The journey from a business idea to live profitable operation can be long and sometimes lonely. There are numerous different aspects to consider when looking at the cost of setting up a company. While many articles tend to jump to the business creation stage, it is crucial to appreciate the potential costs incurred before setting up your business.
Market research
You must know your potential clients and your market inside out. You need to know what they are thinking, often before they do, and you need to react to changes in the marketplace. So, once you have experienced your “eureka moment”, it is time to look at market research.
Issues to consider include:-
- Potential demand for your product/service
- The size of your potential market
- Your target clientele
- The location of your target market
- Is there market saturation
- What is the current market rate for your products/services
Historically, market research companies were employed to carry out telephone or face-to-face interviews. The introduction of the Internet and email has led to a significant reduction in potential market research costs. An article by the Entrepreneur website gives us a ballpark figure for different types of market research:-
- Telephone interviews around $40 per person
- Traditional mail service, from $5000 up to $7000 for 200 responses
- Email marketing, around $3000 up to $5000 for 200 responses
It is perfectly feasible that you could carry out your market research without employing a third party. However, how accurate and what depth of information you would achieve is debatable.
Write your business plan
When looking at business start-up costs, there is a very fine balance between being loose with your funds and cutting your nose off to spite your face. If you cut corners on crucial issues such as writing your business plan, this could backfire and make you less attractive to potential investors. The best way to think of a business plan is a roadmap of your company, how it is structured, how you intend to run it and plans to grow your business in the future.
This is your opportunity to shine, the chance to get your idea over to third parties who may be looking for investments, although very often, you will only get one crack of the whip. Make it count!
There are two basic types of business plan, referred to as:-
- Traditional business plan
- Lean start-up plan
As the term suggests, traditional business plans tend to be more in-depth. The lean start-up plan covers all of the significant points, maybe not in as much detail. For example, a traditional business plan would likely include:-
- Executive summary
- Company description
- Market analysis
- Organisation/management structure
- Service/product line
- Marketing and sales
- Funding requirements
- Financial projections
- Supporting documentation
The format for a lean start-up business plan is a little different and would tend to include the following information:-
- Key partnerships
- Key activities
- Key resources
- Investment proposition
- Custom relationships
- Customer segments
- Sales channels
- Cost structure
- Revenue streams
The lean start-up business plan will be more headlines, more punchy and be something that you can build on in face-to-face meetings. It gives potential investors/lenders an idea of your business, allowing you to add the detail.
Many people create their own business plans, but if you were to approach a professional adviser, they would likely charge anywhere from $1000 upwards. It would depend upon the size of your business, the complexity and the work required. In some cases, this could run into the tens of thousands of dollars.
How much money do you need to start a business?
The introduction of the Internet has had a phenomenal impact on the cost of setting up a business and the level of funding required going forwards. That said, there are still many businesses that are described as “bricks and mortar”. The three typical business types include:-
- Bricks and mortar
- Online
- Service provider
There is a vast difference between having a basic online presence, for example, a company website allowing potential customers to contact you, and an actual online trading business. Business start-up costs will vary widely depending on the type and size of the business. There are many factors to take into consideration, such as:-
- Physical office space
- Equipment/supplies
- Communication equipment
- Utility bills
- Licenses/permits
- Business insurance
- Accountancy services
- Legal services
- Stock
- Salaries
- Advertising/marketing
- Market research
- Marketing material
- Website design
- Website running costs
- Staff training
If you have a business idea that requires a physical presence, this may be more expensive as you will likely need to be “noticed”. Where much of your work is predominantly online, you may be able to source relatively cheap office space as you do not need to be in the frontline. Many service businesses allow their employees to work from home with a relatively small head office. The Internet and the array of online services such as Zoom offer the potential to rein in high historical costs.
When you begin looking at office space, you will notice that many companies now offer relatively short-term rental arrangements. This allows start-up companies a degree of flexibility should they wish to upsize or downsize in the short term. It also ensures that they are not tied to a considerable lease which may be challenging to break. So make use of the new office services out there!
Funding levels for a new business
There is a general misconception that start-up costs need to be kept to a minimum when putting together a business plan and setting up a business. However, as you venture into the business world, you will very quickly realise it is more dangerous to underfund a company than it is to overfund it.
Potential investors want to work with people who know their market, know their business idea, and know the value of not starving a business in the early days. For example, investors in colossal technology start-up businesses such as Snapchat were very wary of underfunding the business in the early days. The initial business plan for this company forecast losses for several years before moving into profitability. Consequently, there was a need to raise sufficient capital to cover early losses.
