonfiglio, CPA, CVA, a principal with Skoda Minotti, to gain some insights into financing start-up businesses, how to complete the process and how doing so increases the chances of success with the new business endeavor.
What sources of financing are available for a start-up business?
Business owners often consider financing a business from their own personal finances, family members or friends; however, there are other sources, such as commercial banks, angel investors or venture capitalists.
There are different factors to consider for each source. Commercial banks often look to ensure that loans made to start-ups are collateralized by company assets or personal assets of the owners. At times, shortfalls in this area can be made up by government programs guaranteeing a repayment of a portion of the loan.
Angel investors and venture capitalists can be more flexible with immediate repayment terms, but often seek a higher overall rate of return than commercial banks. Such financing can often include a mixture of debt and equity or ownership stake in the endeavor. These investors often look for a clear exit strategy. Time horizons for exits differ, but often are in the five- to seven-year timeframe. If considering the purchase of an existing business, there is also the potential to finance the purchase through the seller.
What is the difference between financing a service company versus one that produces a product?
Service businesses typically do not have as many underlying assets, such as inventory and equipment. This makes them tougher to finance because they do not have the underlying collateral. Lending sources will then look to the owner’s personal assets and guarantees or government programs to make up this shortfall.
Do options differ between starting a conventional business versus buying a franchise?
There are the same financing considerations whether buying a franchise or starting a conventional business. However, there are banks and other financial institutions that are familiar with a franchise’s business model and have a comfort level with financing franchisee start-ups.
Should a prospective business owner concentrate more on short- or long-term financing when looking at start-up costs?
New business owners should consider both long- and short-term financing alternatives. Often, longer-term financing can be used for the purchase of capital assets such as equipment. Short-term financing can help finance operational costs such as employee wages and inventory purchases over the course of the business’s normal operating cycle.
What factors should business owners consider when estimating start-up costs?
A key to success is to develop a comprehensive business plan that includes realistic costs to fund initial start-up of the business as well as to pay for ongoing operations and overhead charges. Some start-up costs include the initial purchases of business assets, such as inventory and equipment, costs to set up the business itself, costs related to hiring employees, rent for the primary business location, including the initial security deposit, and costs related to implementing the information technology infrastructure.
Often it is helpful to put together a ‘sources and uses’ cash budget that focuses on starting the business and the first full operating cycle of the business. As a rule of thumb, we see that entrepreneurs should often plan on ‘twice as much’ and ‘twice as long’ versus their initial plans.
What financial criteria should start-up owners consider before financing a business?
The overriding criterion when considering whether to finance a business is gauging whether the sales and profit margins for the business endeavor outweigh the start-up and ongoing costs over time. This involves initially developing an understanding of the business and the market niche you are serving.
Thereafter, the key is ensuring the organization is delivering an excellent product or service and measuring its success by generating sound financial data for decision-making.
JOHN BONFIGLIO, CPA, CVA, is a principal with Skoda Minotti. Reach him at (440) 449-6800 or email@example.com.