Starting a business requires cash, but the question is always how much. The answer is not simple.
Different businesses have different costs. Some don’t even require any money at all at the start, says Brian Headd, economist at the U.S. Small Business Administration’s Office of Advocacy.
“If you want to start a taxi company, you could just lease the car and that would be no money up front,” he says. “But it’s different for something like retail.”
Varies by business type
The kind of financing also varies a lot. According to the U.S. Census Bureau, in 2002, 54 percent of the country’s business owners used their own (or their family’s) money to start or buy in. Bank loans were used in only 11.4 percent of cases, while credit cards were the method 8.6 percent of the time. These percentages differ widely among industries.
Restaurants and accommodations reported using bank loans 26 percent of the time (the highest rate) while for educational services the rate goes down to 3.9 percent. Manufacturing tops the list of businesses that use personal or family savings to start (64.2 percent), while educational services was at the bottom (41.1 percent).
What's right for you? One place to go for help is SCORE (www.score.org). Formerly the Service Corps of Retired Executives, it’s a volunteer organization that partners with the SBA and offers training and workshops for people who want to be entrepreneurs. Most importantly, SCORE offers counseling from people who have been in the business you might want to be in, who know the specific issues that you’re likely to encounter.
Rules of thumb
And while every business is different, there are some rules of thumb that can help.
Drew Gerber started a technology company, a publicity firm and a financial planning company. His estimate for how much cash you'll need at startup: six months worth of fixed costs.
“Have a plan to cover your expenses in the first month,” he says. “Identify your customers before you open the door so you can have a way to start covering those expenses.”
An essential piece is planning: don’t low-ball the expenses, and remember that they can rise as the business grows.
When you look at a business – any business – from the outside, it’s easy to overlook the costs. The vastly differing costs between businesses are precisely why it’s important to calculate the fixed costs early on, Gerber says. Don’t guess.
Project cash flow, and start small
Bill Brigham, director at the New York State Small Business Development Center in Albany, N.Y., says the important thing is to project cash flows so that you don’t go negative early on. Figure out a three-month period at least, Brigham says.
Brigham adds that it’s a good idea to add up not only fixed costs, but to throw in estimates of the costs of goods, as well as best- and worst-case revenues. And if you borrow money , make sure you know not only how much you borrowed but add in the interest. That puts a floor on the revenues needed to keep the business viable as well as providing a good picture of the cash necessary to start.
Gerber advocates starting without borrowing at all, if possible. Borrowing, he says, puts a lot of pressure on any business as it leaves less room for error. People have lost homes because a business failed, he notes.
Above all: Start small. Headd, the SBA economist, notes that it’s a lot easier to get financing when you do that. “If I wanted to get a $1 million loan from a bank to start a restaurant they’d say no, and they’d be right,” he says. “But if I want to start a catering business and need $5,000, that’s a much better investment.”