What was once a faint “what if” has turned into a vivid colorful dream, and you are ready to take the next step to make that dream a reality: to start that business! You researched the entrepreneurial aspects of your passion: making specialty cupcakes, designing creative software applications, selling free-trade hand crafted jewelry, opening a dance studio. But you are going to need some money to get this thing going. How much should you invest in a website? Should you buy some commercial equipment? What kind of office space do I need to rent? How do I pay myself?
If you are at this point in your new business, I want to encourage you to think about forgoing credit or loans and instead fully self-funding your startup.
Here I will outline five reasons why.
Business models commonly change in the early stages
The first reason to fund your startup with your own cash is because it is very likely that while you are growing your idea, the logistics and business model will fluctuate and you need to stay flexible. When Alexis first communicated her dream of starting a financial coaching business, the picture she had in mind looked a lot more formal than it is now. The flexibility of working from home and meeting with people over Skype or in person has turned out to be much more valuable during the foundational stages of the business than having office space would have been. In the beginning, expect your business plan to change.
If you are funding your startup from your own savings you’ll think twice before committing to spend that precious supply of cash.
Here Paying your way during the startup phase helps you balance the pros and cons of being an entrepreneur versus an employee
Dale Partridge has said many times, “don’t sink your ship”, meaning don’t quit your day job too quickly. There is significant risk associated with quitting your job and then being fully responsible for your own overhead, equipment, maintenance, computer IT, and support staff, not to mention things that we often take for granted that are provided by an employer like health insurance, 401K, and paid vacation. If you subsidize your early growth with a small business loan or credit, it can be easy to lose track of the real cash flow of the business.
Make sure the business is viable and capable of self-sustaining before you ditch that steady job.
Self-funding encourages taking small steps before you decide to scale up.
When your business is subsidized by external funds, you may be tempted to scale up too quickly, before sufficiently testing the market or your business model. Say your business is hosting date night art classes for couples. On your own dollar you might test out your business by renting space at a local coffee shop or gallery a few nights a week to see if you can build a faithful client base. In contrast, if you have fifty thousand dollars available by loan or a line of credit, you may be tempted to prematurely sign a six month lease for an expensive studio in a pricey arts district. Similarly, if you need machinery or software licenses, why not rent it first? Once you get into this for a few months you might decide you want to sub-contract or outsource parts of the business rather than do it yourself and it’d be nice to not have sunk a lot of money in the wrong things.
You are more likely to take small steps and test the market prudently when you are the source of the funding.
You are more likely to restrain incidental spending when it is your money.
You have an emotional attachment to your money. Every invoice, business expense, software purchase, etc. should cause you to say “do I need this?” We have seen struggling entrepreneurs burn through a business credit line for non-essential things like business lunches (uh, it’s networking, right?), ineffective advertising (anybody have a professionally designed website with no visitors?), and merchandise (gotta show off that snazzy logo). Things they never would have done if they were paying from their family savings account.
Start with a conservative budget for these things, and you can expand once the business starts generating positive cash flow.
Your money means you retain control of the business and the decision
When your business carries debt you incur risk, plus you must adjust to satisfy creditors, which means you lose control. There is a business term used for publicly traded companies, called debt-to-capital ratio, which quantifies the ratio of all the liabilities to all of the assets or equities (this information is included in their financial statements). When businesses get above certain debt ratios (e.g., greater than 5-10) it can be a sign of a dying company. It is likely that your startup will begin with very little capital (cash or assets), in which case any debt you incur will cause your debt-to-capital ratio to skyrocket very quickly: read, risky business!
Moreover, if you take on investors or partners, other people will be able to tell you what to do.
You may not want to be in a position where you are unable to sell your business for a nice payout because of outstanding liabilities, or forced out because you’ve lost majority control while trying to raise funds early on. It is your dream, so why not fully own it!
What this means for a new startup is don’t borrow any money, don’t take out any small business loans, don’t put anything on credit, and don’t take on investors. This might mean tapping into your existing savings, saving up aggressively for a year, or taking your business slowly at first as a side job so you can grow and pay for it incrementally with cash.
Once your business has found a small but reliable base market, and once it has demonstrated commercial viability, then you can pursue ways to scale up.
When you feel the weight of every dollar invested in your startup, you’ll make better decisions and experience greater rewards as you grow.