One of the key elements in starting or growing a business is developing a comprehensive financing strategy. A long-term plan can help reinforce short-term spending discipline and reduce the likelihood your business will burn through capital too quickly.
Creating a capitalization strategy requires an understanding of the business activities your company plans to finance, estimates of how much these activities will cost, and knowledge of 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 planning for worst-case, realistic, and best-case scenarios. This approach may decrease your 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) to ensure your budget is as reliable as possible. Your local chamber of commerce or a regional business association may help you estimate expenses such as utilities or 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 explains sources that entrepreneurs frequently use and the characteristics associated with each.
|Company profits||Allows owner maximum control of business.||Not feasible for start-up or early-stage company. May be inadequate to finance significant long-term expansion.|
|Business owner’s personal resources||Owner maintains control.||May require business owner to increase personal debt or jeopardize long-term goals such as a secure retirement.|
|Family and friends||May provide flexible terms.||May lack business expertise or be inadequate for long-term needs. Could potentially risk jeopardizing relationships.|
|Loan from bank or commercial finance company||Frequent source of short-term financing. Loan officers may have broad business experience and provide assistance with financial issues.||May be reluctant to provide long-term loan or to finance a start-up company. Requires collateral to secure loan agreement.|
|Loan guaranteed by U.S. Small Business Administration or a business development program sponsored by state government||May 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 finances small businesses||Typically a former entrepreneur or executive, investor may possess considerable management expertise. May provide access to business associates and other investors.||May desire active, involvement in the business, resulting in less control for the entrepreneur.|
|Venture capitalist||Does not require additional debt, providing the business owner with financial flexibility.||Often necessitates a higher rate of return than lenders because there is no requirement to make current 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 may require an infusion of capital to pay interim expenses.
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