"How Much Should You Borrow to Start Your Business"

New Business Start Up Cost

No matter what line of business you go into, you will need startup capital to get your business going. Some typical startup costs facing new business owners include:

- Electronic equipment: computer, printer, scanner, tablet, smartphone

- Vehicle

- Furniture and fixtures: desk, desk chair, lamps, bookshelves

- Office supplies: printer ink, printer paper

- Reference books

- Supplies/inventory

- Manufacturing machinery and equipment

- Advertising: domain name, domain hosting, mailers, website design

- Operating space: home office, co-working space, retail storefront, warehouse

- Licenses

- Permits

- Corporation fees

- Legal fees

- Security deposit for renting a business location

What you need to buy can also depend on the degree to which you want to separate your business from your personal life. Many people will use their personal vehicle, cell phone and a room in their home to meet these needs inexpensively. Incorporating to separate your business assets and liabilities from your personal ones also costs money, but it can offer an extra layer of protection if your business fails.Also consider operating costs that you’ll pay regularly in the course of running your business, like insurance, taxes, membership fees and dues, loan payments and employee wages and benefits.

How Much Capital Do You Need?

There is no one-size-fits-all method for determining startup capital needs because each business has unique requirements. Basically, you need to make a list of the startup items specific to your business and research each one to determine its cost. It’s important to actually do the research and not just guess, especially if you are doing this for the first time. If you rely on hunches, you may grossly under- or overestimate your expenses. Also, if you’re seeking financing, the lender will not take you seriously if your numbers aren’t realistic and well-researched.  

When you’re starting a business, it’s easy to get carried away with spending money. First, you may be tempted by the tax deductibility of business expenses. While tax breaks will reduce your costs, they won’t make your purchases free. You’ll still be paying for the bulk of everything yourself, so you shouldn’t buy it if it isn’t necessary. Second, you may be so excited about starting a business that you have trouble differentiating necessary expenses from optional ones. Do you really need a brand-new, solid wood desk, or will that card table in the garage get the job done just as well? Don’t succumb to the tired adage that it takes money to make money. Bootstrap it instead and you’ll be taking a lot less risk financially. 

Initially, the most important thing is keeping your business afloat so you can earn a profit. Every purchase you make should be directly related to this goal. Minimizing what you need to buy and how much each item costs will help you meet this goal. Get by on as little startup capital as possible. (Sometimes it’s the small expenses that make or break a great idea).

4 Questions You Need To Consider

Taking on any kind of debt requires careful thought. As you think about how much capital you need to fuel expansion, consider these four questions:

1. What is the expected ROI for the loan?

In some cases, the answer is straightforward. Your supplier offers a 30 percent discount on $50,000 in inventory. That’s a savings of $15,000. Even figuring in the interest cost and any fees on the loan, that’s a healthy ROI. Similarly, ROI can be strong if you’re investing in equipment that will immediately boost productivity and sales. Determining ROI isn’t always simple, however. It’s tempting to think that doubling the number of restaurant tables will increase sales by 100 percent. Or hiring a new manicurist will allow you to book 12 new appointments a day.But as every small business owner knows, very few things go exactly as planned. Customers may not materialize, you’ll need extra employees and the cost of supplies will jump. When calculating the ROI for the loan amount, estimate low and add in a cushion for unexpected expenses. 

2. Do the numbers add up?

You’ve built your business by committing your heart and soul to its success. But when it comes to borrowing for expansion, you need to focus on hard data, looking closely at positives and negatives. Positives include revenue and cash on hand, while negatives might include an already-high level of debt and slow sales during certain periods. Any imbalance can indicate that you need to take a closer look at your business model or operations. Before you consider a loan, be sure your business fundamentals are sound. You want the capital infusion to strengthen your business, not just keep it afloat. 

3. Do you have a game plan for continued growth?

Even short-term capital should be part of a long-term plan. In the short term, you may be planning to use capital to add a new line of products or services or expand to a new location. You could be investing in technology to rev up online sales. You might be adding staff or expanding marketing. All of these actions should have a singular goal -- understanding and anticipating customer needs. Since there’s no business without customers, you need to have a strategy for one, three or five years to keep them coming in the door (or to your website). 

4. Have you identified the right type of lender?

There are a lot of ways to secure working capital. Some people borrow from family or friends. Others use their credit cards. Still others seek funding from a range of lenders and other finance companies. Each case is different. Often, banks are the first place people look, but many banks may be less inclined to fund working capital loans of under $150,000. 

As a result, many business owners are choosing to work with online alternative finance companies. Typically, these providers are faster and more efficient. Time-strapped entrepreneurs don’t have to compile reams of documents and wait months for a decision, spending time that could be better used running the business. Securing access to funding from alternative finance companies can be as quick as just a few days. 

Equally important, online lenders use different criteria when making loan decisions. They may look at sales and revenue data, time in business and other performance-based characteristics. They typically don’t require personal collateral or spotless credit from the owner. 

Applying with a company that specializes in working with small businesses can increase your chances of getting the capital you need. Just be sure to do your due diligence so you fully understand the terms of your loan, including the total cost of capital and the payment schedule. These factors should inform your decision about how much to borrow. 

You’ve accomplished a goal that many others never reach. You’ve built a business that is ripe for expansion. By combining an infusion of working capital with a thoughtful long-term plan, you can continue your track record of success. Just be sure you have crunched the numbers and are realistic about the loan’s ROI. Then, just keep doing what you do best - delivering a product or service your customers can’t live without. 

