Making the decision as to whether or not you require outside funding to launch your startup requires careful analysis and thoughtful consideration. This is not a decision that should be taken lightly. While outside funding may seem desirable, loans and nearly any type of business investment come with a lot strings attached as well as a great deal of responsibility. Besides the stress and obligations that come along with being accountable to an investor, the fact that the business might not succeed is also a consideration. And should that happen, the question of how you will repay the loan or investment arises. With this in mind, there are two points that should be taken into consideration before you determine whether or not your startup will require outside funding or investment to launch:
- What is the likelihood that the startup will be successful?
- How much money do you need to launch and sustain the business until it reaches profitability?
First, let’s take a look at the chances that your startup will be successful and grow to be a profitable, sustainable business. Statistics about the percentage of new business ventures that fail each very wildly, ranging from 50% up to 90%. The U.S. SBA says that on average, about one-half of all new establishments survive five years or more and about one-third survive 10 years or more (https://www.sba.gov/sites/default/files/FAQ_March_2014_0.pdf).
However, it is important to note that these statistics encompass all types of business ventures, many of which may not have any employees other than the owner. When you look at specific industries or types of startups, the figures can be much more bleak. For instance, if you look within the technology sector, statistics show that 90% of all tech-focused startups (including Internet-based businesses) will fail (https://www.forbes.com/sites/neilpatel/2015/01/16/90-of-startups-will-fail-heres-what-you-need-to-know-about-the-10/#4ba927ae6679). Other industries and sectors vary, but overall, the percentage of overall failures, generally hovers around 50%.
While the reasons startups fail range from poor management, lack of planning or overly rapid expansion, burning through capital too fast is one of the more common causes of startup failure. In these cases, the founders fail to accurately estimate the amount of cash they will require to launch their businesses and get it to a point of sustainable profitability. More often than not, the timeline for launching a new startup is much longer in reality than it was in the planning phase. This is particularly true for startups that are in sectors such as tech (e.g., hardware, software, apps, etc.), biotechnology, medical devices, energy, or any other industry that requires products to go through various iterations and testing prior to launch. Inevitably, there are bugs, mistakes or failures that lead to unanticipated delays. When these delays are encountered, it is critical that the startup have access to enough capital to keep it afloat until the product launches and the company begins to turn a profit.
This brings us to the second step of the process—determining how much funding your startup needs to launch and become self-sustaining through its own revenues and profits. Suggested steps for determining your funding needs are below.
Step 1: Determine how much funding you need to launch your business:
The first step in figuring out whether or not your startup will require outside funding is to determine how much funding you need to launch the business and grow it to a point of positive cash flow and profitability. Startup costs vary greatly across industries and even within a particular industry, from company to company. One tech company might need $1 million or more to launch while another could require just several thousand dollars. There are a number of different startup cost calculators available online. However, because the needs of each and every startup will be highly unique, I do not recommend relying on any type of standardized calculator to determine how much money you need to launch your startup. They can be useful to get a general idea, but I strongly recommend using multiple methods to calculate your capital needs.
The U.S. SBA has a great overview (https://www.sba.gov/content/estimating-startup-costs) that can be used to start determining your startup’s capital requirements. The SBA says that to determine how much seed money you need to launch your new business, you must start by estimating the costs of doing business for the first several months or even a year or more. Some of these expenses will be one-time costs such as the fee for incorporating your business or the price of a sign for your building. Some will be ongoing costs, such as the cost of utilities, inventory, insurance, etc.
As you look at these costs, decide whether they are essential or optional. A realistic startup budget should only include those things that are necessary to start a business.
These essential expenses can be divided into two separate categories: fixed and variable. Fixed expenses include rent, utilities, administrative costs and insurance costs. Variable expenses may include inventory, shipping and packaging costs, sales commissions, and other costs associated with the direct sale of a product or service. The most effective way to calculate your startup costs is to use a worksheet that lists both one-time and ongoing costs and build from there.
A great way to create your own startup cost worksheet is to work backwards, starting by listing each of the milestones of where you want your company to be over a specified period of time (e.g., six months, a year, etc.). For seasoned investors, this is actually one of the best ways to outlined your anticipated startup expenses. In contrast to broad, unspecific goals, milestones provide specific, tangible points to which specific values can be assigned. Milestones are concrete markers in the startup’s growth trajectory from concept to launch. The specific milestones you choose for your startup will vary depending on your specific needs but they may include hiring key personnel, a beta launch, meeting a particular performance metric or achieving a certification or regulatory approval. Examples are shown further below.
