Often, the hardest work in opening a
business is securing start-up financing. People who don’t plan properly learn there’s no “fun” in funding, and they
increase the risks that are part of any business venture, ranging from slow starts to
failure.
When a business does not succeed, the
gap between cash available after liquidating assets and liabilities taken on by the
business ultimately becomes the responsibility of the owners. To close the gap,
owners have to be realistic about the risks
and the underlying costs of starting a business and be prepared to put some “skin in
the game.”
Smart Business spoke with John
Bonfiglio, CPA, CVA, a principal with
Skoda Minotti, to gain some insights into
financing start-up businesses, how to complete the process and how doing so
increases the chances of success with the
new business endeavor.
What sources of financing are available for a
start-up business?
Business owners often consider financing a business from their own personal
finances, family members or friends; however, there are other sources, such as commercial banks, angel investors or venture
capitalists.
There are different factors to consider
for each source. Commercial banks often
look to ensure that loans made to start-ups
are collateralized by company assets or
personal assets of the owners. At times,
shortfalls in this area can be made up by
government programs guaranteeing a
repayment of a portion of the loan.
Angel investors and venture capitalists
can be more flexible with immediate
repayment terms, but often seek a higher
overall rate of return than commercial
banks. Such financing can often include a
mixture of debt and equity or ownership
stake in the endeavor. These investors
often look for a clear exit strategy. Time
horizons for exits differ, but often are in
the five- to seven-year timeframe. If considering the purchase of an existing business, there is also the potential to finance
the purchase through the seller.
What is the difference between financing a
service company versus one that produces a
product?
Service businesses typically do not have
as many underlying assets, such as inventory and equipment. This makes them
tougher to finance because they do not
have the underlying collateral. Lending
sources will then look to the owner’s personal assets and guarantees or government
programs to make up this shortfall.
Do options differ between starting a conventional business versus buying a franchise?
There are the same financing considerations whether buying a franchise or starting a conventional business. However,
there are banks and other financial institutions that are familiar with a franchise’s
business model and have a comfort level
with financing franchisee start-ups.
Should a prospective business owner concentrate more on short- or long-term financing when looking at start-up costs?
New business owners should consider
both long- and short-term financing alternatives. Often, longer-term financing can
be used for the purchase of capital assets
such as equipment. Short-term financing
can help finance operational costs such as
employee wages and inventory purchases
over the course of the business’s normal
operating cycle.
What factors should business owners consider when estimating start-up costs?
A key to success is to develop a comprehensive business plan that includes realistic costs to fund initial start-up of the business as well as to pay for ongoing operations and overhead charges. Some start-up
costs include the initial purchases of business assets, such as inventory and equipment, costs to set up the business itself,
costs related to hiring employees, rent for
the primary business location, including
the initial security deposit, and costs related to implementing the information technology infrastructure.
Often it is helpful to put together a
‘sources and uses’ cash budget that focuses on starting the business and the first full
operating cycle of the business. As a rule
of thumb, we see that entrepreneurs
should often plan on ‘twice as much’ and
‘twice as long’ versus their initial plans.
What financial criteria should start-up owners consider before financing a business?
The overriding criterion when considering whether to finance a business is gauging whether the sales and profit margins
for the business endeavor outweigh the
start-up and ongoing costs over time. This
involves initially developing an understanding of the business and the market
niche you are serving.
Thereafter, the key is ensuring the organization is delivering an excellent product
or service and measuring its success by
generating sound financial data for decision-making.
JOHN BONFIGLIO, CPA, CVA, is a principal with Skoda Minotti. Reach him at (440) 449-6800 or [email protected].