Estimating Capital Needs for a New Start-Up

I get asked more than ten times a day how much capital a person needs for a new start-up venture.

This is a very hard question to answer as it depends on many, many things including:

Will you rent/lease or purchase space?
What industry the start-up will participate in?
What geographical location?
How much marketing will be required or how much consumers will need to be educated on the product/service and its benefits?
Where the economy is going?
How much it costs to build the product or provide the service?
Etc, etc, etc.

Even if the entrepreneur receives just a single number - there is no way to tell if this will be correct until after the fact - there are just too many variables.

While most budding entrepreneurs just want a single number, there are other ways to grow a new start-up no matter how much funding is available or that will eventually be needed.

What I tell future business owners is this:

Do all that you can to research the probable costs in running a business - especially for costs that can be foreseen. This can be done by researching lease space or purchase space rates and prices, contacting utility companies to get past averages on electric, gas, water, trash, phone, internet, etc for those locations, contacting local employment offices for wage averages and other employment costs, researching rates for several marketing channels that will be used, and contact a CPA to estimate possible tax obligations (local, state, and federal).

Additionally, new business owners can try to research public information regarding other companies in their industry. While these public companies may be much, much larger than the new start-up, the public companies' financial statements can be common sized (each item taken as a percentage of sales or assets). Then, these percentages can be used to estimate costs items by apply those percentages against your sales estimates. Moreover, these financials can also provide an insight into future growth rates or declines for both sales and expenses.

While all of this can provide an educated guess, it will not provide a specific amount that is needed as all things change and one of the major challenges of running a business is dealing with and accounting for circumstances that are just out of a business owner's control.

However, once many of these costs are estimated, the business owner can then approximate the amount of capital needed for the business over the long-term. This should also include a cushion (from 10% to 50%) for each item to account for unseen cost overruns - which always happens. At this point, the entrepreneur has two additional options that should be contemplated simultaneously.

First, the true power of successful entrepreneurship is the ability to manage costs. This requires creating annual budgets (based on the costs estimates outline above and the amount of funding that can be raised) and sticking to these numbers. Additionally, the budget must be prioritized; ranking expenses in an order of need - not want.

If you estimate and budget that your marketing will require $X amount for the coming 12 months but after 6 months are over that amount - then other cost items must be reduced by the amount of the overage on marketing. These must be reduced by the order of need. Marketing is necessary. Spending $500 per month on morning coffee and doughnuts is not or travel can be reduced and replaced with teleconferencing or just simple phone calls.

Second, ensure that you can always go back to the well for more capital. This means keeping very good relationship with vendors and supplier (who could offer trade credit freeing up cash flow) and your lenders. This also includes staying current on all payments - no lender will fund a company or person who is behind on current obligations. Thus, if the need arises - you have reduced all costs to their bare minimum - you can always go back to these sources for more capital. Lastly, constantly be looking for new, alternative ways in which to finance your company - including factoring, leasing, cash advances, or private investors.

Even if your business is really taking off - meaning that sales are growing at a phenomenal rate, your company could still (and usually do) face cash shortages as your bills (current expenses and the huge expense related to the growth) may be outpacing your cash inflow (actual cash into the business, not receivables - the actual amount in you checkbook).

Note: while managing costs is paramount to a successful business - so is managing revenue - ensuring that your receivables are closely matched to your payables.

So, the bottom line is simply this: You don't need an exact figure (precise amount of capital) before starting your business or specific costs amount (these will change daily). No matter what you estimate, if you are willing to make the hard choices and manage both revenues and expense, you can still grow and succeed. It is all up to you - not merely based on some start-up figure.

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