Getting money for starting a business, especially in these difficult economic times, is tough but need not be impossible. The process of finding money for starting a business, or financing a business, will serve to make sure that your business idea is a good one. If you can get financing that means that somebody has confidence that you will succeed and is betting money that you will.

Generally, the higher cost your business startup, the faster you should see a return on your investment. Take into account interest expense when calculating your return.

There are also low cost businesses with a great deal of potential. The person who can start his own business with very little money and perhaps no outside financing will usually invest “sweat equity” into the business instead of financial equity. This means that a low cost business may take longer to produce results. In the long run, however, if it has enough potential, it may be the right business for those that have few financial assets.

How to Get Money for Starting a Business–Start with Your Money First

Getting money for starting a business is one of the thorniest parts of starting a business. The first key is to save money so that you can put your own personal savings into the business. Nobody is going to want to invest in your business if you do not invest in your business yourself.

It is difficult enough to get a loan with a business startup and next to impossible if you don’t invest in your own business. Lenders want a track record and you may have none. Live frugally and save money so you can show potential lenders that you are committed to your business.

The Importance of the Business Plan

Before you look to outside sources for money for starting a business, make sure you have completed the entire business plan. The business plan template is your road map. It will tell you how much money you need, when you will need it, and when you expect to pay it back. Potential lenders will want that information and you should want it also. You should always prepare a business plan before asking anybody for money. The business plan outline I have prepared for you provides you with several free financial calculators including a Starting Costs Calculator, a Cash Flow Projection, and a Break-Even Analysis.

Understanding the Language of Business Financing

There are several business terms you should understand in order to make good decisions on getting money for starting a business:

A credit score is a numerical expression based on a statistical analysis of a person’s credit files, to represent the creditworthiness of that person. A credit score is primarily based on credit report information, typically sourced from credit bureaus.

Lenders, such as banks and credit card companies, use credit scores to evaluate the potential risk posed by lending money to consumers and to mitigate losses due to bad debt. Lenders use credit scores to determine who qualifies for a loan, at what interest rate, and what credit limits. The use of credit or identity scoring prior to authorizing access or granting credit is an implementation of a trusted system.

A secured loan is a loan in which the borrower pledges some asset (e.g. a car or property) as collateral for the loan, which then becomes a secured debt owed to the creditor who gives the loan. The debt is thus secured against the collateral.  In the event that the borrower defaults the creditor takes possession of the asset used as collateral and may sell it to satisfy the debt by regaining the amount originally lent to the borrower.

Unsecured loans are monetary loans that are not secured against the borrower’s assets.

Collateral means a security or guarantee (usually an asset) pledged for the repayment of a loan if one cannot procure enough funds to repay. The amount of collateral determines how much lenders will lend.

Personal guarantee is a promise made by an entrepreneur to repay the company debts in the event of default by the business. If the business doesn’t have enough assets to pay the debts, the owner has to pay out of his personal assets. A personal guarantee tells the bank that the business owner is serious about his business and about repaying his debts. When the owner is unable to cover the debts personally, the bank will start to seize personal assets. In a startup situation it is virtually impossible to borrow money from a bank and not give the bank a personal guarantee.

Alternative Methods of Raising Capital for Your Business

Here is an interesting article on alternative methods of raising capital for your business.

Borrowing Money

You may think of borrowing money from a bank first. Think of the bank last. Here is a hierarchy of money sources after personal sources have been depleted:

• Friends and relatives  Go first to the people who know you best; hopefully these are the people who trust you the most. Consider whether you will be offering an equity stake in the business or whether you want to borrow money. There are advantages and disadvantages to each. You don’t have to repay an equity stake; on the other hand you will be sharing your profits with the stakeholders. You may also give up some control over your own business.
• A lien on your home  This has become much more difficult lately. It used to be that lenders would lend an ever-increasing amount based on ever-increasing home values which caused equity to increase which in turn could be used as collateral. That carousel has stopped, however, and lenders are looking much more carefully at your homeÂ’s (fallen) value as well as your ability to repay. Advantages of this source of money are low interest rates and a long period of time to repay. Disadvantages include the fact that you may lose your home.
• Credit cards  This too has become much more difficult lately. Credit card companies are tightening the amount of money they will lend. Your all-important FICO score, indicating your credit history, will determine how much money you can borrow. Be careful about borrowing more on your credit cards than you can afford to pay back. Many people have borrowed too much money and have gotten into a cycle of ever-increasing debt amounts and ever-increasing interest payments. If you are conservative borrowing on credit cards, however, this can be a relatively easy source of funds.
• Inventory suppliers  Ask your suppliers to finance your purchases for a longer period of time. This can be like free money; however the amount of time suppliers will be willing to carry you may be limited. As with other sources, be sure to pay your suppliers on the agreed-upon date. Inventory suppliers are your lifeblood. When they refuse to sell to you, you may as well close your doors. You have nothing to sell. Suppliers may also help you pay for advertising and promotional programs.
• Equipment suppliers  Compared to your regular purchases, capital purchases can often be financed over longer terms. Consider also leasing equipment rather than buying outright.
• Your landlord  In today’s economy, many commercial landlords are facing high vacancy rates. Many will be willing to negotiate lease improvements that they will pay for in exchange for a relatively long contract. They may also reimburse you for moving-in expenses and may give you a few months free of rent at the beginning of your term.
• Customers  If you are giving credit to your customers you may want to encourage them to pay quicker by means of a discount. Making sure your customers pay you quickly will result in less need for financing so watch your accounts receivable carefully.
• Venture capital  Venture capital is a type of private equity capital typically provided to early-stage, high-potential, growth companies in the interest of generating a return through an eventual realization event such as an Initial Public Offering (IPO) or trade sale of the company. Venture capital investments are generally made as cash in exchange for shares in the invested company.
• Revolving Loan Funds are an often overlooked way to get financing to start or expand a business.  These funds come from local economic development agencies that are trying to increase jobs. BusinessLoanFunds.com has a list of Revolving Loan Funds by County.

Venture capital typically comes from institutional investors and high net worth individuals and is pooled together by dedicated investment firms. If your new business has enough potential, venture capitalists may be interested in investing in it.

• SBA loan guarantee programs  The Small Business Administration (SBA), an agency of the federal government, has a program whereby they guarantee a loan made to your business by a lender. There are SBA loans on continuing businesses as well as startups.
• Leasing companies   A commercial lease on capital equipment can be a lifesaver for startup businesses. Business equipment leasing can reduce your initial costs for acquisitions and can increase your cash flow. You can often borrow more advantageously from a supplier; however, if a supplier has no leasing program, this can be an excellent source of funds.
• Finance companies  Expensive alternative. These companies typically have no money of their own. They finance the business and borrow the money from a commercial bank. They will also sell the loan to a “loan holder” and use those funds to pay off the commercial bank. Often they make their money by servicing the loan. Everybody needs to make money which is why this is an expensive but sometimes necessary alternative.
• Banks  A banker will want to see your detailed business plan; he will want to make sure you’ve got a track record and that he trusts in your ability to pay back the loan. He will most likely ask you to provide the bank with plenty of collateral. Be sure to see a business banker, preferably one you already know or one your CPA knows.

How to Get Loans

• Complete your entire business plan. It is your road map.
• Get the help of a good CPA. CPA’s typically have good contacts.
• Check out BusinessLoanFunds.com list of ways to finance a business.
• Be prepared to give the lender the following documents he may ask for: business and personal financial statements, business and personal tax returns, your business plan including cash flow projections.
• Suggest a proposal with which you can comply for how you will repay the loan. Be honest and conservative. Lenders don’t want bad surprises.
• After you have borrowed the money, make sure you stick to your agreements. If you cannot, communicate with the lender as soon as possible to work something out.

For More Information

You have a great idea but unless you find the right financing, your inventions may never get beyond the notebook. With “All I Need Is Money”, you’ll find out how to secure the funding you need to make your invention a reality.