From the investor’s perspective, using the milestone process to determine your startup’s funding needs demonstrates solid planning and foresight. Moreover, meeting your pre-determined milestones can help you establish a track record of credibility, even helping you to overcome other potential limitations (e.g., lack of startup experience, etc.). Achieving your milestones demonstrates credibility because each time you reach one, it turns speculation into facts, taking your startup from concept to reality by validating the assumptions underlying your startup expense projections.
Using the example of a startup that plans to develop and market a mobile app, we might see the following one-year goal and related milestones (these are simplified of course):
12-month goal 1: Have fully developed, operational, bug-free app in the ABC sector being sold across IOS and Android platforms.
- Milestone 1: Define business model
- Milestone 2: Validate market demand for products
- Milestone 3: Develop Minimum Viable Product (MVP)
- Milestone 4: Beta testing
- Milestone 5: Launch
Next, take each of the milestones and outline each of the tasks necessary to achieve each. Sample tasks for each milestone might include:
- Milestone 1 tasks: identify target market and market demand; develop revenue model and pricing strategy; create financial projections; create marketing strategy; identify key resources necessary to achieve objectives, etc.
- Milestone 2 tasks: conduct in-depth research (e.g., customer surveys, focus groups, etc.) to validate customer demand for product.
- Milestone 3 tasks: contract with qualified developers; outline final specifications; finalize work plan, etc.
Continue through each milestone until you have identified all of the tasks necessary to achieve each of your milestones. Once you are certain you have identified all of the tasks for each milestone, the next step is to determine all of the resources you will need to accomplish each task under each of your milestones. Resources might include: human resources; contractual or professional services (e.g., developers, marketing specialists, accountant, etc.); operational costs (e.g., office space, utilities, etc.); supplies; insurance; and others.
After you have identified all of the resources necessary to accomplish the tasks and milestones, it is time to assign a value to each of the resources. A good strategy is to use the SBA approach outlined above, using the suggested categories. The timeframe for the expenses should be long enough to cover the costs until the startup is generating sufficient revenue to cover recurring costs to sustain the business until it grows and takes hold. This could be three months, six months, nine months, a year, or even more, depending on your startup.
Now it is time to tally up all of the expenses so you have a clear idea of how much it is going to cost to launch your business. Once you have the total, you will need to account for unexpected delays, unanticipated costs and even cost overruns. A common error among entrepreneurs is to underestimate their startup costs, a mistake that can be fatal to a new business venture. To avoid this mistake, be sure to include a buffer to cover unexpected costs, launch delays or slower-than-anticipated revenue growth. There is no hard and fast rule for determining an appropriate buffer. Some entrepreneurs will increase each category by particular percentages (e.g., doubling anticipated marketing expenses, increasing legal fees by 20%, etc.) while others will simply add 25% – 35% to the baseline total. How you choose to account for your buffer is entirely up to you.
The final number you come up with is the approximate total amount of money you should need to launch your startup and grow it to the point where it is self-sustaining. Depending on your industry, your product and your business model, this could be anywhere from 6 to 18 months. You will need to be certain that you have adequate capital and reserves to get you to this point. Since delays are inevitable, you should also budget for unforeseen obstacles or delays. Once you have arrived at this figure, you can now begin to analyze whether or not launching your startup will require outside funding.
Step 2: Explore your funding options:
Now that you know how much money you need to launch your startup you can determine the best strategy for securing the capital to launch. You will also be able to decide whether or not you will be able to self-fund the startup or if you need to seek outside funding. Self-funding (bootstrapping) usually includes funds obtained from savings, investment or retirement accounts, home equity loans, lines of credit, business loans or even credit
You will then have to analyze all of your available self-funding options and then assess whether or not using these funds is practical without jeopardizing your ability to pay for food, housing and other obligations. I suggest creating a spreadsheet itemizing all of your monthly fixed (e.g., mortgage, car payment, insurance, etc.) and variable expenses. Do this both in the historical context (last 12 months) and future context (12 to 18 months). Also be sure to leave a cushion for emergencies. From this point you can assess the impact self-funding your startup will have on your ability to meet these financial obligations. Only after conducting this thorough analysis will you be in a position to determine whether or not it is feasible to self-fund your startup.