Join 100,000 entrepreneurs who read us every month
Going into business for oneself is always a daunting decision especially if you cannot personally fund the launch. If well-planned, one of the key elements in that decision is how best to fund the business start-up with third party money and from which types of sources. The other major financial consideration includes funding your salary or personal living expenses until business revenues begin flowing adequately enough to pay yourself. A minimum of six months and up to eighteen months is the amount of time to plan for funding just yourself. Consider this sum separate and apart from what the business requires. You may not be able to pay yourself as soon as you hope nor as regularly as you wish in the first year or two of operations.
Your paycheck, when you do decide to take one, must be paid last as the founder/leader. It must be cut only after all the business operating expenses, other employee salaries, and payroll taxes are taken care of each month. Founders often skip pay periods or work for no salary until the business is breaking even or can afford the founder's salary. The joy of ownership includes bearing the joy of servant leadership and placing the needs of your employees ahead of yourself.
Related read: Stock options explained
Fewer than 0.5% of new businesses launched each year in America receive professional venture capital. Most source their start-up capital from personal savings, friends and family loans or share purchases, personal credit card advances, home equity loans, or small bank loans you need to guarantee personally. Some of these must be repaid whether or not you succeed. Those are categorized as debt or loans to the business and are often personally guaranteed. Shares or investment in the equity ownership of the company do not need to be repaid if the business is unsuccessful. However, they obligate the founder(s) to share in the profits of the business quarterly or annually and if it is sold to other parties in the future.
The first step in assessing your funding needs requires a business plan and budget forecast of revenues versus expenses supporting that plan. Do this before approaching any source of funding. Make the budget for at least 24 months. This is the most important step in raising funds if you wish to be taken seriously by your funders and investors. Give yourself no less than a few weeks and possibly as much as 6 months to a year to hone and finalize the Business Plan and the Budget forecast before pitching it to your target funding audience. There are several sources for good business plan templates available free across the web to get you started. Select the one that best fits the kind of business you are launching. Are you dealing with products or services? Are you a business to business start-up (B2B) or a business to consumer one (B2C)?
Assuming you have developed a credible plan for a product or service to be offered, you should test its viability or potential for success among knowledgeable peers or friends. Invite others you respect, trust, and who you know you to review and comment on your plan. Let them help guide you in answering important questions: "Am I well suited to do this and to take this step?" "Who may I need to help me and with what complementing skills that I may lack?" Especially find someone knowledgeable of the space or business sector you are considering entering and by all means, speak to an attorney who advises small businesses already. Many advise start-ups on a reduced fee or even pro-Buono basis until the client has revenues.
With a peer-reviewed plan document and budget forecast in hand, you are almost ready to begin speaking with investors or funders.
One final step remains. What do you offer your investors who want shares in your startup? How much money do you ask for what amount of share ownership stake? Answers to this question are manifold. Among the most useful example is to answer the question of how much profit or sales revenues (before deducting expenses) do you expect the venture to produce in five years? That figure multiplied by a price to sales ratio or a price to EBITDA (known as earnings before interest, taxes, depreciation, and amortization) ratio occurring with active companies in that industry or space becomes the go-to number. Use it as a basis for the pricing of the start-up shares. Here is one example of how to do that.
Related read: How to create a pitch deck for investors
You launch a consumer goods, gourmet condiment company startup today. In five years, your expected sales are forecast at $4.5 million per year. Using Yahoo Finance you discover that specialty foods distributors in public markets are currently pricing their shares at four times annual sales. Your start-up in four years might be worth about $18 million using that ratio less a discount to present value of let's say 10% per annum or $1.8 million X 5 years = $9 million. If the discount per annum agreed to is 20%, the value of the shares today is only $4.5 million.
So let's say you settle on $9 million which is, therefore, your asking price for 100% valuation of the shares today. So based upon that figure, you ask investors to pay $90,000 to own shares today representing one percent of your venture or $9,000 for one-tenth of one percent of your venture. A good small business or venture practice attorney can guide you on business valuation math as well as the appropriate investor documents to use with your start-up investors.
We have a video about SeedFunding for startups by Caya Slidebean's CEO: