You’ve come up with an idea for a product or service, identified a target market, and decided to start your small business. Congratulations on pursuing your dream!
Now comes the hard part — long months spent building a business, one customer at a time.
The first year of a small business’s existence is crucial, as entrepreneurs run headlong into critical questions. What should I be focusing on? Where should I turn for financing? And what are the pitfalls to watch out for? We asked members of NerdWallet’s Ask an Advisor network about ways business owners can get off to a good start with their entrepreneurial dreams.
What are the key factors small businesses should be thinking about in the first year of their existence?
Rita Cheng, financial advisor in Rockville, Maryland: Prior to and in the beginning stages of launching your venture, there are a few key things you should do:
- Consult with a certified financial planner professional to ensure that you have the proper insurance in place.
- Consult with a tax advisor to make sure that you have the correct structure for your business (for example, sole proprietorship, S corporation and limited liability company).
- Maintain good records.
- Do not commingle personal expenses with business expenses.
- Focus on cash flow and building client relationships.
- Manage excessive or insufficient inventory.
- Monitor your accounts receivable, because uncollected receivables hamper your business’s growth and could result in cash flow management problems.
- Manage your working capital, which is defined as current assets less current liabilities. Without sufficient working capital, you will not be able to stay in business.
Jeremy Office, Delray Beach, Florida-based wealth advisor to entrepreneurs: The most important factor should always be the quality of the product or service. In focusing on delivering the highest-quality product or service, it is imperative to manage the staging of revenue and investment early in the life cycle. If a company loses sight of delivering its product to market in ample time to generate sufficient revenue to meet obligations, there can be significant consequences, and the future of the business could be at jeopardy.
Also, businesses should be cognizant of their timeline so they know the ripple effects of failing to meet hurdles. This allows them to make strategic shifts, such as financing or ancillary product launches, to ensure they have the necessary resources to meet their objectives. Ultimately, the goal is delivering the best product or service, and the process should be focused around sustainability.
Anna Sergunina, financial advisor in Washington, D.C.: In the first year, it’s hard to see far, therefore focus on bringing in as much revenue as possible. And keep expenses lean — this will circle back when you start thinking about raising capital.
What are some of the options for raising financing at this early stage? What are some of the advantages and disadvantages of these options?
Jeremy Office: One option is self-funding — using your personal savings, as well as leveraging assets or grants. The advantages are that you’re not beholden to outside investors, you retain 100% ownership, and the timing can be fast. The disadvantage is that all the risk is on you and you can potentially lose your life savings and assets.
Businesses can also tap outside money — angel funding, venture capital and private equity funding, and banks and other institutional investors and lenders. The advantages are that you can align with “smart” money, outside investor accountability can be a positive, and there are massive amounts of available funds. The disadvantages are that it can be a difficult process, terms can be less than favorable, it’s time-consuming and expensive, and accountability can also be a negative.
Rita Cheng: Outside investment is an option, but you can reduce or diminish your own control and influence if you accept money from investors too early. Angel investors or venture capitalists may want to have a large share in their invested company as well as have a say in every business decision, including routine ones.
New business owners can also access financial capital through debt financing. Business loans can offer business owners exactly what they value: the essential financial capital to launch their new businesses.
Anna Sergunina: As for getting financing from friends and family, this might create unnecessary tension in the family if something goes wrong. Think about future Thanksgiving dinners! But you could also create a positive outcome and allow for the business to stay in the family.
Another option is strategic partnerships. Consider finding another business that supports your business idea and offers a complementary product or service. Offer it a small share in your business. This will provide exposure to its network of clients and will help build credibility for your brand and business faster.
How can business owners determine how much they should raise?
Anna Sergunina: It will depend on how much expansion is anticipated and how fast you want to grow. Project fixed and variable costs for six to 12 months out. Factor in your sales cycle (how long it takes to sell your product or service) to determine how much capital you will need to support it.
Jeremy Office: Start with the total budget needed to get the business to sustainable cash flow. From there, you should look at the various milestones the business will need to accomplish (for example, conception, prototype, beta testing and market acceptance) and determine how much money is needed for each stage.
For startups backed by outside investors, the earlier the stage, the more equity the business will be giving away; thus the owner should determine the amount of capital needed to get to the next stage that justifies a significant increase in valuation. Business owners should raise that amount with a comfortable cushion. This way you preserve equity for stakeholders while also mitigating risk as you accomplish needed objectives.
Rita Cheng: Seek the guidance of professionals in this area. There can be multiple rounds of financing if a business is going to be successful. The challenge is sometimes getting caught in raising the money, then forgetting about the business. Every company’s situation is unique and must be evaluated independently.
What kind of cash flow analysis might be helpful in this situation?
Rita Cheng: Cash flow has two components: inflow from the sale of goods and services or proceeds from loans or lines of credit, and outflow attributed to business expenditures, loan payments and business purchases. The maxim “Cash is king” holds true. Business owners need cash to create, manage and expand their business. However, despite its importance, many small-business owners experience challenges in understanding and managing their cash flow. Inaccurate cash flow analysis can affect the day-to-day operations of a business, as well as the ability for a business to be approved for a loan.
Anna Sergunina: Figure out your cash burn — how much cash you’re going through within a specific period of time. This will help you determine what your needs are for how much needs to be raised. Also, this should help point out unnecessary expenses and what could be cut or reduced.
Jeremy Office: It is important to project cash flows and consistently monitor against such projection. The business owner must focus on actively modifying the projections as production or delivery timelines change. Too often, businesses delay product launches without considering the impact to their cash flow. Taking a proactive approach to constrained cash flow is the best method to ensure you make it through.