You Now Know…
The most frequent reason for startup companies to fail is because they are undercapitalized. That means they haven’t got the money for starting a business. You now know:

• To capitalize a business start first with your own money.
• A business plan is crucial to being able to borrow money.
• The language of business financing.
• That there is a hierarchy you should follow in borrowing money from least difficult to most difficult and from least expensive to most expensive. You have learned that hierarchy.
• How to get loans.
• That there are advantages to starting businesses which require small monetary investments.
• Where to get more information.

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Starting Costs Calculator

Starting Costs Estimator Calculator

What does it cost to start a business? This simple starting costs calculator can help you estimate. The money required includes the components shown here:

• Expenses before the starting date, such as legal, design, etc.
• Enough money in the bank (an asset) to support the company during the early months before sales reach break-even levels.
• Other assets you need such as inventory, furniture, buildings and equipment.

Starting Costs Calculator – Paloalto

Cash Flow Calculator

Cash flow is critical, but not intuitive. Profits are not cash.

Use this calculator to experiment with factors affecting cash flow.

Amazing fact: many business failures are profitable when they go under. This cash flow calculator shows you how business-to-business sales, carrying inventory, and rapid growth can absorb a business’ money. Change the variables and watch their impact on real business cash flow.

Cash Flow Calculator – Paloalto

Investor Offering Calculator

In the classic start-up situation, investors purchase a share of a new company for an amount of money. They look for return on investment, hoping to cash in when the company grows. How much they spend, and how much ownership they get in return, are both subject to negotiation. There are no easy rules or simple formulas. Investors weigh the risks of investing against the potential gain, using two classic financial formulas — Net Present Value and Internal Rate of Return — as a common basis for comparison. Use this tool to evaluate both sides of the table — what the investor gets, and what the company gives up.

Investor Offering Calculator – Paloalto

Discounted Cash Flow Calculator

Analysts use discounted cash flow to explore the “time value of money.” Essentially, money today is worth more than the same amount of money tomorrow. Double-click the variables and move the sliders horizontally to explore this concept.

Discounted Cash Flow Calculator – Paloalto

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The key to using this tool is to be realistic in your expected revenues and conservative (high) in your expected costs. The break-even analysis will force you to do the research that will allow you to know whether you should pursue your business idea further.

You will need to do a break-even analysis for your business plan anyway, but it’s a good idea to do it now to determine whether it is even realistic to pursue your business idea and whether it is worth writing a complete business plan.

Revenues above the break-even point result in profits whereas revenues below the break-even point result in losses. You can do a break-even analysis whether you are selling a product or a service. If you have a rough idea of what your expected revenues will be, you can tell after doing a break even analysis whether you can expect a profitable business. If not, you either have to make some changes or give up your business idea. It is crucial to understand some basic concepts before doing a break-even analysis.

• Sales revenue is the total dollars from sales activity that you bring into your business each month or year. To perform a valid break-even analysis, you must base your forecast on the volume of business you really expect — not on how much you need to make a good profit.
• Fixed costs (sometimes called “overhead”) don’t vary much from month to month. They include rent, insurance, utilities, and other set expenses. It’s a good idea to add a cushion to your projected fixed costs because there will always be miscellaneous expenses that you can’t predict.
• Variable costs are expenses that change in proportion to the activity of a business. Variable costs vary with the number of units produced. Variable costs are made up of direct costs which are costs that are attributable to preparing each unit for sale, and indirect costs like certain overhead which can vary with the number of units prepared for sale. Together, variable costs and fixed costs make up the two components of total cost.
• The break-even point for a product is the number of units you need to sell for total revenue received to equal the total costs, both fixed and variable.
  To prepare your break-even analysis for your potential startup business you have to make an educated guess as to the number of units you can sell, the expected sales price per unit, fixed costs and variable costs. This educated guess is made on the basis of research.

