There’s no getting around it. When you start a new business, financial risk is a huge reality. In most cases it’s the single biggest risk, and the one that makes most would-be entrepreneurs think twice. The good news is there are some steps you can take to make the financial risks of a startup business more manageable.
As a startup entrepreneur, not only are you giving up the security of your regular paycheck, you may also be putting your personal savings, retirement savings or other investments, and even your home on the line. And the risk of running out of money is very real for startups. In fact, most surveys of small business owners show that a lack of capital is the No. 1 reason for business failure. Other top reasons for failure include lack of adequate planning, inability to control costs or price, and overoptimistic sales and revenue projections.
By taking the following four steps, you can go into your new business with your eyes wide open to the financial risks it poses and the possible profits it can bring.
1. Assess Your Personal Finances
How much money do you have? Include checking accounts, savings accounts, “toys” such as memorabilia, cars, or boats that you could possibly sell to fund the business, retirement accounts, the cash value of any life insurance policies, and the value of your home or other real estate. Next consider your debts, such as your mortgage, car payments, and other outstanding loans. Subtracting your debt from your assets equals your total net worth.
How much of this are you willing to put on the line? Most new businesses do not break even right away, so you most likely will need to go six to 12 months without a paycheck, possibly longer. What will you live on until your business can start paying you a salary? Also be aware that the lower your net worth is, the harder it will be to get financing from outside sources. Start now to sock away savings and cut your living expenses as low as you possibly can, so you’ll have more money for the business.
2. Assess Your Projected Startup Costs
Depending on the type of business you plan to start, you’ll need to consider aspects such as office equipment, rent, utilities, fixtures and furniture, inventory, business insurance, costs of licenses and permits, professional services such as accounting and legal advice, and marketing expenses. You might also need to consider the cost of developing and manufacturing a product or paying employee salaries.
3. Assess Possible Sources of Capital
If your costs outweigh your available assets, start figuring out how you will fill the financing gap. After using their personal funds, most new business owners get their additional startup capital from family and friends. Play the “six degrees of separation” game and figure out who the people you know might know. Depending on the amount of money you need and the scope and industry of your business, other financing options to consider include personal credit cards, bank loans, Small Business Administration loans, individual angel investors or angel capital groups, or venture capital funds.
4. Write a Business Plan
No matter what type of capital you’re seeking, whether it’s a $10,000 loan from Aunt Sally or $3 million in venture capital from the hottest VC firm in Silicon Valley, you need to be able to show the potential investor a well-thought-out business plan that details why you want the money and what you will use it for.
Even if you’re one of the lucky few who doesn’t need outside capital, the business plan will help you figure out exactly how you’ll use your own hard-earned money to launch your business. A business plan enables you to think through exactly how you will build your business. If done properly, it requires you to create financial statements and projections that will force you to look at how your business will actually make money and how much money it has the potential to make. Think of your business plan as a way to test-drive your business idea and fix any mistakes, before they actually cost you real money.
Karen Axelton is Chief Content Officer at GrowBiz Media, a content and consulting company that helps entrepreneurs start and grow their businesses.