Financing Your Start Up Business
One of the most challenging aspects of starting a business is funding your new venture.
The cost of setting up a new business can vary dramatically. For example, an online business might simply require a computer, an internet connection and a website. That might amount to just a few thousand dollars but the set-up costs for a franchise could be hundreds of thousands of dollars.
To calculate how much money you might need to borrow to start the business you first need to work out your set-up costs. To help new entrepreneurs, we have put together the ‘Business Start-Up Expense Checklist’ that lists some of the potential costs you might incur when starting a new business. You can download the checklist from the resources section of our website and you’ll find the checklist breaks the costs down into various categories including legal and professional fees, costs associated with your premises, marketing and promotion, furniture and equipment as well as stock and working capital.
Failing to Plan is Planning to Fail
Before you approach any potential financier like a bank you need to prepare a business plan. This should demonstrate how much money you need and why you need it. The plan should instil confidence in your business and management skills and convince your bank or investors to lend you the necessary funds. To raise substantial capital for your privately-owned business the plan must be clear, complete and realistic.
A poorly prepared business plan will impact on your chances of receiving the funding and it must include all your financial projections and assumptions behind the numbers. Make sure your forecast sales are realistic because unsupported ‘pie in the sky’ numbers have no place in your business plan. We recommend you put together several financial forecasts including the best and worst case scenarios. It’s not easy but you know the business better than anyone else because you’ve explored the competitors and know their pricing.
Once you know how much funding you need it’s time to explore your finance options.
1. Business Loan from a Bank
A bank loan is the traditional way to raise funds, however, it’s not easy for start-ups to secure finance given they have no trading history. Banks don’t take risks and have stringent lending guidelines. As such, they will expect you to offer them some form of collateral to secure the loan. That means, should you stop making the scheduled loan repayments, the lender can seize the collateral to recoup its losses. The most common form of collateral to secure loans is residential homes. This means your home is on the line so you need to get the numbers right.
Don’t forget, there are plenty of banks outside the big four of ANZ, Westpac, NAB and Commonwealth. Community banks tend to support local businesses but they will almost certainly want some forms of bricks and mortar as collateral. There are also online lenders that offer small business loans but the interest rate is generally higher than that on offer from traditional lenders. If you go down this path, read the fine print.
2. Private Investors – Friends & Family
You can look to private investors (usually friends and family) to back your new business but make sure you seek legal advice and put the agreement in writing. If you’re sourcing loan funds from family members identify how much you need, agree on the interest rate and monthly repayments and also think about special conditions like the option to make lump sum repayments. The last thing you want is conflict with friends or family members because the ramifications could extend way beyond just money.
If you’re offering shares or a stake in the business make sure you are crystal clear about the number of shares or percentage ownership they are entitled to. Will they have a say in the management of the business? What is the earliest date they can cash in their investment? How will the business will be valued at the point of exit? The key is identify and document all the possible issues so you avoid a clash or conflict. Make sure the investor has realistic expectations regarding their likely return on their investment and work with your solicitor and accountant to address the problematic issues.
The beauty of borrowing money from friends and family is the trust that already exists. As such, it can be relatively easy to get the funding quickly. However, because of the familiarity, you and the lender might gloss over the finer details which could come back and bite you down the track. Remember, business is business and blood is thicker than water but money will tear families and friendships apart.
3. Superannuation Savings
For a lot of mature age entrepreneurs looking to start a business, the temptation is to dive into their superannuation savings. There are obviously rules and regulations regarding when you can access your superannuation savings but there are also some dangers with this strategy. A failed business could impact both your current earnings and your retirement plans.
4. Credit Cards
There are many stories of business owners maxing out their credit cards to fund their start up business. It’s quick and easy to access the funds but interest rates on credit cards are high. Also, don’t forget, credit card balances will impact on your lending capacity. It can be a great source of short term funding but one of the first warning signs that a business could be in trouble is a credit card at their limit.
5. Angel Investors
An ‘angel’ investor is someone who provides financial backing with the expectation they will share in the financial success of the business. If you’re familiar television shows like Shark Tank or Dragons Den, the angel investor provides the funding, experience and valuable advice to the business in exchange for a stake in the business. It’s a trade off in the hope the angel can help grow the business exponentially.
Angel investors want a say in the management of the business but do they need to be consulted on all decisions or just finance issues? How often will they be briefed on the progress of the business and when will they have the option to cash out? Again, cover the legalities and talk to your solicitor and accountant if this is your preferred finance option.
Crowdfunding websites let individuals support businesses or specific projects through small contributions. They can work if you create a great story to support why your business deserves funding and it inspires supporters to recruit their network to support your cause. It’s a relatively new option but can work.
In summary, getting funding for your new venture won’t be easy. Traditional financiers will want the loan secured over your assets while non-traditional sources will charge higher rates or there will be a lot of red tape. In some cases, you might find a combination of funding works best for you.
The most important thing is, consult with us before you sign any agreement.
For a comprehensive guide on starting a new business, download our free e-book "The New Business Starter Kit" from the right-hand side of this page.