On The Money Figuring out how much cash you <i>really</i> need to start your business

Entrepreneur magazine, September 1998

Anxious to start turning a profit, entrepreneurs often launchtheir companies without carefully estimating the amount of capitalthey'll need to actually get started. Many insist passion andenthusiasm will be enough to get them through the rough periods."Passion and dedication are important," agrees MargeLovero, president of the Entrepreneurial Center Inc., a businesstraining and consulting firm in Purchase, New York, "butunfortunately, they can't pay the bills or keep you aliveduring the start-up months."

Lovero recommends new companies start out with enough capital tocover projected expenses for at least six months. "It'sfoolish to expect to generate revenue immediately," she says."It's best to play it safe and plan for allcontingencies."

The type of business you start plays a critical role indetermining the amount of start-up funds you require, says Lovero."A retail business, for example, can regenerate revenueimmediately, whereas service businesses typically have to waitbetween 30 and 90 days before they're paid," she explains."These facts give you some idea [as to] how much workingcapital you'll need during the early months."

The following four scenarios provide a window into situationsyou may someday face-and might help you avoid mistakes whenpredicting your start-up expenses.

Bob Weinstein is the author of 10 books and is a frequentcontributor to national magazines.

Proceed With Caution

Nick Yonano, 31, spent his money carefully when he launched TeaBody's Inc., a Turlock, California-based gourmet iced teacompany, in 1995.

The former attorney financed his company through his savings andmodest borrowing from friends and family. His vision? To developiced teas and market them to specialty food stores throughout theUnited States. To achieve that end, he watched his pennies,meticulously planning each step.

The tough part, he says, was determining how much money he'dneed. "The idea was to eliminate nonessentialexpenditures," Yonano says.

When he reviewed his estimated costs, he figured $60,000 shouldallow him a modest start. So he sold his Porsche 911 for $18,000and tapped into his savings. Soon, he was in business.

Yonano's most significant costs were in product development."About half the start-up money was apportioned to buyingquality teas," he says. The rest of his costs were allocatedto marketing, promoting and packaging.

It didn't take Yonano long to realize that his businesswould cost more than he imagined. Originally, he thought he couldfinance his company's art, graphics and logos for around$5,000. But once he began getting estimates starting at $25,000, heincreased his own estimate to between $10,000 and $15,000.Fortunately, Yonano was able to find an artist who worked from hometo create the graphics for his fledgling company. The job'sfinal cost: $12,000.

And when it came time for market research, rather than payingrates of up to $10,000 for the help of an expert, Yonano did ithimself for only $1,200.

Rent? That was easy: Yonano converted his garage into a blendingfacility. Later, he moved to a small, rent-free office in hisparents' company until he could afford the $600 monthly rentpayment for his first official office.

Even with such meticulous planning, $60,000 in start-up feesbarely covered it. To keep the company afloat, he borrowed $20,000from his parents.

Today, Yonano's cautious financial strategy is paying off.Last year, sales jumped 250 percent, from $50,000 to $175,000. Thisyear, he's confident sales will reach the $300,000 mark.

Even though things are looking better, Yonano is still acautious pragmatist when it comes to projecting his finances. Tosave the business money, he didn't take a salary until lastyear. "My salary ranges between 2 percent and 5 percent ofsales," he says. "I plan on keeping it that way untilwe're well on our way."

Wake-Up Call

As careful as Yonano was in estimating his start-up costs,entrepreneur Gerald Chamales, 47, was downright careless when itcame to estimating how much money he'd need to launch OmniComputer Products, a Carson, California, manufacturer and recyclerof computer supplies.

Chamales launched the business without a financial plan andevaluated his costs through trial-and-error. "I didn'thave a clue [as to] how much money I'd need," he says.

With a meager $7,000 in savings, in 1980, Chamales leased anoffice in Santa Monica, California, and started Omni. He rentedoffice furniture and phones, hired two salespeople, and contractedwith a company to label his products and then drop-ship them tocustomers-allowing Chamales to start quickly withoutinvesting in inventory.

But other expenditures crippled Chamales during that first yearin busines. "I was paying way too much rent," he says."Tack on expenses for office equipment and supplies, and Iburned through the $7,000 in just a few months."

Six months after launching Omni, Chamales found himself runninghis company out of his apartment in Venice, California. With just$1,200 left on his credit card, he was forced to rethink hisstrategies.

"When I was down to the proverbial wire, I wised upfast," says Chamales. "I realized I'd better get myfinancial act together or I wasn't going to make it."

