How to Start a Business
Article Index
How to Start a Business
How to Start a Small Business
Why Small Businesses Fail
Part 1: The Executive Summary
Part 2: Market Analysis
Part 3: Company Description
Part 4: Organization And Management
Part 5: Marketing and Sales Strategies
Part 6: Service or Product Line
Part 7: Funding Request
Part 8: Financial
Part 9: The Appendix
Key Points to Consider
All Pages

 

Before you decide to start a business

Opening your own business can be a life changing decision, so it makes sense to identify if your business idea is feasible before you quit your job, tell all your friends or invest your funds.

Don’t forget to talk to friends, family and any other business owners or professionals you may know who can give you good honest advice.

Is Entrepreneurship For You?

In business, there are no guarantees. There is simply no way to eliminate all the risks associated with starting a small business - but you can improve your chances of success with good planning, preparation, and insight. Start by evaluating your strengths and weaknesses as a potential owner and manager of a small business. Carefully consider each of the following questions:

Are you a self-starter? It will be entirely up to you to develop projects, organize your time, and follow through on details.

How well do you get along with different personalities? Business owners need to develop working relationships with a variety of people including customers, vendors, staff, bankers, and professionals such as lawyers, accountants, or consultants. Can you deal with a demanding client, an unreliable vendor, or a cranky receptionist if your business interests demand it?

How good are you at making decisions? Small business owners are required to make decisions constantly - often quickly, independently, and under pressure.

Do you have the physical and emotional stamina to run a business? Business ownership can be exciting, but it's also a lot of work. Can you face six or seven 12 hour workdays every week?

How well do you plan and organize? Research indicates that poor planning is responsible for most business failures. Good organization ­ of financial, inventory, schedules, and production ­can help you avoid many pitfalls.

Is your drive strong enough? Running a business can wear you down emotionally. Some business owners burn out quickly from having to carry all the responsibility for the success of their business on their own shoulders. Strong motivation will help you survive slowdowns and periods of burnout.

How will the business affect your family? The first few years of business start ­up can be hard on family life. It's important for family members to know what to expect and for you to be able to trust that they will support you during this time. There also may be financial difficulties until the business becomes profitable, which could take months or years. You may have to adjust to a lower standard of living or put family assets at risk in the short-term.


How to Start a Small Business

Starting and managing a business takes motivation, desire and talent. It also takes research and planning.

Like a chess game, success in small business starts with decisive and correct opening moves. And, although initial mistakes are not fatal, it takes skill, discipline and hard work to regain the advantage.

To increase your chance for success, take the time up front to explore and evaluate your business and personal goals. Then use this information to build a comprehensive and well­ thought­ out business plan that will help you reach these goals.

The process of developing a business plan will help you think through some important issues that you may not have considered yet. Your plan will become a valuable tool as you set out to raise money for your business. It should also provide milestones to gauge your success.

Getting Started

Before starting out, list your reasons for wanting to go into business. Some of the most common reasons for starting a business are:

  • You want to be your own boss.
  • You want financial independence.
  • You want creative freedom.
  • You want to fully use your skills and knowledge.


Next you need to determine what business is "right for you." Ask yourself these questions:

  • What do I like to do with my time?
  • What technical skills have I learned or developed?
  • What do others say I am good at?
  • How much time do I have to run a successful business?
  • Do I have any hobbies or interests that are marketable?


Then you should identify the niche your business will fill. Conduct the necessary research to answer these questions:

  • Is my idea practical and will it fill a need?
  • What is my competition?
  • What is my business advantage over existing firms?
  • Can I deliver a better quality service?
  • Can I create a demand for your business?


The final step before developing your plan is the pre-business checklist. You should answer these questions:

  • What business am I interested in starting?
  • What services or products will I sell? Where will I be located?
  • What skills and experience do I bring to the business?
  • What will be my legal structure? (see overview below)
  • What will I name my business?
  • What equipment or supplies will I need?
  • What insurance coverage will be needed?
  • What financing will I need?
  • What are my resources?
  • How will I compensate myself?


Your answers will help you create focused, well researched business plan that should serve as a blueprint. It should detail how the business will be operated, managed and capitalized.

