Business Start-Up Funding

According to the Bureau of Labor Statistics, about 20% of all business start-ups fail within the first year of business.  Michael Ames in his book Small Business Management lists the many factors that contribute to business failure.  One of these factors is insufficient capitalization.

Almost every business will require some form of start-up funding.  A web-based business will need to pay for internet access and some hardware.  A retail store will need some inventory and sales space.  A farmer will need land, seed, fertilizer/pesticide and some money to cover his living expenses until he can harvest his crop.

About 78% of all small businesses are classified as non-employers.  This means that they are self-employed and have no other employees on the payroll.  Many non-employers start small and rely on the income of the spouse to cover their start-up period.

Most starting enterprises use ‘Bootstrapping’ to fund the venture.  Bootstrapping means that the entrepreneur gathers funds from wherever he can to get the business started and keep it going.  Sources for bootstrapping include credit cards, personal loans, savings accounts and even retirement accounts.  In his USA Today article “Boomer Entrepreneurs Bet Nest Eggs on Dreams,” Rodney Brooks gives the specifics on ROBS (Rollovers as Business Startups).  A ROBS allows the account holder to use retirement funds for a business venture without incurring taxes or penalties.

Crowdfunding is a new phenomenon in business capitalization.  It is the collection of finances from a large pool of backers (the ‘crowd’).  Crowdfunding is often accomplished online and there are websites where you can pitch your idea, as well as find good ideas to support.  Jacksonville has a live crowdfunding event every year called One Spark.  This year they expect 200,000 people to visit 600 ‘creators’ set up in 70 venues in a 20 block section of downtown.  50 of these creators are Small Business Development Center (SBDC) clients.

Retail businesses can often start with low inventory costs by ‘Floor Planning.’  In the case of floor planning, the inventory belongs to the vendor or a finance/lease company until the business can generate enough revenue to purchase its own inventory.  Floor Planning can also be used to acquire the furniture, fixtures and equipment needed to start business operations.  Other existing businesses secure funds by ‘Factoring’ or borrowing against receivables (unpaid customer invoices).  The need for this type of borrowing is often caused by a poor accounts receivable policy and is a good discussion for a future column.  Your local SBDC consultant can go over these ratios with you compared to your industry standard to determine the best policy for your business.

Some entrepreneurs choose to exchange some of the ownership in their business to acquire financing.  There are ‘Angel Investors’ who provide capital for start-ups in exchange for a percentage of ownership.   Established business that still can’t access traditional forms of lending can sometimes trade a portion of ownership in exchange for ‘Venture Capital.’  These two options should be carefully considered as they can affect the future direction and the managerial control of the enterprise.

Traditional business lending from banks can be very challenging for a business start-up.  The entrepreneur needs to consider the 5 C’s of financing. 

·         Character – He needs to have a good credit history

·         Competence – He needs to have experience and knowledge of the industry

·         Capital – He needs to have cash to put in the deal (usually 25%)

·         Collateral – He needs to be able to secure the loan with something tangible (the assets you are buying, other cash or securities, land, etc.)

·         Conditions – Is the industry stable, growing and able to service this loan?

Communicating these C’s to the bank requires a well-written and researched business plan as well as realistic financial projections.  Your local SBDC consultant can help you with your business plan and financial projections.

Many businesses utilize a ‘Line of Credit’ for operating expenses.  A line of credit is a sum of money that is available to the business to use as it is necessary.  The borrower only pays interest on the amount used.  This is helpful for start-ups as it gives them discretionary funds to use until they pass the break-even point.  Farmers also utilize lines of credit to secure operating funds until harvest.  A line of credit is secured by land or other assets and the principal is usually paid back as the venture becomes profitable.

Buying an existing business is often easier because the business has a financial history that can be leveraged to secure a business loan.  Even in this case, the 5 C’s will be carefully evaluated by the lending institution.  For an aspiring business owner who lacks sufficient cash for the deal, the seller may be convinced to help with a portion of the financing to bridge the gap.  This also established the seller as a stakeholder who is interested in the ongoing success of the business.

The name of the game for financing start-ups is to be creative.  Once the business reaches the 2 year mark and has a solid financial history, many more sources of financing will become available.  Many businesses do whatever is necessary in the first 2 years to survive and then roll their bootstrap financing into one nice, manageable loan package moving forward.