Figuring Out How Much Capital You Need
If lack of financing is a major obstacle to starting your business, take heart. Many small businesses start on a shoestring.
Almost half of all new businesses begin with less than $5,000 in total capital, according to U.S. Census and Federal Reserve surveys. Then again, some entrepreneurs invest hundreds of thousands of dollars in a business venture and fail without knowing why.
The amount of money with which you start your business is no guarantee of success, said Debra Esparza, director of USC’s Business Expansion Network.
Whether you have only a few dollars or a lot, you can drastically miscalculate the amount of capital needed to get the businesses started on solid ground.
“Where people misjudge is figuring out how much working capital they’ll need,” Esparza said. “If they just do the part that gets the store open, then they don’t have enough money to run it.”
Esparza divides start-up capital into two major categories: one-time capital expenditures--your basic start-up costs--and ongoing, fixed expenses--the money you’ll need to open your doors and go to work.
“People don’t realize how much it costs to actually run the business,” Esparza said.
Typical cost factors--some fixed, some variable--are listed below.
One-time capital expenditures: These include the basics to get your business started.
* Equipment--Be sure to compare the price of new and used equipment. Don’t forget to include basics such as desks, chairs and file cabinets. Obtain bids on the items you would consider purchasing. Three bids are generally enough to get a good idea. In a buyer’s market, negotiate for delivery or installation.
* Fixtures--Fixtures typically include items that are fastened in place but can be removed, such as signs, storage shelves, lighting, checkout counters, showcases, display counters, partitions and paneling. Obtain at least three bids, and consider new and used fixtures before buying. Items can be purchased at liquidation prices at auctions.
* Inventory--Retail stores in particular must budget start-up inventory carefully. Market and client profiles you have obtained will be invaluable in determining which product and quantity you should stock. Other businesses may need certain raw materials in inventory. Compare and consult with two or three suppliers and vendors.
* Leasehold Improvements--Improvements that usually can’t be removed if you move to another location, including carpeting, electrical wiring, plumbing and bathroom installations, permanent wall partitions, windows, sprinkler or security systems, heating and air conditioning and interior design. Plans and permits are often required and costs can range from $5 to more than $100 per square foot. Bids are a must for this type of expenditure. Consult with your landlord for favorable terms or cost-sharing.
* Licenses, Permits and Tax Deposits--Don’t forget to include taxes, licenses and permits in your start-up budget. You may be required to post a deposit for the amount of sales tax you may collect during the first three months. For example, if you project $20,000 in sales during the first three months, you may have to deposit 8.25% ($1,650) with the State Board of Equalization when you apply for your resale number.
* Professional Services--Expenses for attorneys, accountants, management consultants or sales representatives are not always included in start-up costs. But like purchasing insurance early on, engaging these services at the beginning of your business provides peace of mind and added expertise. Some professionals work on a retainer, a fixed amount per month, and others on a negotiated hourly rate.
Ongoing, fixed expenses: These are typically monthly expenses.
* Rent--Usually a landlord requires first and last month’s rent to enter into a lease agreement. Some require a security deposit. Be sure to read the fine print before you sign an agreement.
Some landlords whose properties have been vacant for some time may be willing to offer the first month rent-free or forgo a security deposit if the tenant agrees to sign a longer lease.
* Utilities--Phone and utility deposits are often based on the number of lines or your projected usage. Don’t overestimate usage because you may end up with a larger deposit. Also, make sure you understand the conditions on the deposit. Some are refundable to you after a certain time or after a series of prompt payments.
* Salaries--Although it’s unlikely that investors or banks will give you the money for your own salary during the beginning months, that amount must be budgeted. If you will be hiring staff and employees immediately, you should budget for their salaries, taxes, insurance and benefits.
* Marketing and Advertising--Businesses typically budget 2% to 5% of estimated annual sales for marketing and advertising. But before spending the money, research the types of advertising and marketing available and choose those most likely to attract your desired customer. Many new businesses, particularly retail stores, host a grand opening in the first three months of operations to attract local customers. Check with your neighborhood Chamber of Commerce to get an announcement in their newsletter or mailing list. Budget money for food, entertainment and mailing costs and start a “preferred customer” mailing list.
A good rule of thumb is that it takes, on average, eight times before a prospective client or customer associates advertising with your business.
* Insurance--Many new businesses skip this important expense in the beginning. But disasters, theft and other business interruptions don’t always wait until a business is on its feet. Esparza tells of one restaurant owner who went without insurance for three years while his business struggled. When he finally began to see a profit, he scheduled an appointment with an insurance broker for a Saturday morning. But two days before the appointment, the business burned to the ground.
Adding It Up
Many would-be entrepreneurs do a good job of estimating start-up and monthly expenses. But determining the optimum amount to start with is up for debate.
Many experts recommend beginning with at least three months of operating expenses, plus 10% of that amount as a contingency fund. Others suggest setting aside money based on how long it will take for the business to begin taking in cash to offset expenses. Determine how long it will take to make the sale (getting to “yes”), to produce the product or service, to invoice for the sale and then, barring any returns or adjustments, to receive payment.
In some industries and for some large purchases, it may take more than three months of sales calls and business development to persuade the customer to say yes. Then it may take 30 days to build it or to provide the consultation, another week for the invoice to get to the customer, and then, even if your terms are “payment due upon invoice,” another 15, 30 or even 60 days to receive payment. Government or institutional clients typically take longer.
In this scenario, the three-month buffer will be completely expended before the first sale. A better estimate would be to have working capital to cover six months.
That estimate increases, however, if you make another sale during this period. Now, you need to buy more inventory . . . and the cycle begins again.
Exercise: List the actual start-up dollars you will need in the categories above. To help, The Times has fashioned an online grid at https://www.latimes.com/smallbiz
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The USC Business Expansion Network is at 3375 S. Hoover Blvd., Suite A, Los Angeles, (213) 743-1726.
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The Bottom Line
“Entrepreneurship 101” is a tutorial on how to choose, start, finance, plan and grow a business. The program, written by Times staff writer Vicki Torres, was developed by Debra Esparza, a faculty member at the Entrepreneur PrograM OF USC’s Marshall School of Business. Esparza also heads USC’s Business Expansion Network, a community and economic development project that has counseled more than 5,000 small-business owners in the Los Angeles area over the last six years. BEN provides help with financing, business planning, accounting, marketing and other issues. The tutorial can also be found on the Times’ Small Business Web site at https://www.latimes.com/smallbiz