Is Your Business Idea Viable?

It’s easy to come up with an idea for a business, but it makes sense to ensure that your business idea is viable before you invest too much time and money in it. There’s obviously no way to guarantee that your idea is going to succeed, but thorough market research will go a long way to ensuring that you’ll be investing your time and effort in a business venture that should offer a reasonable return on investment.

If you can answer yes to the following questions, there is a good chance that your business idea is a viable proposition, which means your next step would be to draw up a business plan

Do you have a unique selling point?

Unless you’ve been lucky to find a gap in the market, your product or service is going to have to compete against other similar products for customers and market share. To compete, your business has to stand out from the competition – it has to have a unique selling point that you can use to encourage customers to buy from you.
This doesn't mean you have to invent a totally new product or service, your offering might be:

  • Cheaper or more economical to use.
  • Smell better or work better.
  • Come in a more fashionable design or appealing color range.
  • Weigh less, or be made of better material.
  • Anything else that compares favorably with similar products on the market.

If you have a unique selling point, it’s worth doing further research into the viability of your business. If you’re not sure if your product or service adds value that customers can’t find elsewhere, it might be better to brainstorm a few more business ideas before you forge ahead.


Why Small Businesses Fail

Success in business is never automatic. It isn't strictly based on luck - although a little never hurts. It depends primarily on the owner's foresight and organization. Even then, of course, there are no guarantees.

Starting a small business is always risky, and the chance of success is slim. In fact majority of new businesses fail within the first few years.

The following are some reasons for small business failures:

  • Lack of experience
  • Lack of business skills
  • Insufficient capital (money)
  • Poor location
  • Poor inventory management
  • Over-investment in fixed assets
  • Poor credit arrangements
  • Personal use of business funds
  • Unexpected growth
  • Competition
  • Low sales


Success can be yours if you are patient, willing to work hard, and take all the necessary steps!

On the Upside

It's true that there are many reasons not to start your own business. But for the right person, the advantages of business ownership far outweigh the risks.

  • You will be your own boss.
  • Hard work and long hours directly benefit you, rather than increasing profits for someone else.
  • Earning and growth potential are far greater.
  • A new venture is as exciting as it is risky.
  • Running a business provides endless challenge and opportunities for learning


Write a Business Plan

Essential Elements of a Good Business Plan for Growing Companies

A business plan should be a work-in-progress. Even successful, growing businesses should maintain a current business plan.
As any good salesperson knows, you have to know everything you can about your products or services in order to persuade someone to buy them. In this discussion, you are the salesperson and your products represent your business. Your customers are potential investors and employees. Since you want your customers to believe in you, you must be able to convince them that you know what you are talking about when it comes to your business.

To become an expert (or to fine-tune your knowledge if you already believe you are one), you must be willing to roll up your sleeves and begin digging through information. Since not all information that you gather will be relevant to the development of your business plan, it will help you to know what you are looking for before you get started. In order to help you with this process, we have developed an outline of the essential elements a good business plan.

Every successful business plan should include something about each of the following areas, since these are what make up the essentials of a good business plan:

  • Executive Summary
  • Market Analysis
  • Company Description
  • Organization & Management
  • Marketing & Sales Management
  • Service or Product Line
  • Funding Request
  • Financial
  • Appendix

Part 1: The Executive Summary

The executive summary is the most important section of your business plan. It provides a concise overview of the entire plan along with a history of your company. This section tells your reader where your company is and where you want to take it. It's the first thing your readers see; therefore it is the thing that will either grab their interest and make them want to keep reading or make them want to put it down and forget about it. More than anything else, this section is important because it tells the reader why you think your business idea will be successful.
The executive summary should be the last section you write. After you've worked out all the details of your plan, you'll be in a better position to summarize it - and it should be a summary

Contents of the Executive Summary

  • The Mission Statement - The mission statement briefly explains the thrust of your business. It could be two words, two sentences, a paragraph, or even a single image. It should be as direct and focused as possible, and it should leave the reader with a clear picture of what your business is all about.
  • Date business began
  • Names of founders and the functions they perform
  • Number of employees
  • Location of business and any branches or subsidiaries
  • Description of plant or facilities
  • Products manufactured/services rendered
  • Banking relationships and information regarding current investors
  • Summary of company growth including financial or market highlights (e.g. your company doubled its worth in 12-month period; you became the first company in your industry to provide a certain service)
  • Summary of management's future plans - With the exception of the mission statement, all of the information in the Executive Summary should be highlighted in a brief, even bullet-ed fashion. Remember, these facts are laid out in-depth further along in the plan
  • If you're just starting a business, you won't have a lot of information to plug into the areas mentioned above. Instead, focus on your experience and background as well as the decisions that led you to start this particular enterprise. Include information about the problems your target market has and what solutions you provide. Show how the expertise you have will allow you to make significant inroads into the market. Tell your reader what you're going to do differently or better. Convince the reader that there is a need for your service or product, then go ahead and address your (the company's) future plans.

    To assist the reader in locating specific sections in your business plan, include a table of contents directly following the executive summary. Make sure that the content titles are very broad; in other words, avoid detailed descriptions in your table of contents.

Part 2: Market Analysis

The market analysis section should illustrate your knowledge about the particular industry your business is in. It should also present general highlights and conclusions of any marketing research data you have collected; however, the specific details of your marketing research studies should be moved to the appendix section of your business plan.

This section should include: an industry description and outlook, target market information, market test results, lead times, and an evaluation of your competition.

Industry Description and Outlook

This overview section should include: a description of your primary industry, the current size of the industry as well as its historic growth rate, trends and characteristics related to the industry as a whole (i.e., What life cycle stage is the industry in? What is its projected growth rate?), and the major customer groups within the industry (i.e., businesses, governments, consumers, etc).

Identifying Your Target Market

Your target market is simply the market (or group of customers) that you want to target (or focus on and sell to). When you are defining your target market, it is important to narrow it to a manageable size; many businesses make the mistake of trying to be everything to everybody. Often times, this philosophy leads to failure.

In this section, you should gather information which identifies the:

  • Distinguishing characteristics of the major/primary market you are targeting. This section might include information about the critical needs of your potential customers, the degree to which those needs are (or are not) currently being met, and the demographics of the group. It would also include the geographic location of your target market, the identification of the major decision-makers, and any seasonal or cyclical trends which may impact the industry or your business.
  • Size of the primary target market. Here, you would need to know the number of potential customers in your primary market, the number of annual purchases they make in products or services similar to your own, the geographic area they reside in, and the forecast-ed market growth for this group.
  • The extent to which you feel you will be able to gain market share and the reasons why. In this research, you would determine the market share percentage and number of customers you expect to obtain in a defined geographic area. You would also outline the logic you used to develop these estimates.
  • Your pricing and gross margin targets. Here, you would define the levels of your pricing, your gross margin levels, and any discount structures that you plan to set up for your business, such as volume/bulk discounts or prompt payment discounts.
  • Resources for finding information related to your target market. These resources might include directories, trade association publications, and government documents.
  • Media you will use to reach your target audience. These might include publications, radio or television broadcasts, or any other type of credible source that may have influence with your target market.
  • Purchasing cycle of your potential customers. Here, you will need to identify the needs of your target market, do research to find the solutions to their needs, evaluate the solutions you come up with, and finally, identify who actually has the authority to choose the final solution.
  • Trends and potential changes which may impact your primary target market. Key characteristics of your secondary markets. Just like with your primary target market, here you would again want to identify the needs, demographics, and the significant trends which will influence your secondary markets in the future.


Market Tests


When you are including information about any of the market tests you have completed for your business plan, be sure to focus only on the results of these tests. Any specific details should be included in the appendix. Market test results might include: the potential customers who were contacted, any information or demonstrations that were given to prospective customers, how important it is to satisfy the target market's needs, and the target market's desire to purchase your business' products or services at varying prices.

Lead Times

Lead time is the amount of time between when a customer places an order and when the product or service is actually delivered. When you are researching this information, determine what your lead time will be for the initial order, reorders, and volume purchases.

