START-UP COSTS and CAPITAL SOURCES

by Jim Chamberlain Management Counselor James.Chamberlain@SCORE114.org

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START UP COSTS

IF YOU DONT HAVE ENOUGH CASH TO START YOUR BUSINESS RIGHT, WAIT UNTIL YOU CAN. BUSINESS PLAN WILL HELP

Gateway Business Bank

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START-UP COSTS and CAPITAL SOURCES

START-UP CASH INVESTMENT

FIXED CAPITAL INVESTMENTS

START UP GROWTH MAINTENANCE

WORKING CAPITAL INVESTMENTS

START UP GROWTH MAINTENANCE

CASH OUTLAYS UNTIL BREAKEVEN

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START-UP COSTS and CAPITAL SOURCES

FIXED CAPITAL How do you calculate how much your business needs at start-up and to maintain growth? Do not confuse the justification with how it will be financed. Justify first, then determine how to finance the investments.
SALES FORECAST 24 to 36 months How much capacity investment is required? How fast will you grow? New products or services?
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START-UP COSTS and CAPITAL SOURCES

WORKING CAPITAL INVESTMENTS The excess of current assets over current liabilities or the amount of cash required to fund the business on a day-to-day basis. An indication of short-term financial strength. Dont be under-capitalized. No business has ever failed because they had too much working capital. Working Capital = CURRENT ASSETS minus CURRENT LIABILITIES
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START-UP COSTS (INVESTMENTS) FIXED CAPITAL Office Furniture Vehicles Tenant Improvements Printing Machines Total Fixed Capital start-up Vehicles Printing Machines Total Fixed Capital Year Two $ 2,000 20,000 10,000 20,000 $52,000 $ 20,000 10,000 $ 30,000
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START-UP COSTS (INVESTMENTS) WORKING CAPITAL

Start-up Operating Cash Inventories Prepaid Rent Prepaid Insurance Total Working Capital start-up Cash losses first six months Total Working Capital Year One Required Working Capital Year Two (Based on a $50,000 increase in sales)

$ 10,000 15,000 5,000 8,000 $ 38,000

$ 25,000 $ 63,000 $ 10,000
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CAPITAL SOURCES

HOW BUSINESS ARE REALLY FUNDED

Seed Cash Percentage of Inc 500 CEOs

surveyed (2002) who launched their company with seed capital (including personal assets) of: Less than $1,000 14% $1,000 - $10,000 27% $10,001 - $20,000 10% $20,001 - $50,000 15% $50,001 - $100,000 12% More than $100,000 22% 8

CAPITAL SOURCES

EQUITY FUNDING Financing your business by selling a minority equity interest. This cash is less risky but more expensive. Valuation issues must be addressed. Initial and target valuation calculations must be made.

43% of founders started the company alone. The rest had: 1 partner 12% 2-3 partners 36% 4+ partners 9%

CAPITAL SOURCES
Private Equity and Venture Capital funding Angel investors tend to like proprietary products and non-capital intensive businesses. They anticipate future rounds of financing. Angel investors look for: 1. Market niches potential to dominate or be #1 or #2 in the industry 2. Advanced technology and a disruptive model (going to change things) 3. Compelling and sustainable advantage not me too 4. Planned exit in 4-6 years 5. Reasonable valuation 6. Performance equal to 5 -10 times original investment 7. ROI equal to 20-40% per year 8. Sitting on your board but not having control 9. Higher risk business models 10. Angels spend, on average, 51 hours on due diligence per investment
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CAPITAL SOURCES
BANK LOANS or DEBT FINANCING
1. 2. 3. 4.

5.

Banks will loan 2.5 4.0 times Cash Flow usually based on EBITDA Banks would like to see a 3-5 year track record or a history of business experience Debt is less expensive but more risky than equity Banks will not lend on pure projections: You must have a history of cash flow or a current personal guarantee. Three sources of repayment:
Cash Flow Liquidation value of assets Personal Guarantees of each 25% equity owner

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CAPITAL SOURCES
NEGATIVES TO A BANKER
1. 2. 3. 4. 5.

6.
7. 8. 9.
1. 2. 3. 4. 5.

Getting involved with something outside your normal business model Absentee management / ownership Divorce Burnout Growing beyond owners capacity to operate the business Parent turns over business to son or daughter Computer conversions Relocation and / or expansion of facility Companies hit the wall at: Manufacturing companies at $2 million in sales Distribution companies at $4 million in sales Retailers at 3 stores and distance Service companies at 12 employees Contractors at 2 or more big jobs
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CAPITAL SOURCES
A bank would rather see a 640 FICO score with all payments as agreed (no late payments, foreclosures, repossessions, charge offs or collection accounts) than a 740 FICO score with a past foreclosure, and three previously delinquent accounts now paid.
Having a stable source of income to meet personal income requirements can be a significant factor in reducing business risk for a start-up.
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CAPITAL SOURCES
QUESTIONS A BANKER WILL ASK YOU
1.
2. 3. 4. 5. 6. 7.

8.
9. 10.

Do you have a Business Plan? How much experience do you have in this industry? How is your credit and how much personal debt do you have? How much is your down payment? Is it at least 25%? How much collateral do you have? Who is the competition? Do you have personal and business insurance? Do you have services of an accountant and attorney? Have you ever filed for bankruptcy? Do you have 2-4 years of tax returns available?
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CAPITAL SOURCES

SBA ELIGIBILITY Cannot be a business in lending, life insurance, real estate development or rental property. Gambling, promoting religion, pyramid sales plans, consumer marketing cooperatives and persons of poor character are ineligible. Individuals must be lawfully in the U.S. Business cannot be located outside the U.S. Import businesses may be ineligible

Go to www.SBA.gov for a complete list of ineligible businesses. Also, a good resource for minority and micro-loan plans.
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CAPITAL SOURCES
MISTAKES ENTREPRENEURS MAKE WHEN RAISING CAPITAL
1.
2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13.

Dont understand share prices or valuations Confuse broad market with served market Make unrealistic assumptions about an exit strategy Dont understand long term capital needs Have no clue about competition Dont understand that marketing beats technology 9 out of 10 times Write a poor executive summary Use off the wall numbers or pull numbers from thin air Lack focus; e.g. many products or niches Develop too simplistic of a market plan / analysis Underestimate expenses Rely on financial plans with major inconsistencies; e.g. numbers dont match or tie 16 Speak in techno-jargon. No one understands what they are saying

CAPITAL SOURCES
BEST WAYS TO IRRITATE AN INVESTOR
1.
2. 3. 4. 5. 6. 7. 8. 9. 10.

Lying to investors or not being forthright; omission of material information Inability to answer direct questions with direct answers Surprises; e.g. problem with credit checks, hidden liabilities or debts Over hype or exaggerate upside Your story always changes Arguing with investors Late for meetings Excessive secrecy or legalese; expect investor to sign NDA Investing capital in fancy facility and furniture Fail to attract top talent 17

QUESTIONS

SCORE
JIM CHAMBERLAIN James.Chamberlain@SCORE114.org
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