Sources of Startup Capital

How much money you can afford to risk on your business from your personal savings and how much money you need to open your business will determine whether you need to look elsewhere to raise startup capital. Let’s consider the pros and cons of each potential money source.

Personal Savings

Most business owners use personal savings to help pay for startup costs. You won’t incur any interest expense when you use your own money to finance your business. You also won’t have any creditors to repay, and no one will come after you for money if your business fails or isn’t successful right away. On the other hand, most people have already earmarked their personal savings for other uses, like retirement and a rainy day fund.

Unless you already have plenty of extra money lying around, you might want to start setting aside some of your savings each month to put toward your business. You might also be able to tap your home equity, but it’s a big risk to tie the success of your business up with having a place to live.  

Business Loans

Banks provide business loans to finance vehicles, equipment, real estate and other expenses. These loans are generally for a short term, such as five years, but the duration can vary based on the type of financing required. Many loans require collateral — usually the vehicle, equipment or real estate being purchased with the loan, or a blanket lien on other assets. The good news is that a loan secured by collateral usually has a lower interest rate than one that doesn’t. 

Expect to pay a loan origination fee and, of course, interest. Business loans can offer the security of a fixed monthly payment and a fixed interest rate, although variable rate loans may also be available.  Some banks only offer loans on large amounts; if you need to borrow less than the minimum requirement, seek other financial institutions to provide a more accommodating loan. You might also want to finance your needs with a line of credit.

Other options for small business loans include invoice financing, working capital financing, equipment financing and merchant cash advances. If you plan to seek a bank loan, be prepared to provide a detailed explanation of how much money you need and for what purposes, as well as a detailed explanation of how you will be able to repay the loan. The bank may want to see recent personal income tax returns, bank statements, credit history and other personal financial information. 

Small Business Administration Loans

Small Business Administration (SBA) loans are an option if you don’t qualify for a regular business loan.SBA loans come in several varieties to meet different borrowing needs:504 loan (Grow loan)7(a) loan (Advantage loan)Express loanCAPLines loanDisaster loanExport loanMicroloan. 

Because these loans are guaranteed by the government, they can be easier to qualify for than conventional business loans. The graphic above shows the basic requirements. SBA loans also allow you to make lower payments over a longer period. SBA loans are provided through regular banks; the government simply acts as the guarantor. Special SBA loans are available for veterans, active duty military, reservists, National Guard members and the spouses of people in these groups.  

Credit Cards

You can always use a business and/or personal credit card to pay your business startup costs, assuming you already have or can qualify for a credit card. But be aware that putting business expenses on a business credit card doesn’t mean you’re not personally liable for them. Business credit cards typically require the business owner’s personal guarantee. You’ll have to repay whatever you charge, even if your business doesn’t succeed.  

Credit card financing can quickly get you in trouble, too. You don’t want to borrow money for your business at a 20% interest rate because the balance will grow each month and it can become difficult to pay off the debt.  Sometimes it’s possible to get a card with an introductory interest rate as low as 0% if you have good credit. If you take advantage of an offer like this, make sure you have a plan for paying off the money you borrow before the card’s interest rate goes up, which usually happens within 9 to 21 months.  

Business Line of Credit

A business line of credit is similar to a business credit card in that it is an unsecured loan and you can use it as you need it rather than borrowing a lump sum all at once. It can be used to refinance debt as well as to finance working capital, payroll and all the same types of expenses as credit card financing. It is typically designed to be a short-term loan and may have a variable interest rate and an annual fee.

Family and Friends

Are you willing to risk your personal relationships by mingling them with money? Only you know the nature of your relationships with friends and family, and whether any of these people are a viable source of financing. But if your business goes under, would you rather have to explain to a stranger or to your best friend that you’re not sure when you’ll be able to pay them back? Mixing friends and family with finances adds yet another risk to your business endeavor — the risk that you’ll ruin a close relationship. 

Nothing can strain a relationship like money. Merely asking for it can be enough to introduce awkwardness into an otherwise sound relationship. If your dad won’t lend you startup capital, you might find yourself thinking, “How can my own father not believe that I have what it takes to succeed?” It’s much easier to be rejected for a loan by someone who doesn’t know you because you’ll know it’s purely a business decision and you won’t take it personally. 

That being said, if this idea makes sense given your situation and relationships, consider formalizing the loan using a third party company. Going this route can help make sure expectations are clear on both sides and can facilitate record-keeping and payment transactions. 

Peer-to-Peer Loans 

Peer-to-peer loans for small businesses aren’t widely available until you’re established with two years of history and substantial income. However, Lending Club and Prosper both offer personal loans that you can use for any purpose, including starting a business. Prosper will lend you $2,000 to $35,000, and Lending Club makes loans of $1,000 to $40,000. Both charge APRs of about 6% to 36%. 

Pursuing venture capital means bringing someone else, generally a stranger, into your business as a partial owner. If retaining total control of your business is important, you shouldn’t consider this financing option. Usually, you will not receive any profit yourself until your investors have profited from your business. Additionally, this type of financing limits the entrepreneur’s upside potential since venture capitalists will often require majority ownership of the business. On the other hand, the lending party also assumes most of the downside risk.

Bottom Line

Starting a business is an exciting venture. You get to channel your talents and ingenuity to create an organization you believe in. But the process isn't simple. It requires time, dedication and money. If you're thinking about launching a new business, you must know where to start with your finances and  make sure to do a ton of research to make sure you are getting the best funding for you and your business.