Competitive Analysis

When you are doing a competitive analysis, you need to identify your competition by product line or service as well as by market segment; assess their strengths and weaknesses, determine how important your target market is to your competitors, and identify any barriers which may hinder you as you are entering the market.
Be sure to identify all of your key competitors for each of your products or services. For each key competitor, determine what their market share is, then try to estimate how long it will take before new competitors will enter into the marketplace. In other words, what is your window of opportunity? Finally, identify any indirect or secondary competitors which may have an impact on your business' success.

The strengths of your competitors are also competitive advantages which you, too, can provide. The strengths of your competitors may take many forms, but the most common include:

  • An ability to satisfy customer needs
  • A large share of the market and the consumer awareness that comes with it
  • A good track record and reputation
  • Solid financial resources and the subsequent staying power which that provides
  • Key personnel


Weaknesses are simply the flip side of strengths. In other words, analyze the same areas as you did before to determine what your competitors' weaknesses are. Are they unable to satisfy their customers' needs? Do they have poor market penetration? Is their track record or reputation not up to par? Do they have limited financial resources? Can they not retain good people? All of these can be red flags for any business. If you find weak areas in your competition, be sure to find out why they are having problems. This way, you can avoid the same mistakes they have made.

If your target market is not important to your competition, then you will most likely have an open field to run in if your idea is a good one - at least for a while. However, if the competition is keen for your target market, be prepared to overcome some barriers. Barriers to any market might include:

  • A high investment cost
  • The time it takes to set up your business
  • Changing technology
  • The lack of quality personnel
  • Customer resistance (i.e., long-standing relationships, brand loyalty)
  • Existing patents and trademarks that you can not infringe upon


Regulatory Restrictions

The final area that you should look at as you're researching this section is regulatory restrictions. This includes information related to current customer or governmental regulatory requirements as well as any changes that may be upcoming. Specific details that you need to find out include: the methods for meeting any of the requirements which will affect your business, the timing involved (i.e., how long do you have to comply? When do the requirements go into effect?), and the costs involved


Part 3: Company Description

Without going into detail, this section should include a high level look at how all of the different elements of your business fit together. The company description section should include information about the nature of your business as well as list the primary factors that you believe will make your business a success.

When defining the nature of your business (or why you're in business), be sure to list the marketplace needs that you are trying to satisfy; include the ways in which you plan to satisfy these needs using your products or services. Finally, list the specific individuals and/or organizations that you have identified as having these needs.

Primary success factors might include a superior ability to satisfy your customers' needs, highly efficient methods of delivering your product or service, outstanding personnel, or a key location. Each of these would give your business a competitive advantage.


Part 4: Organization & Management

This section should include: your company's organizational structure, details about the ownership of your company, profiles of your management team, and the qualifications of your board of directors.

Who does what in your business? What is their background and why are you bringing them into the business as board members or employees? What are they responsible for? These may seem like unnecessary questions to answer in a one- or two-person organization, but the people reading your business plan want to know who's in charge, so tell them. Give a detailed description of each division or department and its function.

This section should include who's on the board (if you have an advisory board) and how you intend to keep them there. What kind of salary and benefits package do you have for your people? What incentives are you offering? How about promotions? Reassure your reader that the people you have on staff are more than just names on a letterhead.

Organizational Structure

A simple but effective way to lay out the structure of your company is to create an organizational chart with a narrative description. This will prove that you're leaving nothing to chance, you've thought out exactly who is doing what, and there is someone in charge of every function of your company. Nothing will fall through the cracks, and nothing will be done three or four times over. To a potential investor or employee, that is very important.

Ownership Information

This section should also include the legal structure of your business along with the subsequent ownership information it relates to. Have you incorporated your business? If so, is it a C or S corporation? Or perhaps you have formed a partnership with someone. If so, is it a general or limited partnership? Or maybe you are a sole proprietor.

