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Fueling Up

Explore these options to make sure you have enough money to start your business.
December 1, 1996
URL: http://www.entrepreneur.com/article/13600

When Joanne Mitchell left her corporate job six years ago, she was excited about testing the entrepreneurial waters. But before she hung out a shingle announcing her services as a medical-claims billing specialist, mitchell carefully planned her start-up.

"I calculated how much money I'd need to start Mitchell Medical Billing by estimating costs for software, business manuals, computer, printer and brochures to market my services. Then I figured out how I'd raise the money I needed. This planning gave me added confidence about getting my business off on the right foot," says the San Diego entrepreneur, who has also founded Pacific Medical, a training academy which helps individuals start their own medical-billing businesses.

Estimating your start-up costs is indeed essential to business success. "The most common reason small businesses fail is running out of cash," says David H. Bangs, Jr., author of Business Planning Guide: Creating a Plan for Success in Your Own Business (Upstart, $22.95, 800-235-8866). "Typically, a business is undercapitalized. It does not have enough capital to cover all its start-up costs plus a cushion for expected losses during start-up," notes Bangs. How much money will you need to get your business up and running? Consider these key factors:

One-time costs. Begin by estimating expenses you'll incur only once to start your business. These include furniture, fixtures and equipment for your office (such as a desk, chair, computer and software), fax machine, modem, phone system, lighting, filing cabinets, bookshelves and other items. If you're opening a retail store, you'll need counters, storage shelves, display stands, a cash register, window display fixtures, and outside signage.

Other one-time charges include: deposits for public utilities and lease of office space; installation of phone systems; licenses and permits; professional and accounting fees; first-year premium for a business insurance policy; and advertising and promotional materials to announce your opening. Add to your list business cards, stationery and envelopes, plus enough office supplies to get you started. If you're running a retail store, you'll need enough inventory on hand to sell to your first customers.

How can you estimate these costs? "You'll be very accurate in projecting start-up costs if you speak with vendors, check out catalogs and price lists, and look for actual, as opposed to approximate, prices," says Bangs, who advises adding a cushion to cover unexpected expenses or special purchases.

First month's expenses. In addition to your one-time start-up costs, you'll need enough money to cover your first month's operating expenses. Calculate how much you'll need for rent, maintenance, advertising, transportation charges and office expenses.

Salary. Chances are, your start-up won't immediately generate enough revenue to cover all your business bills plus pay a salary. Therefore, you'll need to add to your start-up costs enough money to cover your personal living expenses. Depending on your circumstances, it could take anywhere from a few months to one or two years before your business will be able to pay you a salary.

"Within eight months after starting my business, I was paying myself the equivalent of what I made at my corporate job, about $4,500 a month," says Mitchell. "I was able to start paying myself a salary because I didn't borrow heavily at the outset and I kept my expenses down." Mitchell's initial start-up costs, she notes, were around $2,000.

To minimize your start-up costs, you can lease or borrow equipment or buy second-hand. "I started out with an old computer I had on hand and bought a used printer. To have my business brochures printed, I traded office services with the owner of a local print shop. I also worked out of my condo to keep my initial costs low," says Mitchell. "It pays to be creative when figuring out how you'll spend your start-up capital."

Explore These Options

Once you've estimated your start-up costs, how will you raise the money you need? Explore these options and decide which are best for you:

Liquid assets. Start with the cash you have in your checking and savings accounts. Look at other assets you could sell, including stocks or bonds, real estate, cars, boats and antiques.

Family and friends. Depending on how deep their pockets are, family members and friends might be willing to invest. The advantages of borrowing from those you know are obvious: You won't have to talk with a loan officer or pay the current interest rate. A possible drawback: If your business falters, your relationship with your family members or friends might also.

Credit cards. In addition to her savings, Mitchell used credit cards to raise the $2,000 she needed to start her business. Credit cards provide instant money, and you can deduct the interest you pay if what you purchase is a business expense. "Be cautious," advises Mitchell. "Easy money is harder to pay back."

Life insurance policy. If you hold a whole life policy with at least three years of maturity, you can likely get a loan against the cash value of your policy. Most insurance companies will lend you up to 90 percent of your policy's cash value at rates generally more attractive than those charged by credit card companies. You are responsible, of course, for keeping up the premium payments on your policy.

Retirement plan. Still working for a firm while starting your small business? Then check into borrowing from your 401(K) plan. While rules vary, you generally can borrow half of what you've put into your retirement plan, up to a maximum of $50,000. There are drawbacks, however. If you quit your job to run your small business full time, you'll probably be required to immediately repay the amount you've borrowed.

Home equity. If you own your own home, you can take out a home-equity line of credit, apply for a second mortgage, or refinance your original mortgage. Generally, you can borrow as much as 80 percent of your home's equity.

Partner. Partners can be a great source of financing for a start-up. You'll gain additional capital and benefit from the skills and experience another individual brings to your business. Conversely, you'll have to share profits, and, if the business relationship doesn't work out, you'll have to terminate your partnership.

SBA-guaranteed bank loan. Depending on your credit record and the strength of your business plan, you might secure a Small Business Administration (SBA)-guaranteed bank loan. Loan interest rates are generally two percent over the prime rate, and you can typically borrow $150,000 to $750,000. The application process can be tedious, the competition intense, and you must first be turned down by a commercial lender before you apply.

Bank loan. While it's difficult for a start-up to secure a conventional bank loan, it's not impossible. "Banks don't make small-business loans, but they do make loans to people who start small businesses," says Bangs. "Get to know your banker. Show him you've done your homework by estimating your costs, developing a financial plan, and being specific about the amount of money you need. Then he'll have reason to invest in you."