Chapter 8: Fundraising for business
How much money do I need to start my business?
You’ve done the financial projections and put the marketing plan into operation. Now you just wait for the money to come rolling in… Hopefully soon!
From day one of your new business, you need funds in place.
- Opening a store – you’ll need stock.
- Manufacturing products – you’ll need equipment and supplies.
- Selling online – you’ll need computers and a good website.
By looking at your individual scenario, you can determine how much you will need to raise.
Remember to take into account three different types of costs:
What’s the minimum to start a business?
We’ve all heard of people who have started a business for under $1,000 and gone on to fame and fortune, but how realistic is it for most startups? Maybe you can get away with an initial fund requirement of less than $5,000 or $10,000 if you work from home and need no special equipment or stock.
Otherwise, you need to cover your costs for at least six – twelve months if you want to be able to sleep at night.
For example, you may have the following needs:
- $10,000 one-time costs on day one
- $5000 recurring expenses each month for six months
In this case, you’d need $40,000 in place to get started. However, be sure that you are able to generate revenues and reach break-even by month six or you may be better to raise $70,000 to cover your needs for the entire first year. The startup landscape is littered with bankrupt companies who may have had good ideas but were under-capitalized.
Tip From An Expert
“Conserve your cash and bootstrap as much as you can. Your business can’t survive without cash flow. And in the beginning stages, it’s easy to get under water when it comes to cash. If you don’t have cash flow in your business, you don’t have a business. Yes, cash really is king for a small business. Here are five things you must do to manage the cash flow in your business. 1. Understand how cash works in your business. 2. Don’t sell yourself short. 3. Remember, you are not a bank. 4. Save cash for a rainy day. 5. Prepare (and use) a Cash Flow Budget.”
–Denise O’Berry, Small Business Owner
Grow revenue and control costs
With funding in place, you’ve secured the business for six months or a year. Well, sort of. Unless you focus on driving revenue and controlling costs, you’ll just burn through the capital.
So make sure you understand your total costs and have a realistic prospect of getting money in. And, look at ways of protecting your capital by leasing equipment, rather than buying outright or paying month-to-month with web hosting rather than a full year upfront.
Did you know?
Amazon, Apple, Disney, Google and Harley Davidson all started their businesses from a home garage.
Look for the breakeven point
It’s a great day for the business when you break even for the first time. That’s the point when your revenue reaches and exceeds your recurring expenses.
There are two types of breakeven points. The first is the one we just described. You can forecast that by using your projections to compare your monthly revenue forecast with your monthly operating costs.
The second refers to the point when your profit-to-date covers your accrued losses.
Here’s how the two differ:
- In month 12 you make $50,000 in sales revenue and your operating costs are $45,000. This is the first month in which you break even and hopefully are profitable on an ongoing monthly basis.
- By month 12, your losses total $150,000. You are profitable that month but it may take another year (more or less) to recover your accrued losses before you break even on an accrued profit basis.
This is an important measure for two reasons:
- It indicates when you can return capital – until you reach breakeven and are generating positive cash flow, you need to draw on investor funds for working capital to run the business.
- It tells investors when they will see a return on their contribution.
9 ways to find investors
There are plenty of investors out there, but where do you start and what are the implications for your business?
1) Your contribution – Put your own money in and you send signals to other investors that you are committed to the business. By showing you’ve put in as much as you can afford, you’ve got a good basis for asking others.
2) Friends and family – Okay, it may feel uncomfortable, but if you’ve already shared your ideas and sought their advice, they will understand. Make sure they feel they receive fair value for their investment.
3) Professional investors – Time to turn to people you don’t know. Speak to your accountant or lawyer, they may be able to refer you to a suitable venture capitalist or angel investor they know and trust. Venture Capital firms invest in new companies but come in every shape and size. Some want to fund smaller amounts very early in a startup’s development while others are only interested when the startup has proven their concept and begun to generate revenue or at least proven their concept by creating traffic, visitors, clients etc.
- TIP 1 – Professional investors know that initial funding represents the highest risk. Therefore they will demand more shares (a lower valuation of your company). Once you’ve proved yourself and you’ve got a track record, you can approach investors with greater confidence and subsequently a higher valuation. For this reason you may want to raise enough to cover your launch and first year operations, but avoid giving away too much equity in the early stages of development.
- TIP 2 – The ideal investor doesn’t just bring money; they can offer expertise, networking potential and give your business credibility. Don’t overlook this added value.
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Reach out to all possible investors
4) Incubator networks – If you set up your office in an incubator center (see below), ask other tenants and advisors for contacts interested in funding startups.
5) Crowdfunding – Sites like crowdfunding.com provide handy lists of top-ranked crowdfunding sites like gofundme, KICKSTARTER and Indiegogo. This style of funding often allows you to offer a discount on your product which could create a source of initial seed funding.
6) Websites offering loans – There are many sites and programs that give access to sources of commercial loans. Don’t forget, you’ll have to provide collateral for a loan and that could put your home or existing business at risk. Of course be very careful going down this road.
7) Line of credit – If you’re thinking about taking a second mortgage or getting a loan from a bank, the same risks apply. Do you really want to risk your home if it doesn’t work out? Be very realistic about all possible outcomes before jumping forward in this direction.
8) State grants and loans – Many states want to encourage new businesses – they create jobs and they’re great for the local economy. States vary in their approach, but you could be able to secure a grant, a loan at favorable rates, or maybe a tax break. It’s worth checking your state website, before looking at commercial loans. Check the conditions – you may not have to repay a grant and the loan may have a helpful long repayment term.
9) Federal programs – The US Small Business Administration (SBA) offers a variety of loans for small businesses. The SBA arranges the loans through partners and guarantees them, reducing some of the risk for the lender.
Again, carefully check the terms and conditions.
What should I offer shareholders?
In the previous chapter, we looked at the options for selling shares and determining holdings. When you get into negotiations with investors, you’re often faced with the big question – how much should I give up to get the money?
Here are some questions to ask yourself:
- How much are you willing to give away – what is the balance between cash raised and control?
- What’s a reasonable valuation of the business – will investors think it’s fair?
- Can you validate your claims – how much have you sold, are the right ingredients in place?
- What will the investor bring to the business – just money or expertise and credibility?
As we discussed earlier there is no magic here but one exercise you may try is simply asking yourself how you would react to the offer you are considering presenting to others. If it doesn’t interest you it won’t interest potential investors.
- TIP – You can get some clues to the negotiating process by catching a couple of episodes of “Shark Tank,” the reality TV show where entrepreneurs pitch their ideas to a panel of investors. The investors do their best to find weaknesses in the entrepreneurs’ plans and forecasts.