Important ownership information that should be incorporated into your business plan includes:

  • Names of owners
  • Percentage ownership
  • Extent of involvement with the company
  • Forms of ownership (i.e., common stock, preferred stock, general partner, limited partner)


Management Profiles

Experts agree that one of the strongest factors for success in any growth company is the ability and track record of its owner/management, so let your reader know about the key people in your company and their backgrounds. Provide resumes that include the following information:

  • Name
  • Position (include brief position description along with primary duties)
  • Primary responsibilities and authority
  • Education
  • Unique experience and skills
  • Prior employment
  • Special skills
  • Past track record
  • Industry recognition
  • Community involvement
  • Number of years with company
  • Compensation basis and levels (make sure these are reasonable - not too high or too low)


Be sure you quantify achievements (e.g. "Managed a sales force of ten people," "Managed a department of fifteen people," "Increased revenue by 15% in the first six months," "Expanded the retail outlets at the rate of two each year," "Improved the customer service as rated by our customers from a 60% to a 90% rating").

Also highlight how the people surrounding you complement your own skills. If you're just starting out, show how each person's unique experience will contribute to the success of your venture.


Part 5: Marketing and Sales Strategies

Marketing is the process of creating customers, and customers are the lifeblood of your business. In this section, the first thing you want to do is define your marketing strategy. There is no single way to approach a marketing strategy; your strategy should be part of an ongoing self-evaluation process and unique to your company. However, there are steps you can follow which will help you think through the strategy you would like to use.

An Overall Marketing Strategy would include a:

  • Market penetration strategy
  • Strategy for growing your business. This growth strategy might include: an internal strategy such as how to increase your human resources, an acquisition strategy such as buying another business, a franchise strategy for branching out, a horizontal strategy where you would provide the same type of products to different users, or a vertical strategy where you would continue providing the same products but would offer them at different levels of the distribution chain.
  • Channels of distribution strategy. Choices for distribution channels could include: original equipment manufacturers (OEMs), an internal sales force, distributors, or retailers.
  • Communication strategy. How are you going to reach your customers? Usually some combination of the following works the best: promotions, advertising, public relations, personal selling, and printed materials such as brochures, catalogs, fliers, etc.
    Once you have defined your marketing strategy, you can then define your sales strategy. How do you plan to actually sell your product?


Your Overall Sales Strategy should include:

  • A sales force strategy. If you are going to have a sales force, do you plan to use internal or independent representatives? How many salespeople will you recruit for your sales force? What type of recruitment strategies will you use? How will you train your sales force? What about compensation for your sales force?

Your sales activities. When you are defining your sales strategy, it is important that you break it down into activities. For instance, you need to identify your prospects. Once you have made a list of your prospects, you need to prioritize it. Next, identify the number of sales calls you will make over a certain period of time. From there, you need to determine the average number of sales calls you will need to make per sale, the average dollar size per sale, and the average dollar size per vendor.


Part 6: Service or Product Line

What are you selling? In this section, describe your service or product, emphasizing the benefits to potential and current customers.

Focus on the areas where you have a distinct advantage. Identify the problem in your target market for which your service or product provides a solution.
Give the reader hard evidence that people are, or will be, willing to pay for your solution. List your company's services and products and attach any marketing/promotional materials. Provide details regarding suppliers, availability of products/services, and service or product costs. Also include information addressing new services or products which will soon be added to the company's line.

Overall, this section should include:

  • A detailed description of your product or service (from your customers' perspective). Here, you would need to include information about the specific benefits of your product or service. You would also want to talk about your product/service's ability to meet consumer needs, any advantages your product has over that of the competition, and the present development stage your product is in (i.e., idea, prototype, etc.).
  • Information related to your product's life cycle. Be sure to include information about where your product or service is in its life cycle, as well as any factors that may influence its cycle in the future.
  • Any copyright, patent, and trade secret information that may be relevant. Here, you need to include information related to existing, pending, or anticipated copyright and patent filings along with any key characteristics of your products/services that you cannot obtain a copyright or patent for. This is where you should also incorporate key aspects of your products/services that may be classified as trade secrets.
  • Research and development activities you are involved in or are planning to be involved in. R&D activities would include any in-process or future activities related to the development of new products/services. This section would also include information about what you expect the results of future R&D activities to be. Be sure to analyze the R&D efforts of not only your own business, but also that of others in your industry.

