CHAPTER 4
Finding the Money to Run a Business
Writing your business plan and reviewing your personal budget and credit has given you a clear picture of the kind of business you want to run and how much of your own money you can devote to it. Next, you will need to know how you can get more financing to fund your business.
By creating a personal budget, you know how much money you need each month to cover your personal expenses. Now, make a list of business expenses you expect to have and how much you will spend on them each month. At this point, these numbers are probably estimates.
What do you expect to spend every month for the following expenses?
- Lease office or shop space
- Telephone
- Utilities for office or shop space
- Supplies
- Bank charges
- Professional services (accounting and legal)
- Advertising
- Postage and delivery
- Transportation
- Inventory
- Other business expenses
- Total estimated monthly business expenses
- Total monthly personal expenses (the budget form in Chapter 3 )
- Total monthly estimated business and personal expenses
(You will need to earn this much income from all sources to cover all your expenses.)
Click to download a copy of the above as either a Microsoft Excel worksheet or CSV document.
In your business plan, you estimated that people would pay a certain amount for your product or service.
- Based on this price, how many products must you sell or how many hours of service must you provide to cover your business expenses?
- How many sales will you need to earn a profit?
- How many products would you need to sell if you have to pay for both your business expenses and your personal expenses?
- There are five business days in a week, and an average of four weeks in a month. How many products do you need to sell each day or how many services must you provide each day to pay for both your business and personal expenses? How long will it take before you can give yourself a paycheck?
- Do you anticipate that you can sell that much on the very first day your business is open? If not, how long will it take to sell that much?
- Do you have enough customers lined up to ensure that, on your first day of business, you will have a full schedule of customers or orders?
- Do you anticipate you will have enough sales during your first weeks and months to cover all your expenses?
- Are the numbers you are projecting realistic?
Click to download a copy of the above list as either a Microsoft Word document or Text document.
Often, new business owners believe they will simply open their business, and it will generate money and that’s how they will be able to afford to go into business. However, it takes time and effort to build a business, attract customers and make a profit. Realistically calculate the amount of money you will need before you go into business.
Sue was a massage therapist who felt she would easily make enough money to cover all her expenses and save some money, too. The typical rate for a massage in her community was $65 an hour, so if she provided four massages a day, five days a week (a total of 20 appointments) she could make $1,040 a week. During an entire year, she would earn over $50,000, which would cover her estimated business and personal expenses of $800 a week, or $3,200 a month.
Based on her estimates, she felt she could quit her job. She found office space for her new massage business and signed a lease. She paid a deposit for her office space, purchased a massage table and ordered a few supplies. In the process, she spent her savings of a few thousand dollars.
Sue had no massage clients the first week, which meant she did not earn any income the first week. However, she still had business expenses and personal expenses, but no money to pay them. The next week, Sue had three appointments and earned $195. During the following two weeks, she had five more appointments, earning a total of $520 that month. But she needed $3,200 to cover her business and personal expenses. Rather than pay her business and personal expenses, Sue used the $520 she made to pay for advertising to promote her massage business. Sue was now a month behind on her business and personal expenses.
The next month, Sue had 12 massage clients, and earned $780 for the month. Again, she had business and personal expenses of $3,200, plus $3,200 from the previous month. Although she paid her utilities and a few small bills, she asked her business and personal landlords to wait for rent. The third month, Sue had 20 appointments and earned $1,300. She had the same amount of business and personal expenses, plus additional unpaid bills from the previous months of $5,620, for total expenses due of $7,500. Sue’s business and personal landlords demanded rent money.
Sue had overestimated how quickly customers would find her and become steady clients. At the end of three months, she reworked her business budget. Sue could continue to operate with a deficit and incur more debt, or she could close her business. If Sue incurred more debt, she would need more income to cover her debt, so she made the decision to close her business. She had to find a way to pay back the extra debt she incurred. In addition, Sue had to find someone else to lease her office space so she did not have to pay rent on it for the length of the lease.
Because Sue had spent all her savings on business equipment, she used her retirement savings from her previous job — but had to pay high tax penalties. She still needed more cash so she borrowed money from her parents, who used some of their savings to help Sue. This left Sue’s parents with less money available for their own needs.
What could Sue have done to save her business and avoid hurting her own and her parents’ finances? She could have kept her full-time job so she had income, then started her massage business part-time. This would have allowed her to find out if there was a demand for her services and build a client base. Her business could have grown until she had enough clientele to quit her job and run her massage business full-time. That way, Sue would have consistently had steady income.