Fear is a powerful motivator, as Chamales soon learned. "Ilived simply and turned everything I made back into thebusiness," he explains.

He says the whole experience has taught him many lessons."Before you launch a company, [make sure you] have enoughmoney to cover all your projected expenses for a year,"Chamales advises.

As for determining accurate cost estimates, Chamales says a goodrule of thumb is to assume everything will cost more than youexpect. "My telephone bill, for example, was three timeshigher than I imagined, and the same went for my travel and gasexpenses," he says. "Until you're generatingpredictable sales, you'd better be prepared with flexible moneystrategies."

After the first six months, Chamales took no financial risks. Infact, he paid himself only $200 a week for five years.

When Omni had moved into the black, he relocated the business toa new office and moved into a small studio apartment to lower hisliving expenses. "I evaluated every expense," Chamalessays. "I was determined to succeed."

And he did, far exceeding his expectations. Two years afterstarting the business, he had 15 salespeople and hefty profits.Today, Omni employs 275 people and boasts sales of nearly $30million.

Too Much Is Never Enough

Deborah Simpson had a good idea from the start as to how muchmoney she'd need to launch Santa Clara, California-basedMetaSound Systems Inc. in 1996. MetaSound makes cutomized softwarethat programs and plays music and messages for callers on hold.

The former corporate consultant knew she'd need at least $1million to finance research and development expenses. However, shehad to settle for only $300,000 of angel financing-an amountthat barely got her out of the starting gate. Six months later, themoney was gone and she was forced to raise an additional $1.3million through angel financing.

Simpson, 41, was prepared to give away up to 90 percent ofownership in her company to secure big returns. But soon she, too,discovered she needed far more capital than she had originallyestimated. While the amount surpassed that of moststart-ups-software development requires large amounts ofcapital-the lessons she learned could be applied to allfledgling companies.

No matter how much time you spend estimating start-up costs,Simpson urges entrepreneurs not to follow them like gospel."Take what you think you'll need and multiply it by10," she says. "The more you have, the faster you canbuild the foundation of your company."

Simpson also recommends raising money-even when you thinkyou don't need it. This strategy has certainly worked for her:Last year, MetaSound's sales hit $500,000; she expectsthey'll jump to $2 million this year.

Where The Money Goes

Smart planning for the start-up years

Tom S. Gillis is a successful Houston entrepreneur who has beenstarting and selling businesses for more than 50 years. His book,Guts & Borrowed Money (Bard Press), is used by theUniversity of Houston's Center for Entrepreneurship andInnovation and covers the critical stages of running abusiness.

Entrepreneur asked Gillis for his thoughts on moneymanagement in the start-up stage:

Entrepreneur:How do you determine how much money youneed to start your company?

Tom S. Gillis: You need enough capital to cover allexpenses until you reach the break-even point. You break even whenthe revenues from customers pay all the expenses, including yoursalary, with a little bit left over for repayment of debt. But allbusinesses don't have the same capital requirements.

Entrepreneur:How does an entrepreneur determine hissalary?

Gillis: The entrepreneur ought to receive a paycheck onlyafter employees and bills are paid.

Entrepreneur:What kind of bank is more likely to loanmoney to a start-up company?

Gillis: The key to opening the door to bank funding is aproven record of loan repayments. If you don't have that, thenext best things are collateral and a profitable operation.

Still, all banks are not the same. Some specialize in smallbusinesses, while others concentrate on midsized and largebusinesses. Talk to as many bankers as you can, and establishbanking relationships as soonas you start your business. It'sbest to have a relationship with a bank before you actually needmoney.

Ask The Experts

Surround yourself with a corps of advisors.

When getting your business off the ground, don't go italone. Consult the experts in virtually all critical areas of yourbusiness, especially financial advisors who can help gauge start-upcosts, says Kathy Jones-Price, a senior financial advisor forAmerican Express Financial Advisors Inc. in Salt Lake City."It's worth the effort to build a tight corps of advisorswho have experience with small business," she says.

These advisors should include a CPA, an attorney and a fewentrepreneurs with backgrounds in all aspects of the start-upexperience.

A financial advisor offers tips for both saving and makingmoney. For example: "No matter how limited their workingcapital and reserves, [entrepreneurs] should maintain both achecking and an interest-generating market account," saysJones-Price.

It's a commonly used tactic of midsized and large companies."It may not translate into enormous amounts in the earlyyears," Jones-Price explains, "but if you keep sweepingmoney into a money market account, one day you'll have asubstantial nest egg that can be used to build yourbusiness."