Part 7: Funding Request

In this section, you will request the amount of funding you will need to start or expand your business. If necessary, you can include different funding scenarios, such as a best and worst case scenarios, but remember that later, in the financial section, you must be able to back up these requests and scenarios with corresponding financial statements.

You will want to include the following in this section: your current funding requirement, your future funding requirements over the next five years, how you will use the funds you receive, and any long-range financial strategies that you are planning that would have any type of impact on your funding request.

When you are outlining your current and future funding requirements, be sure to include the amount you want now and the amount you want in the future, the time period that each request will cover, the type of funding you would like to have (i.e., equity, debt), and the terms that you would like to have applied.
How you will use your funds is very important to a creditor. Is the funding request for capital expenditures? Working capital? Debt retirement? Acquisitions? Whatever it is, be sure to list it in this section.

Last of all, make sure that you include any strategic information related to your business that may have an impact on your financial situation in the future, such as: going public with your company, having a leveraged buyout, being acquired by another company, the method with which you will service your debt, or whether or not you plan to sell your business in the future. Each of these are extremely important to a future creditor, since they will directly impact your ability to repay your loan(s).


Part 8: Financial

The financial should be developed after you've analyzed the market and set clear objectives. That's when you can allocate resources efficiently. The following is a list of the critical financial statements to include in your business plan packet.

Historical Financial Data

If you own an established business, you will be requested to supply historical data related to your company's performance. Most creditors request data for the last three to five years, depending on the length of time you have been in business.

The historical financial data you would want to include would be your company's income statements, balance sheets, and cash flow statements for each year you have been in business (usually for up to 3 to 5 years). Often creditors are also interested in any collateral that you may have that could be used to ensure your loan, regardless of the stage of your business.

Prospective Financial Data

All businesses, whether start up or growing, will be required to supply prospective financial data. Most of the time, creditors will want to see what you expect your company to be able to do within the next five years. Each year's documents should include forecast-ed income statements, balance sheets, cash flow statements, and capital expenditure budgets. For the first year, you should supply monthly or quarterly projections. After that, you can stretch it to quarterly and/or yearly projections for years 2 through 5.

Make sure that your projections match your funding requests; creditors will be on the lookout for inconsistencies. It's much better if you catch mistakes before they do. If you have made assumptions in your projections, be sure to summarize what you have assumed. This way, the reader will not be left guessing.

Finally, include a short analysis of your financial information. Include a ratio and trend analysis for all of your financial statements (both historical and prospective). Since pictures speak louder than words, you may want to add graphs of your trend analysis (especially if they are positive).


Part 9: The Appendix

The appendix section should be provided to readers on an as-needed basis. In other words, it should not be included with the main body of your business plan. Your plan is your communication tool; as such, it will be seen by a lot of people. Some of the information in the business section you will not want everyone to see, but, specific individuals (such as creditors) may want access to this information in order to make lending decisions. Therefore, it is important to have the appendix within easy reach.
The appendix would include:

  • Credit history (personal & business)
  • Resumes of key managers
  • Product pictures
  • Letters of reference
  • Details of market studies
  • Relevant magazine articles or book references
  • Licenses &permits
  • Legal documents
  • Copies of leases
  • Building permits
  • Contracts
  • List of business consultants, including attorney and accountant if required


Any copies of your business plan should be controlled; keep a distribution record. This will allow you to update and maintain your business plan on an as-needed basis.

Types of Business Organizations

When organizing a new business, one of the most important decisions to be made is choosing the structure of a business. Factors influencing your decision about your business organization include:

Sole Proprietorship

This is the easiest and least costly way of starting a business. A sole proprietorship can be formed by finding a location and opening the door for business. There are likely to be fees to obtain business name registration, a fictitious name certificate and other necessary licenses. Attorney's fees for starting the business will be less than the other business forms because less preparation of documents is required and the owner has absolute authority over all business decisions.


Partnership

There are several types of partnerships. The two most common types are general and limited partnerships. A general partnership can be formed simply by an oral agreement between two or more persons, but a legal partnership agreement drawn up by an attorney is highly recommended. Legal fees for drawing up a partnership agreement are higher than those for a sole proprietorship, but may be lower than incorporating. A partnership agreement could be helpful in solving any disputes. However, partners are responsible for the other partner's business actions, as well as their own.