When you open your new business, your income will not be as reliable as a steady paycheck. Business income typically comes in after a product or service is provided or purchased, and a bill is issued. In many cases, the bill isn’t due immediately, but on a monthly cycle. In some cases, the billing cycle could be longer than a month — for instance, the cycle could be quarterly if making or building your product takes a long time.
If you are used to getting a weekly or biweekly paycheck, adjusting to a fluctuating income can be difficult. You will still have personal expenses while you open a business, so remaining at your full-time job while you start your business is a wise idea. As your business grows, you may want to increase your business hours and decrease the hours at your job — if your employer is willing to work with you.
If business is slow, you may think you can use credit cards to cover your expenses. But financing a business with credit cards is hazardous. A recent study by Monmouth University in New York showed that the more a business increases its credit card debt, the more likely the business is to close.
Len owns a small bookstore. He used 29 credit cards to finance his business, and has accumulated more than $200,000 in credit card debt. He didn’t intend for this to happen, but now he has to make 29 credit card payments each month. The interest rates on the cards vary from 19.9% to 32.9%. So in addition to his credit card balances, Len owes approximately $50,000 in interest on his credit card debt. What Len pays toward his credit card debt is robbing him of money he needs to expand his business, and is putting him at risk of bankruptcy. Len poured his heart into his business and regrets relying on credit cards to finance his business. If he ends up going bankrupt and has to sell his business, someone will buy it for much less than Len’s inventory and assets are worth.
If you consider taking a line of credit against your home to finance your business, think carefully before you do. Borrowing against your home can be a source of capital for your business, but the risks of that type of loan are considerable. If you borrow against your home and then are unable to make the loan payment, you risk losing your home. You don’t want to find yourself in a position where you have to close your business and lose your home, too.
Using Your Own Money
Keeping Your Job
One of the simplest ways to finance your business is to keep your full-time job. You will have consistent income to cover your expenses, as well as the opportunity to earn additional income as you start your business. As your business grows, you can keep your business open longer and reduce your hours at work. Before you quit or even reduce your hours, consider benefits you may be losing. If you have a full-time job that provides medical insurance, life insurance and retirement benefits, how will you replace these? Find out how much health insurance for yourself and your family will cost if you must buy it yourself. Will you have to buy life insurance? Do you have a plan in place to continue saving money for retirement? Take these expenses into consideration before you quit your full-time job.
If you are married, are benefits such as medical insurance available through your spouse’s job? Could you sign up for benefits there? Research this possibility early on when you are planning to start a business so you are ready to shift your coverage to your spouse’s plan during the next open enrollment period. Then, you will know you will still have benefits if and when you decide to quit your full-time job.
If you decide to start your business right now and leave your full-time job, you may need to get a part-time job to cover your expenses.
Using Your Savings
You can also use your own savings to finance your business. If you are going to go into business full time without working another job, how much money will you need to save? Review your personal budget, as well as the cost estimates and questions at the beginning of this chapter. How many months or years will it take before your business earns enough profit to cover its expenses and your personal expenses? This could be a substantial amount of money. In Sue’s case, it may have easily taken 12 to 18 months before her business was generating enough income to cover all of her expenses. Sue would have needed between $38,000 and $58,000 to cover her expenses during those 12 to 18 months. Depending on your monthly business and personal expenses, you may need more or less savings than Sue. Be realistic — hope for the best, but plan for the worst.
Using Other People’s Money
Maybe your business requires a substantial input of cash — more than you can supply with your savings or by working full- or part-time — so you may want to consider other options. You may borrow money, or others may invest in your company, but you will still need to invest some of your own money in your business, too. People who loan money or invest in your company will want to know how much money of your own you have invested in your business. If you don’t have an investment in your company, why would others want to invest in you? Everyone wants to know that you are willing to take the same risks you are asking them to take.
Loan from a Friend or Relative
You can finance your business in a variety of ways. Perhaps a friend or relative is willing to loan you money. They may loan the money unsecured or may request some security. Perhaps they will loan you money but want your coin collection as security. This agreement needs to be in writing so you both know the terms of the loan and when you have to repay the loan. This agreement should be drafted by your attorney. You will need to include a repayment amount for this loan in your budget. Keep in mind that if you run into trouble repaying your loan, that may create ill feelings between you and your friend or relative.
If you do have financial difficulties or you anticipate that you will face some financial problems, immediately contact the friend or relative who loaned you money and try to work out alternate payment arrangements. Perhaps they will accept lower payments from you until your finances recover. Just be sure to be honest with anyone who lends you money and communicate with them regularly.
