Article by Luke Richbourg .
Small businesses face many hurdles to success. Low margins, poor product-market fit, unattractive value proposition, manufacturing or distribution challenges, internal strife, all can doom a business. However, even if the business fundamentals are sound, cashflow or liquidity issues are a particular threat to small businesses, which usually fail due to under financing or lack of capital. If your business is in a growth phase and spends more than it brings in, or requires significant upfront capital expenditures, you must take care to ensure that it is not undercapitalized. Here are a few problems and solutions that arise with financing a small business.
Warning – Undertaking a small business can be extremely rewarding and profitable. But it’s also risky. About half of all small businesses fail within four years.
Model Your Business – If you’re not familiar with spreadsheets, start now, you will be astonished by the ease with which you can construct constellations of related calculations and the insights they produce. You don’t need to be an accountant to familiarize yourself with the basics of business: Fixed costs, marginal costs, and potential for revenues. Life is uncertain, and so are financial models – develop best- and worst-case assumptions. If your costs spike or your sales tumble, can your business survive? This exercise with shine the cold light of reality on your dreams, but there exists no better way to stress-test business fundamentals on the front-end. And the best part: it’s basically cost-free.
Understand Your Financing Needs – A “bootstrapped” company requires little to no capital – that’s where revenues exceed costs. Example: Buy a widget on 30-day terms and sell it at a profit on 15-day terms. That by definition is a good business. Most businesses in the real world don’t have it so easy, you’ll likely require capital to purchase inventory or manufacturing capacity, to hire employees, to satisfy regulatory requirements, for research and development, and for marketing. Your model should justify, in numbers, why the capital required will produce a reasonable return for an investor or, if projected cashflows are persuasive enough, why bank debt could reasonably be expected to be paid off by the profits.
Know the Difference Between Debt and Equity – Greatly simplified, debt (that is, a loan) gives the lender the right to take control of the business on default, while equity gives the investor a participation in the profits of the business. Many lenders require the personal guarantee of the business owner; that means you may be personally liable upon a default. An equity investment would generally be considered to be higher-risk, a higher-reward proposition by the investor.
Educate Yourself – Managing a business will require wide range of skills that no one person could be expected to have. Much will be trial-and-error, and learning on the job. But much is well-trodden territory, and you reduce your risk by taking advantage of great resources freely available in advance of setting out full-bore on your entrepreneurial ambitions. Search online for educational tools and attend business seminars relevant to your project. Seek to arrange informational interviews with accountants and lawyers to clear up areas of confusion, and use them and your personal network to identify others who may have traveled a similar path and can act as resources, or potentially as mentors, on your journey.
Luke Richbourg aims to use his proficiency in the fields of law, finance, and business to provide practical and perceptive counsel for early-stage entrepreneurs looking to achieve success with their startups. You can find out more about Luke Richbourg on his Facebook page.