A Partnership Agreement should include the following:

  • Type of business.
  • Amount of equity invested by each partner.
  • Division of profit or loss.
  • Partners’ compensation.
  • Distribution of assets on dissolution.
  • Duration of partnership.
  • Provisions for changes or dissolving the partnership.
  • Dispute settlement clause.
  • Restrictions of authority and expenditures.
  • Settlement in case of death or incapacitation.


Corporation


A business may incorporate without an attorney, but legal advice is highly recommended. The corporate structure is usually the most complex and more costly to organize than the other two business formations. Control depends on stock ownership. Persons with the largest stock ownership, not the total number of shareholders, control the corporation. With control of stock shares or 51 percent of stock, a person or group is able to make policy decisions. Control is exercised through regular board of directors' meetings and annual stockholders' meetings. Records must be kept to document decisions made by the board of directors. Small, closely held corporations can operate more informally, but record-keeping cannot be eliminated entirely. Officers of a corporation can be liable to stockholders for improper actions. Liability is generally limited to stock ownership, except where fraud is involved. You may want to incorporate as a "C" or "S" corporation.

Financing Your Business Start-Up

One key to a successful business start­ up and expansion is your ability to obtain and secure appropriate financing. Raising capital is the most basic of all business activities. But, as many new entrepreneurs quickly discover, raising capital may not be easy; in fact, it can be a complex and frustrating process. However, if you are informed and have planned effectively, raising money for your business will not be a painful experience.

This information summary focuses on ways a small business can raise money and explains how to prepare a loan proposal.

Finding the Money You Need

There are several sources to consider when looking for financing. It is important to explore all of your options before making a decision.

Personal savings:

The primary source of capital for most new businesses comes from savings and other forms of personal resources. While credit cards are often used to finance business needs, there may be better options available, even for very small loans.


Friends and relatives:

Many entrepreneurs look to private sources such as friends and family when starting out in a business venture. Often, money is loaned interest free or at a low interest rate, which can be beneficial when getting started.

Banks and credit unions:

The most common source of funding, banks and credit unions, will provide a loan if you can show that your business proposal is sound.

Venture capital firms:

These firms help expanding companies grow in exchange for equity or partial ownership

Borrowing Money

It is often said that small business people have difficult time borrowing money. This is not necessarily true.
Banks make money by lending money. However, the inexperience of many small business owners in financial matters often prompts banks to deny loan requests.

Requesting a loan when you are not properly prepared sends a signal to your lender. That message is: High Risk!
To be successful in obtaining a loan, you must be prepared and organized. You must know exactly how much money you need, why you need it, and how you will pay it back. You must be able to convince your lender that you are a good credit risk.
Borrowing money is one of the most common sources of funding for a small business, but obtaining a loan isn't always easy. Before you approach your banker for a loan, it is a good idea to understand as much as you can about the factors the bank will evaluate when they consider making you a loan. This discussion outlines some of the key factors a bank uses to analyze a potential borrower. Also included is a self-assessment checklist at the end of this section for you to complete.

 


Key Points to Consider

Let's begin by exploring some of the key points your banker will review:

1. Ability to Repay/Capacity

The ability to repay must be justified in your loan package. Banks want to see two sources of repayment cash flow from the business, plus a secondary source such as collateral. In order to analyze the cash flow of the business, the lender will review the business past financial statements. Generally, banks feel most comfortable dealing with a business that has been in existence for a number of years because they have a financial track record. If the business has consistently made a profit and that profit can cover the payment of additional debt, then it is likely that the loan will be approved. If however, the business has been operating marginally and now has a new opportunity to grow or if that business is a start-up, then it is necessary to prepare a thorough loan package with detailed explanation addressing how the business will be able to repay the loan.


2. Credit History

One of the first things a bank will determine when a person/business requests a loan is whether their personal and business credit is good. Therefore before you go to the bank, or even start the process of preparing a loan request, you want to make sure your credit is good.