Taking on a Partner
Taking on a partner is an option many small-business owners choose. Perhaps one person has a great business mind and the other has technical expertise, so a partnership to pool these abilities seems like a wise move. However, a partnership should always be set up with the assistance of an attorney. All partnerships should be in writing, detailing each partner’s responsibilities and how each gets paid.
A partnership has some advantages. A partner can help bring funds or customers to your business. You may want to add a partner because that person brings additional expertise to help your business grow. Perhaps you want someone to collaborate with and who can take on some of the work of running a business.
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If you decide to take on a partner, be sure each person’s responsibilities are clearly explained. For example, write a job description for each, including the hours each person will work. Set a work schedule for both partners to stick to. How much will each partner be paid?
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Describe other business operations. Who will handle business duties such as payroll and sales? Who will handle duties such as customer service, supervising production and ordering supplies? Set regular meeting times so that both partners can update each other on business matters. Communication is key for maintaining a successful partnership. Your friendship, working relationship and your business will suffer if both partners don’t fulfill their obligations and do all the work necessary to keep the business running.
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When you have a partner, you should both sign all checks, withdrawals and loan documents. Both partners have to be accountable for financial decisions so that both partners can be fully aware of the business’ financial status. Both partners should have equal amounts of money invested in the business. If the business should fail, and one partner has invested more than the other, that partner will be responsible for paying the bills (liabilities) that the business has incurred.
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Having full disclosure of all business finances and clear expectations for both partners are essential for a business partnership to survive.
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Taking on a business partner can also be risky. A partnership agreement outlines each person’s responsibilities, but an agreement will not be able to spell out every situation the business partners will face. It is not unusual for two business people to have different opinions about how a business should be run and expanded. How will you deal with these disagreements? Perhaps your business partner is against purchasing a large piece of equipment that you believe would help your company grow; how will you resolve that? Partnerships typically are set up to be long-term, 20 years or more. What if your partner becomes ill and is unable to complete his or her responsibilities? What would you do if your partner hired someone who isn’t a hard worker or makes mistakes that cost your company thousands of dollars? What if your partner makes a decision that isn’t legal for your business and you become liable for the decision? What if your partner wants to hire his or her children? Do you think you and your partner can resolve these situations? -
Running a business will affect your family, and so will having a business partner. Be aware that it’s not just you and your business partner who must get along; your families will be affected by this business relationship, as well. For example, if one partner’s spouse feels that their family is not getting the same benefits as the other partner’s family, this could cause jealousy and other problems, and this concern must be addressed. Clearly defining each partner’s duties, working hours and salary can ease some of these problems.
A silent partner offers some of the advantages of a partnership, but fewer complications. Typically, a silent partner is someone you know personally who believes in your ideas and business and can afford to invest money in your business. He or she is looking for an investment opportunity and will expect to be paid back with interest. Your silent partner will not have input in how you run your business. However, silent partners can be hard to find.
If you need help starting your business, you may prefer to hire someone to work for you if you can afford it, rather than partnering with them. Partners believe they are entitled to things, and as your business grows, they expect their share of it to grow and increase in value. Employees are paid to do a job. If you hire someone, you will need to follow all the state and federal labor laws. Before adding a partner, be sure you understand what is involved before making this kind of decision.
A Loan from a Financial Institution
Perhaps you are considering borrowing money from a bank or credit union. Not all banks and credit unions give business loans. Before you make an appointment with a loan officer, find out if that bank or credit union makes business loans.
A banker will want to see your financial statements for your business and for you personally. If you plan to borrow money for start-up costs, the banker will need a list of all the equipment and property you plan to use as collateral, and he or she will need to know how you plan to repay the loan. You will need to create a start-up budget to estimate the costs involved in starting your business. If you seek a loan after you have opened your business, you will need to provide an operating budget to show your expenses and income. Your financial institution will want to see if your business is generating any income, and if it is paying for its expenses.
When you seek a loan from your bank or credit union, your banker will want to see your business plan, projections of your business incomes and your personal financial statement. The financial institution wants to see your investment in your business. If they are going to risk loaning you money, they want to know that you believe enough in your own business to risk your money too. Bankers also want to know that, if your business isn’t making enough money to cover the loan payments, you personally will be able to make the payments.
Before you apply for a loan, and especially before signing any loan document, have your accountant review it. You need professional advice to make sure your business can afford to make the payments required by the loan. You will be better prepared to answer any questions the banker has if you have reviewed this with your certified public accountant.