Once you’ve estimated the four numbers above, it’s easy to calculate your break-even point by using the following formula:

Break-even Point = Fixed Costs / (Unit Selling Price – Variable Costs)

Let’s see how that works in an example where we estimate we can sell 1,200 widgets per month at $10 each, resulting in sales revenue of $12,000. We estimate that our fixed costs for rent, utilities, and so on are $5,000 per month. We also estimate that it will cost us $5 per widget to buy raw materials and prepare the widgets for sale (our variable cost).
Plugging our numbers (except the number of widgets we expect to sell) into the formula, we get the following:

Break-Even Point = $5,000/ ($10 – $5)

or, Break-Even Point = $5,000/$5
or, Break-Even Point = 1,000 widgets per month

At the Break-Even Point, then, we would sell 1,000 widgets at $10, for sales revenues of $10,000. Our costs would be $5,000 fixed costs + $5 x 1,000 widgets, or $10,000. If we sell more than 1,000 units per month we make a profit. If we sell fewer than 1,000 widgets per month, we lose money.
Based on our break-even analysis, we calculate that if we sell the number of widgets projected, 1,200, we would make a profit of $1,000 per month, as follows, using the numbers we already know:

Profit = Sales Revenues – Fixed Costs – (Variable Costs x Units Sold)

or, Profit = 1,200 units x $10 – $5,000 – ($5 x 1,200)
or, Profit = $12,000 – $5,000 – $6,000
or, Profit = $1,000 per month
Are you satisfied with $1,000 profit per month? If not, you must have a plan to increase sales or lower costs. Maybe you can start by selling 1,200 widgets per month, knowing you will earn $1,000 per month and then have a plan to expand your product line. Many such issues can be addressed once you have determined your break-even point and your expected profit given your expected sales.

If your Estimates Fail to Break Even

If your estimate doesn’t at least show sales at the break-even point you can make adjustments before you start your business. Consider the following:

• Find a less expensive way to make your product.
• Reduce your fixed costs. Maybe you can save on rent. Maybe you can do with fewer employees.
• See if you can sell your product or service at a higher price.
• Find a larger market niche to increase unit sales.

If you can do none of those things, maybe your idea is not economically feasible. It’s better you know it now than later.

Conclusion

Break-even analysis is a powerful tool you can use to determine whether your business idea will be profitable. Consider your break-even analysis to be only one tool in your arsenal. Even if this analysis shows that you can make a profit given your expected sales and costs, there are other tools you will use in your business plan to give you a fuller picture of your financial forecasts. Among them are:

• A profit and loss statement
• A cash flow projection
• A start-up cost estimate

These tools are covered in the business plan section.

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This scenario is common today. It just isn’t easy to get your hands on cash from lenders. The reason is rather straightforward. When a lender loans money, they want to know there is little chance they will not get their money back, and in our current economic conditions, lenders see the probability as too high that they won’t get their money back, so they simply stop lending! Fortunately, there are other options. Although credit is still very tight here in the U.S., there are several alternative methods of raising a working capital loan to help finance your new business venture.

Friends and Family

Borrowing from friends and family is a common place to start when looking for financial help in your small business. If you have friends and family who may be willing to help you out, there are several pros and cons to consider before making the decision to take investment capital. First of all, there is a rule that must never be broken—NEVER take money from a friend or relative who cannot afford to lose that money! This is a non-negotiable. As an entrepreneur, you are most likely very optimistic that your business is going to do well, but you must understand that it is always possible your business could fail due to reasons completely outside of your control. A government regulation could change, the market could change, etc. Therefore, never take a working capital loan or loans from people you are close to unless you have clearly communicated that the investment money or loan could be lost.

Partner

Another alternative option is to take on a partner that has cash. Now, it has been said that you should never enter into a business partnership with someone unless you are willing to marry them. All joking aside, business partnerships are not easy. You must have 100% trust and confidence in your potential business partner. A common business partnership model is to have one partner who is the technical/product specialist and one partner who brings the money to the table. So, if you decide to do this, this is a common method of raising capital. The major drawback is that you are going to give up a significant portion of your ownership in the company. Your financial partner is risking capital. You are risking time and energy. Both are extremely valuable. The major question you need to ask is if the business explodes and reaches your wildest dreams, will you be upset if you have given a certain percentage of ownership up. If the answer is no, then take on a partner!

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