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The Cost of Starting a Business
As of 2020, there were 31.7 million small businesses in the United States, according to the U.S. Small Business Administration. And roughly half of the small business launched each month won’t make it past the five-year mark.
The Kauffman Foundation noted that, although it varies among industries, “the average cost to start a new business from scratch is about $31,150.” That’s a hefty sum when you’re already paying your own living expenses.
- Clean water services
- Gender-neutral personal care
- Gun violence protection
- Healthier junk foods
- Next-wave logistics
When is the right time to put your money into a business, either yours or someone else’s? What do you need to know before you do it? Predicting startup and operating costs as well as ongoing investing costs can help you avoid a mistake — or create your dream company.
- A small business refers to an independent company with less than 500 employees.
- 36 percent of business owners are women, compared to 64 percent for men.
- More than 50 percent of U.S. employees work at a small business.
Becoming an Entrepreneur
The inspiration to stake it out on your own comes from myriad sources. It’s an overnight idea for some and the pursuit of a dream for others.
The desire to be independent, set their own hours, dictate the rules and develop a unique culture motivates many owners. Manta, an online small business directory, and tech giant Dell surveyed 3,000 small-business owners in 2014, and found that 37 percent of respondents were motivated by a sense of accomplishment from “fulfilling a lifelong dream.”
In a 2014 report, Keap, a company that creates tools for small businesses, found that entrepreneurs are driven by the need for wealth accumulation, a passion for a specific project or community, the production of a unique idea and the desire to provide for the long-term financial stability of their families.
The desire to be your own boss and embrace independence will result in long hours, intense work and barely getting by. If financial need is not an initial motivation, it is likely to become one at some point in your venture.
Your Business Plan
Embarking on a journey without a roadmap can be dangerous — especially when that journey involves tens of thousands of dollars and your valuable time and energy. Creating a business plan is vital for achieving stability and success. While it requires intense research, it gives you the momentum to maintain growth and future financial goals.
The plan functions like a broad to-do list with the first priorities at the top, a detailed explanation for executing each step and a vision for where you want to be in the first, fifth and even tenth year of business.
Your business plan will help you determine the size and scope of the business, from overseeing employees to choosing vendors. It also demonstrates that you are aware of the environment you will be competing in. Present your completed plan to potential investors to show an exact schedule for how and when you expect to bring in revenue.
- Executive summary
- Market analysis
- Company description
- Description of product or service
- Sales strategy
- Pro forma/projected financial statements
Getting Cash for Startup Costs
Wannabe business owners scrape together startup capital from a variety of resources. They turn to personal savings, loans from friends and family, business loans from banks, grants, venture capitalists, commercial lenders and financial assistance from the Small Business Administration.
Savvy entrepreneurs find ways to save when they can and spend when it’s unavoidable. Using your own money can prevent a long and painful loan repayment period. The more money borrowed, the more time it takes to reap profits. Instead of putting off a business launch, some business owners max out their credit cards and mortgage their homes to get enough capital. Other options, like using a portion of retirement savings, can be less risky.
Money stored in a 401(k), IRA or annuity is often an untapped resource. If you have a structured settlement or single premium annuity, selling payments may cover costs like renting an office, buying equipment and paying employees.
- Pay yourself during the transition from working part-time at another job to full-time at your business.
- Bail yourself out when business savings run out.
- Start repaying a business loan.
- Increase cash flow to cover operating costs and pay vendors in a timely fashion.
- Increase production of inventory as seasonal demand grows.
- Cover payroll.
- Cover periods of waiting for clients to pay the business for products or services.
- Pay quarterly estimated taxes to the IRS and state taxing authorities.
- Handle operational costs during slow periods.
- Protect investments by avoiding selling shares.
- Expand the business.
- Avoid bankruptcy.
Requirements for Owning a Business
The first big decision you have to make is how to structure your company. Let your CPA, accountant or financial advisor help you formulate the structure that’s right for your particular size and shape of business.
- Sole proprietorship
- A cooperative
- An incorporated company
- A limited liability company (LLC)
- A partnership
- An S Corporation
Once you pick your company’s organizational structure, you’ll need to register your business with the state and federal governments and secure an Employer Identification Number from the Internal Revenue Service. An EIN is business identification number — think Social Security number for businesses — that gives you tax advantages and instills credibility.
Next you need to figure out what permits and licenses you need to open. Your location and industry will determine much of what you need.
As a business owner, you’re responsible for proving a safe, secure work environment for your employees. You’re also responsible for meeting payroll and paying all the bills.
You should also learn any legal regulations your business — and you as its owner — must follow. You’ll have federal and state laws to guide you, but you will likely also encounter other municipal laws.
Chances are you will need business insurance. Note that the more employees you have, the more liability you will take on.
Seek the advice of an attorney and insurance agent to learn about potential liabilities that accompany owning a small business. You may be responsible for providing unemployment insurance and workers’ compensation.
How Soon Will Your Business Show a Profit?
If you’re like most business owners, you want to reach profitability sooner rather than later. It’s not easy.
- Year 1
- Owners make less than their previous salary. They re-invest most of their profits directly into their new business.
- Year 2
- Owners make less than their previous salary. They re-invest most of their profits directly into their new business.
- Year 3-4
- Owners sometimes increase their salary. They can make more profit from selling shares of the business or selling off part of their ownership.
With such a range of costs and fluctuating circumstances, predicting how much you will earn is difficult. Your business plan should allow for flexibility and ways to pivot to meet long-term goals.
- Total startup costs (including how much you borrow)
- Number of people you employ
- Expenses of maintaining the business, including vendor costs
- Sales of product/service
- Speed of business growth
- Economic climate
The longer you’re in business, the more creditworthiness you’ll be able to show potential investors, lenders and vendors. Having a history of paying bills on time not only establishes you as a low credit risk when times are tough, but also encourages business associates to offer you discounts. While you can’t speed up time, you can take steps to build your business credit from the start.
Apply for business credit as soon as possible. This may mean settling for a smaller loan, minimal line of credit or getting a store credit card. Even if you have a larger amount you want to borrow, you may be able to increase your credit after months of using credit responsibly.
Banks will be more likely to extend business credit to applicants with a high personal credit rating. Your history shows banks that you know how to use credit wisely and pay your bills in a timely fashion. If you already have some blemishes on your history, do your best to correct any errors and pay back debts you’ve been ignoring.
Register with Dun & Bradstreet and secure a DUNS number to track your credit use. You can use your number to show off your favorable credit record to vendors. And you’ll need this number to apply for grants and government contracts.
Investing in a business isn’t a task for the faint-hearted. It will be easy to feel discouraged when you face initial hiccups.
Business plans may be thwarted by a vendor mix-up, customer complaint or your first major financial hurdle. You jump through hoops to get the right paperwork approved and licenses in hand. You wait on loans or responses from potential investors. And it could be years before your finances improve enough to pay for a comfortable workspace.
To sustain your business, keep manageable goals and the long-term vision in mind.
Making the commitment to start and develop your own company can be incredibly rewarding. The time and energy you dedicate toward your passion can help your business evolve into a competitive industry force.
13 Cited Research Articles
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