How to secure funding for your business
Using the start-up costs mentioned above, your profit forecast for the short to medium-term and ongoing running costs, you will be able to calculate the degree of funding required, including working capital. The vast majority of new businesses will work on a stage by stage process where they raise funds for the early years, after which point the situation will be revisited. This is important because it:-
- Incentivises business owners
- Ensures the business is not sold short as it develops
- Can attract more investors if successful
As we touched on above, many investors are willing to invest heavily in the early days if they can see a long-term path to profitability. The three main types of investment tend to be as follows:-
- Self-funding
- Outside investors
- Loans
In a perfect world, the business owner would have “skin in the game”, having invested in the early days and at different stages as we advance. This encourages outside investors, although it is predominantly the business plan which opens the door to loan finance. A mixture of these three different types of investment should help the business owner retain a significant interest in the business in the future.
Outside investors
There are several outside investors you may wish to consider when setting up a new business. These include:-
- Venture capital
- Family and friends
- Business angels
- Business partners
There is a saying in business, never mix business and pleasure, and this is very true. If you bring family and friends into your business, offering them the opportunity to invest, your relationship may never be the same again. However, when looking at venture capital groups, business angels and business partners, you could negotiate as hard as you wish.
Securing venture capital finance
If you look at the history of some of the largest tech companies in the world today, the vast majority started with self-funding, loans and then progressed to venture capital investment. The cost of self-funding and loans is obvious. When it comes to venture capital investment, the price is the share of your business you hand over in exchange for an investment. While the process of seeking venture capital funding is relatively straightforward in principle, it can be very different in practice!
Find an investor
Many people assume that all venture capital groups will consider any investment put before them. Some will consider a wide range of investments, while others focus on specific areas and specific types of business. So, the first thing to do when looking at venture capital funding is to match your business/funding requirements with the criteria used by different venture capital groups. In effect, horses for courses.
Present your business plan
If you’ve got to the stage of presenting to a venture capital group, then it is safe to say you either have a successful growing business or a great idea. At this stage, for an existing business, you would look to present a summary of your start-up history and details of your plans/forecasts for the future.
If you have jumped straight to venture capital funding to cover your business start-up costs, you need to have a detailed business plan and be able to stand your ground during negotiations. While venture capital companies regularly spend billions of dollars a year, they can sometimes drive a hard bargain.
Due diligence
Whether theoretical or already operating, every business will need to go through a process known as due diligence. This is a check to see that all information in your business plan is credible and look at the management team, market, products, and services. Then we have the subject of profit forecasts,with many venture capital companies also looking at future investment and exit routes.
Negotiating terms
Once you are past due diligence, it is now time to negotiate the terms of an investment by the venture capital group. In some cases, this investment may be structured to include equity, loans and short-term liquidity requirements. Again, this is where you need to stand your ground, demonstrate your in-depth knowledge of the business and your markets and get the best deal possible.
Securing investment
As we touched on above, many venture capital groups will be looking at future investment opportunities and exit routes simultaneously with their initial investment. To encourage and incentivise management, milestone payments and funding rounds are regularly discussed. This ensures that all parties are looking towards the same goal, a successful long-term viable business.
In some cases, you may require outside assistance when presenting your business plan to venture capital groups – there will be a cost to this. There is no hard and fast rule regarding this cost which will depend upon the size of your business and the level of work required. However, you would be looking in the thousands of dollars and potentially tens of thousands.
Crowdfunding
Many people cover the costs of setting up a company by instigating crowdfunding offerings. In simple terms, crowdfunding platforms offer a means of connecting those looking for investment and those looking to invest. As they effectively miss out on the “middleman”, the relative cost to business owners is significantly reduced. There is still a need to create a detailed business plan with cash flow and profit forecasts. This is the only way in which you can present and promote your business idea.
Such has been the success of crowdfunding platforms, compared to traditional business loans, that many large worldwide banks are now taking stakes in successful crowdfunding operations. However, when looking at venture capital groups and crowdfunding platforms, there is one other aspect to consider. Venture capital groups will likely look to take an active role in managing and expanding your business, while crowdfunding investors tend to be passive.
Traditional business loans
Traditional business loans are still popular even if their market share has come under significant pressure of late. While much will depend on the size of the loan and the structure, there are some costs to consider:-
- Set-up fee which can run into thousands of dollars
- Headline interest rate
- Additional management charges
Earlier, we suggested that many business owners tend to look towards self-funding, outside funding and business loans. In theory, a successful business should allow you to repay your business loan without giving up any equity. However, in practice, you will likely be asked to put up collateral that may be at risk in the event of default. This again reflects the need to find a balance between debt and equity, active and passive investors. There’s a lot to think about!
Looking to the future
One of the main challenges many business entrepreneurs face is a reluctance to give up on their “business baby”. Unfortunately, we have seen instances where this issue has led to the ultimate failure of what should have been a successful venture. So, there are numerous issues to consider, such as underfunding/overfunding, debt/equity and active/passive investors.
Looking at the cost of setting up a company in isolation will likely blow your mind. Consequently, it is advisable to cut this process down into more manageable chunks, which you can focus on in isolation. Ultimately, everything will depend on the business idea and its long-term viability. Whatever the economic outlook or concerns for the future, there is always funding available for good business ideas.
