5 steps to prepare your finances for a startup
By Elaine Pofeldt | Published: August 5, 2015
Starting a small business isn't easy. Even tougher is keeping it afloat long enough for it to pick up traction -- something many newbies don't anticipate.
What goes wrong? Often, owners haven't taken the right steps to prepare their finances so they can give the business the runway it needs to succeed.
"The nightmare is you have this great idea, scrape together all of your savings and spend $500,000 -- and your revenues don't live up to projections and you're tapped out," says David Hiller, head of small-business banking for SunTrust.
Fortunately, it is possible to prevent this scenario -- and many owners do. According to the U.S. Small Business Administration, about 80 percent of the 630,357 businesses launched in 2013 survived through 2014.
So how to you avoid joining the 20 percent of businesses that fail in the first year? Take these five steps that entrepreneurs and experts agree will prepare your finances and personal credit for business ownership.
Step 1. Take stock of your finances. "The most important thing you can do is have a really good understanding of your financial situation," says Hiller. Some questions to ponder: What cash do you have on hand? What assets do you have? Do you own anything you can sell to raise cash? What debt do you have? What payments do you have? The answers will help you assess your capability to start and sustain a small business.
Scaling back your lifestyle in the months leading up to your start date can give you financial breathing room as you launch the business. Koel Thomae, an entrepreneur who lives in Boulder, Colorado, took that approach with her husband when launching her yogurt company Noosa, in 2010. It specializes in making a velvety-textured yogurt from a family recipe in Australia, where Thomae is from. "We were very frugal until I could start pulling in income from Noosa," says Thomae, a natural-foods industry veteran who was working on a consulting project to pull in income at the time. "It was tough. There were definitely some moments where I saw my friends taking off on another holiday and I took a deep breath."
What enabled her to maintain her "financial fortitude," she says, was reminding herself of why she was making sacrifices in her personal life -- her passion for bringing the yogurt to market. After about nine months, the business started taking off, which reinforced the reasons she was keeping her household budget lean. "I am really thankful I did make those sacrifices," says Thomae, who has now grown the firm to 100 employees.
Step 2. Create two financial plans. Crystal Stranger, a Honolulu-based consultant who advises small-business clients, recommends that all would-be entrepreneurs prepare two plans for new ventures: a best-case scenario and a Plan B that takes into account potential setbacks. Otherwise, it's easy to get sucked into the common trap of being blindsided by routine obstacles you could have anticipated. "A lot of the problem is people get overly exuberant," says Stranger, who is president of 1st Tax and author of "The Small Business Tax Guide."
Common mistakes are underestimating unexpected expenses and how long it will take for early marketing efforts to result in revenue, she says. Consider how you will secure the extra money you need if these things happen. "Create a contingency plan," she recommends.
Step 3. Build your war chest. Saving six to 12 months' worth of living and business expenses before you start a business -- a common recommendation -- is never a bad idea, but it isn't the only way to set yourself up for business ownership. By making sure you have at least one income stream that can support your household -- such as a spouse's salary or your pay from a day job -- and enough savings to sustain the business during the early months, you can give yourself similar staying power to ride out the initial startup period.
What if you're starting a business because you lost your job? That makes your financial situation tougher, but it may also give you a powerful incentive to succeed that you might not otherwise have. The trick is to maximize whatever financial resources you have. "If you're starting a business after losing a job, usually you'll have some level of severance or savings, but you've got to stretch that cash as far as you can," says Hiller. "Whatever you can give up in terms of expenses, give it up."
Step 4. Do some on-the-ground interviews. If you're new to an industry, some of the financial realities are likely to surprise you. The best way to anticipate them is by speaking with as many people in that industry as you can, says Hiller. "Have those conversations, rather than read about it," he says.
The nightmare is you have this great idea, scrape together all of your savings, and spend $500,000 -- and your revenues don't live up to projections.
One thing you need to know for your planning is what the payment cycle is in your industry. You may not get to dictate the payment terms, especially if your clients are big, well-established businesses.
Ask Greg Van Ullen. In 2011, he and his wife Julie started OMilk, a Brooklyn, New York-based maker of dairy-free milk made from ingredients such as almonds and cashews that is sold in Whole Foods stores in the Northeast. The first store that began carrying the brand was gourmet foods purveyor Dean & Deluca. The payment terms were "net 60," meaning the net, or total, amount was due to be paid in 60 days.
This put considerable financial pressure on tiny OMilk -- and the Van Ullens, who had just gone on their honeymoon and bought a condo. "We were delivering for two months, buying bottles and not getting any money back," recalls Greg. "It was really tough until that first check came. It didn't cross our minds that our cash flow was going to be so tied up. It was kind of frightening. We had really used up a lot of our rainy day money." But riding it out paid off for the now six-person firm, which Greg says brings in $500,000 in annual revenue.
Step 5. Build a loan-ready business. Most entrepreneurs don't get a big bank loan right out of the starting gate, says Hiller. Securing a credit card can be a good initial way to extend your cash on hand, and it is something you should be able to do very early in the life of your business if you have good credit. "Getting a business credit card will give you 25 days of float," says Hiller.
Getting a business credit card is preferable to securing personal cards and using them for the business, Hiller says. "If you get a business card, it will be personally guaranteed, but you will also start building business credit," says Hiller. Use it wisely and you'll be in a much better position to secure any loans you need to expand your business down the road.
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