First get your personal credit report. You can obtain a report by calling Fiji Credit Bureau. It is important that you initiate this step well in advance of seeking a loan. Personal credit reports may contain errors or be out of date. In many cases, people find that they paid off a bill but that it has not been recorded on their credit report. It can take 3 to 4 weeks for this error to be corrected -- and it is up to you to see that this happens. You want to make sure that when the bank pulls your credit report that all the errors have been corrected and your history is up to date.


3. Equity

Financial institutions want to see a certain amount of equity in a business. Equity can be built up in a business through retained earnings or the injection of cash from either the owner or investors. Most banks want to see that the total liabilities or debt of a business is not more than 4 times the amount of equity. (Or stated differently, when you divide total liabilities by equity, your answer should not be more than 4.) Therefore if you want a loan you must ensure that there is enough equity in the company to leverage that loan.

Don't be misled into thinking that start-up businesses can obtain 100% financing through conventional or special loan programs. A business owner usually must put some of her/his own money into the business. The amount an individual must put into the business in order to obtain a loan is dependent on the type of loan, purpose and terms. For example, most banks want the owner to put in at least 20 - 40% of the total request.

Example: A new business needs a $100,000 to start. The business owner must put $20,000 of her own money into the new business as equity. Her loan will be $80,000. The debt to equity ratio is 4:1. Note also that this is only one of many factors used to evaluate the business -- just having the right debt/equity ratio does not guarantee you'll get the loan.

The balance sheet indicates the amount of equity or net worth of a business. The net worth of the business is often a combination of retained earnings and owner's equity. In many cases, owner's equity will be shown as a loan from shareholders and therefore a liability. If a business owner wishes to obtain a loan, she will be obligated to pay the bank back first and not herself. Consequently, it may be necessary to restructure the liability so that it becomes owner's equity or subordinate the loan. If the current debt to net worth is 4 or over it is unlikely that the business will be able to obtain additional debt/loan.

4. Collateral

Financial institutions are looking for a second source of repayment, which often is collateral. Collateral are those personal and business assets that can be sold to pay back the loan. Every loan program, even many micro loan programs, requires at least some collateral to secure a loan. If a potential borrower has no collateral to secure a loan, she/he will need a co-signer that has collateral to pledge. Otherwise it may be difficult to obtain a loan.

The value of collateral is not based on the market value. It is discounted to take into account the value that would be lost if the assets had to be liquidated.

Experience

A client that wants to open a business and has no experience in that business should not seek financing let alone start the business unless they intend to hire people who know the business or take on a partner that has the appropriate experience. Regardless, the client should be advised to take some time to work in the business first and take some entrepreneurial training classes.


Questions Your Lender Will Ask

Before you apply for a loan, you need to think about questions like these:

 

  • Can the business repay the loan? (Is cash flow greater than debt service?)
  • Can you repay the loan if the business fails? (Is collateral sufficient to repay the loan?)
  • Does the business collect its bills?
  • Does the business pay its bills?
  • Does the business control its inventory?
  • Does the business control expenses?
  • Are the officers committed to the business?
  • Does the business have a profitable operating history?
  • Does the business match its sources and uses of funds?
  • Are sales growing?
  • Are profits increasing as a percentage of sales?
  • Is there any discretionary cash flow?
  • What is the future of the industry?
  • Who is your competition and what are their strengths and weaknesses?


Government Regulations and Your Business

It may be inconceivable to you that your home based consulting service or hand knit sweater business would have to comply with any of the numerous local, state and federal regulations, but in all likelihood it will. Avoid the temptation to ignore regulatory details. Doing so may avert some red tape in the short term, but could be an obstacle as your business grows. Taking the time to research the applicable regulations is as important as knowing your market.

Below is a checklist of the most common requirements that affect small businesses, but it is by no means exhaustive. Bear in mind that regulations vary by industry. If you're in the food service business, for example, you will have to deal with the health department. If you use chemical solvents, you will have environmental compliance to meet. Carefully investigate the regulations that affect your industry. Being out of compliance could leave you unprotected legally, lead to expensive penalties, and jeopardize your business.

Business Licenses

There are many types of licenses. You need one to operate legally almost everywhere. If the business is located within town or city limits, a license must be obtained from the city; if outside the city limits, then from the Rural Authority.