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Monday, August 15, 2016

The financial side of launching a startup

By Nate Vickery

Only a small percentage of several thousand companies that are being incorporated every year can be called startups. Paul Graham, famous computer scientist, investor and essayist says that startups are companies that are designed to grow fast. 

Startup business financing
Proper appropriation of capital is essential for startup success
For this reason a startup business model requires a highly specific launch protocol. Since finances are usually the most critical segment of company’s incorporation, in this article we explained some basic financial principles, which should be applied in first phases of startup development.

Understand and categorize your costs

Determining your budgetary needs is critical for launching a successful startup. There is no universal method for determining your expenses, since every business niche comes with its own specific expenses.

Manufacturing businesses require a much larger initial investment because you need to acquire production equipment and rent a production hall. Service businesses usually require you to rent property on a top location. You will also need a niche-specific license surety bond that will guarantee the level of services you are offering to the public. Surety bonds are also required for contractors who are working on government-funded projects. Also don’t forget to add workforce costs to this mix, which include the costs of recruiting and training new employees.

In order to understand your expenses, you should separate them into several categories:

Onetime vs ongoing expenses

Costs of incorporation and production equipment are onetime costs. Months with significant onetime costs, can bring very small (or no) profits. That’s why you need to use the following months to fix this cash flow disruption and make up you lost returns. Ongoing costs, by contrast, are paid on the regular basis. They usually include: utilities, property rent, salaries and raw materials purchase.

Essential vs optional expenses

Essential costs are necessary for your business to run smooth. You must pay them, even if this leaves you without profits for one or several months. Optional costs benefit your business process, but they should be paid only when your budget is full. Most entrepreneurs postpone optional purchases, until they receive a more significant ROI.
Fixed vs variable expenses

Variable expenses depend on your company’s performance, while fixed ones are consistent from month to month. Corporate tax is a good example of variable cost, while rent, utilities and salaries (without bonuses) are usually considered as fixed costs.

How to fund your business launch?

If you wish to build a successful business, you shouldn’t only rely on your own funds. The higher initial investment makes your company more competitive and if you have a worthy business idea, you will definitely find investors who will be ready to pour their funds into your project. For finding the right investors you will need a well-written business plan and a lot of patience. You can use several ways to fund your newly-launched business, including:
  1. Using your own funds, and funds you acquired from friends and family

Most people start their business with their own funds. Friends and family are the easiest investors to find, but they are not accredited investors, which increases the complicity of your relations with them, especially if your business fails (they might consider their investment as a loan). Taking money from unaccredited investors can also cause troubles with SEC and delay your initial public offering (IPO).
  1. From consulting to production and service business

Consulting businesses are great because they don’t require high initial investment and they offer outstanding ROI. Many entrepreneurs decide to start offering their consulting services, and use the profits they’ve gained for adding production or service segment to their company.
  1. Angel investors

Angel investors are rich individuals. Taking money from angel investors is considered as a proper venture funding. It means that they expect a promised return. If your business doesn’t bring enough return, they can urge you to sell the company or offer its stocks on IPO. Receiving an angel investment requires you to create an elaborate exit strategy that will enable you to return your own investments.
  1. Seed funding

Seed funding firms invest relatively small amounts of money in newly-incorporated companies or entrepreneurs with valuable business ideas. These investment companies are also called the Incubators and investing represents their prime business. Unlike angel investors they often take a much bigger role in company’s development. They give out advice and help entrepreneurs to solve various technical and organizational problems.

Return on investment

Return on investment is the most popular profitability ratio, but it isn’t necessarily the same as company’s profits. While profits measures your company’s performance, ROI only focuses on the money you invested in the project and on the return you’ve realized. If you invested $400,000 in your startup’s launch and your net profit is $100,000 (in the first fiscal year), it means that your ROI is 25 or 25%. This also means that you will need to wait 4 years before you return your whole investment, and all the money you gain after this date, can be viewed as a pure profit. ROI is a very important figure, which can be used for measuring the performance of your pricing policies, inventory and capital investments and overall profitability of your business.

After the successful first phase of company’s development, startups usually become the object of interest of rich venture funds. These investment funds can pour in huge investments and turn startups into highly successful international companies. That’s why overcoming financial problems in first stages of startup’s development is one most important tasks for every entrepreneur.

About the author: Nate Vickery is a business consultant, and editor-in-chief at Bizzmarkblog.com.

Image: US-PD