Troy wanted to start a small business, so he reviewed his personal budget, created a business budget and estimated his costs for starting his business. He believed that he needed $30,000, so he made an appointment with his lender to discuss a business loan. However, after reviewing Troy’s finances, his lender told Troy he could only loan him $16,000. Troy insisted that he needed $30,000. Troy’s lender told him to redo his business budget to see if he could manage with less. Troy scaled back the supplies and equipment he wanted, tightened his budget to reflect only what he really needed to open his business, and went back to his lender. Troy was able to borrow $16,000. Because he had scaled back his budget, he didn’t even spend the full $16,000 on start-up costs and had some money left over. The leftover money was almost like a bonus for Troy because he considered what he really needed, versus what he wanted, for his business. Careful, frugal planning allowed him to have extra money that he can now save for an emergency or use to cover unexpected expenses.
About every six months, the banker will want financial reports from you regarding your business — especially if you borrowed money from him. Regular communication with your banker keeps the door open for future financial assistance.
Small Business Administration and CDFI loans
Guaranteeing loans is one of many services provided by the Small Business Administration, or SBA. The SBA is an independent agency of the federal government that helps Americans start, build and expand businesses. Through field offices and partnerships with public and private organizations, SBA has locations throughout the United States, Puerto Rico, the U.S. Virgin Islands and Guam. The SBA offers a variety of benefits to small businesses. SBA’s web site, www.sba.gov, lists all its services and can provide a great deal of assistance to you. This is a site worth spending time to review.
Many business loans given out by banks and credit unions are SBA loans. SBA loans are guaranteed loans, but the guarantee is not for you; it is for the bank or credit union making the loan to you. Because the loans are guaranteed by SBA, and SBA is a government agency, these loans are in essence government loans. If you do not make your payments and the loan goes into default, the SBA may repay the agreed percentage of the loan to the lender. Then, the SBA will attempt to collect the loan amount from you.
SBA loans have different terms and guarantees. Whenever you seek any type of business loan, ask lots of questions so you get the terms most favorable to you. Ask to have the specific terms of the loan explained to you so there are no misunderstandings between you and the lender. How much money are you being loaned? How long will you have to repay the loan? What will your loan payment be each month, and when must your payment be made each month? Who should you contact if you have questions after you receive your loan? What happens if you default on your loan?
Try to avoid getting a loan that requires full payments immediately. While you are starting your business, you will not likely be ready to make a loan payment. Unless you have business income coming in right away, you don’t want an immediate loan payment. If possible, you also want to avoid a loan that has a pre-payment penalty — meaning you will pay extra fees if you pay off the loan early.
Other loans may be available to you through Community Development Financial Institutions, or CDFIs. CDFIs are organizations that are certified to provide financial help for individuals and economically distressed communities throughout the United States. CDFI customers typically lack or have limited services from traditional banks and credit unions. CDFIs help by offering various financial services, including basic banking for individuals and funding for small businesses. Many of these services are geared for those with lower incomes. To find organizations in your state that are certified CDFIs, go to www.cdfi.org and click on CDFI info.
Investors
Suppose someone you know wants to be an investor in your company. He or she may be willing to
invest money in your company for a return on his or her money. Keep in mind that you will need to repay the original investment as well as interest or a return to your investor. If having investors is an option you want to consider, discuss this with your attorney. Is your company set up or structured so you can have investors? Your attorney would write the contract for an investor — how and when the investor is repaid, what input, if any, the investor will have in your business, and all other details of the contract.
Drew and Cameron were owners of a service business that was struggling. Drew agreed to buy out Cameron’s share of the business, but he needed $1 million to do it and was having trouble raising the money. Local lenders refused to loan Drew that much money, so he turned to out-of-state venture capitalists. Cameron was paid; Drew was left dealing with an investor who wanted to dictate how the business was run. Drew spent two years coping with the stress of the investor’s demands before he was able to secure local financing and pay off the venture capitalist.
Selling Stock in Your Company
Another option is to sell stock in your company. A stock investor puts money into your business for a share of your business. As the value of the stock increases, their investment is worth more. If your business isn’t doing well, their investment decreases in value. Depending on how this is set up, the investors’ rights could force you to merge or sell your company. Make sure you thoroughly understand all the consequences of taking on investors by visiting with your attorney and your Certified Public Accountant, or CPA.
Now you have a better idea of what kind of financing might be available to help you start your business. By determining what your combined business and personal expenses will be, you have a better idea of how much you need your business to earn and how much you might need to borrow. Next, you need to talk to professionals who will help you get a business structure, insurance and licenses. They can also give you more information about the types of business financing options that would be best for you.
“If you work just for the money, you’ll never make it. But if you love what you are doing, and always put the customer first,
success will be yours.” - Ray Kroc, founder of the McDonald’s Corporation
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