Before tearing your hair out worrying about money, it is essential that you develop a firm understanding of how much you will actually need.
The term “firm understanding” is used loosely here; if you are still in the planning stages, then the best you will be able to produce is a good estimate.
If you have already made some sales (but your venture hasn’t taken off yet) you will have a much better sense of what that estimate will look like.
The exact nature of your startup cost estimation will, of course, depend heavily on the nature of your venture, but here are some of the expenses that are common to nearly all startups:
This includes access to high-speed internet, computer, and phone along with your domain name, site hosting, and design elements.
Starting a business can often be done without the assistance of a lawyer, but that doesn’t mean it’s a great idea to go it alone, especially if you are unsure.
The services of an accountant are recommended as well, particularly for taxes and setting up your chart of accounts.
Make sure you are familiar with regulatory expenses such as
- licensing fees,
- operating licenses,
- and other regulatory considerations.
Not every venture will require initial inventory, and some will require more than others. Keep in mind that startups that sell services (as opposed to physical products) still often require on-hand inventory in the form of supplies or other consumables involved in the execution of services.
Initial marketing expenses cover small costs such as business cards as well as more significant expenses such as signage and initial awareness campaigns (and everything in between).
It is not prudent for new ventures to dump all of their initial marketing dollars into one marketing method. A lot of marketing consists of experimentation—until you have historical data that tells you what works, what doesn’t, and what you haven’t tried yet, it is best not to put all of your eggs in one basket.
The list above encompasses only the broad categories of startup expenses that you can’t forget about—it is by no means an exhaustive list.
Break-Even Point And Your Burn Rate
The money that you are putting together at this stage isn’t just to cover one-time or infrequent startup expenses such as professional services or licensing fees.
The money that your startup relies on in the beginning of its life cycle can also be thought of as padding to combat your venture’s burn rate.
A burn is best described as a negative cash flow.
A startup’s burn rate is the rate at which it is experiencing negative cash flow that eats into the money that has been raised for this very purpose—to combat burn.
Remember, in the initial stages of a startup, sales represent only a trickle of revenue if there are sales at all.
If all goes as planned, your startup will reach its break-even point, start turning a profit, and no longer rely on the money that was initially raised.
The problem is, that point may not be for a while yet.
The exact window between launching and reaching profitability depends heavily on the kind of business a startup is.
Internet-based businesses have the potential to reach profitability much faster than brick-and-mortar businesses, for example.
Break-Even Point Template
We don’t dive into it here in the text, but calculating the break-even point of your venture is covered in downloadable templates materials that can be found here.
This is another reason a comprehensive business plan is an important part of the venture-planning process:
for understanding how much money you will need.
A thorough planning process produces as robust an estimate as is possible of the amount of money that will be needed.
Your venture’s estimated break-even point, combined with your burn rate, produces your runway, or the amount of time you can be in business before your burn rate surpasses the amount of money you have raised.
The relationship between the amount of money you have raised, your burn rate, and your runway is complex.
Key questions concerning…
- how fast of a burn rate is appropriate (how fast is too fast?),
- what represents an appropriate runway,
- and how or when a drive for profitability should be surpassed by a drive for growth
…can be hotly contested within the entrepreneurial community.
To get to the bottom of some of these issues, it might be a good idea to step back and take a look at the big picture.
The break-even point—the point when your venture actually turns a profit—is the point when you as an entrepreneur can breathe a (small) sigh of relief.
By no means does it mean that you can put up your feet and let your business run on autopilot—once your business has reached its break-even point you are faced with an entirely new set of challenges.
Until then, the startup capital you put together will have to get you to that point.
Working backward from an estimated break-even point, remember that your burn rate doesn’t just need to cover basic startup costs such as equipment or inventory—it will also need to cover everyday operations until revenue is sufficient to make those operations self-sustaining.
Entrepreneurs are optimistic, passionate, and hardworking, but that doesn’t mean they can see into the future.
Planning the amount of money your startup will need without adding in as large a safety margin as possible is not only shortsighted but imprudent.
There are many reasons why businesses fail, which is all the more reason that a safety margin should be worked into your financial planning.
Shifting customer preferences, economic contractions and downturns, surprise expenses, and fluctuating supplier costs all coalesce into a minefield of potential costs that can derail carefully planned runway and burn rate calculations.
Like many answers to key questions regarding your venture, the answer to the ultimate question “How much money do I need?” ends up being “It depends.”
In this article, we’ll discuss where the money actually comes from, but if it fails to cover key costs until your venture reaches profitability, it isn’t enough.
Your funding must cover the following:
- Initial startup costs including equipment,
- and initial marketing expenses
- Operations until they become self-sufficient
- Losses up to the point where the venture reaches its break-even point (enough money to cover the burn rate)
- As large a safety margin as possible
When startups die, the official cause of death is always either running out of money or a critical founder bailing. Often the two occur simultaneously. But I think the underlying cause is usually that they’ve become demoralized. You rarely hear of a startup that’s working around the clock doing deals and pumping out new features, and dies because they can’t pay their bills and their ISP unplugs their server. Startups rarely die in mid keystroke. So keep typing!