Not having sufficient capital is one major reason why many businesses fail. Underestimating capital needs can quickly drain your financial institution account and leave your business in a cash crunch. When starting any venture, two types of capital are required: start-up capital, money needed for equipment, supplies and initial services; and working capital, money needed for the everyday operation of the business.

To prevent under capitalization, you should carefully estimate your financial needs for the first three years of your venture. It is especially important to have adequate working capital in year one. Estimating capital needs should follow the proven five-step planning process:

• • Based on market research gathered, set a sales goal
  • Gather information to estimate how many dollars will be required to cover all expenses until your sales begin to generate enough revenue to operate your business
  • Decide how much sales will have to increase, or adjust your prices accordingly, to keep expenses and profit goals in line
  • Put your decision into action
  • Evaluate the consequences of your action and determine how close you were to your estimated capital needs

Sources of Funding

Once you know how much money you need, you will have to find sources of funding. At the outset, you should anticipate that many traditional lending and investment sources judge new ventures as high risk. Thus, you should try to get initial financing from personal savings, family, and friends.

There are two types of financial assistance available that a new business owner should be familiar with—debt and equity. Debt financing can be compared to renting money from someone: you repay the debt plus a fee for renting the money. The fee, or interest rate, depends upon several factors, such as source of the loan, the period of the loan, the general economic conditions at the time of borrowing, and how much risk your opportunity presents. Financial institutions, trust companies, government agencies and other credit institutions are the major sources for debt financing. As mentioned previously, family and friends may also be willing to lend you money. Prospective lenders will want to know relevant information, such as how much money you need, what you need the money for, when you will need it, how long you will need it for, how it will help you to generate revenue and how and when you expect to repay the loan.

In equity financing, you give up a percentage of business ownership. The percentage depends upon how much money you need, how much risk the investor thinks your business represents and how much management control the investor wants. Investors will be interested in what kind of return on investment your company will provide. Two public sources of equity financing are venture capital firms and private individuals. Chartered accountants and management consultants often have connections with these two groups.

Both investors and lenders are always looking for new businesses they think will succeed. The challenge is to possess the right mix of risk, potential, and a great plan. Investors and lenders must be confident you will succeed. The first place to demonstrate this is with a sound business plan and financial statements.