Thinking about starting a business? Well before you take the plunge, ensure you have a plan and understand your finance options. In this week’s Let’s Talk we ask financial experts about the finance traps and pitfalls of starting a business, such as putting your home up as security, over-estimating revenue, forgoing insurance and borrowing money you can’t repay. According to Byronvale AdvisorsPrincipal Stephen Barnes: “The reality in Australia is that only 60% to 70% of micro business survive four years. If your business is one of the businesses that fails, and you can’t return the capital you’ve borrowed … then you lose your reputation as well as your money.”
So, if you want to avoid the traps first-time operators fall into when seeking finance, read on to discover what our experts have to say on this topic.
Stephen Barnes, Principal, Byronvale Advisors: There are some reasons why business owners should not borrow money. Borrowing money makes you lazy. Borrowing money from rich (or richer than you) benefactors makes you not think about ways to create and make money. Raising finance takes time and energy and that is time and energy you should or could be spending on the business. Raising finance is a distraction. Borrowing money or raising capital reduces your freedom. Some lenders will demand not only a return on the money, but also input into the decision making. Borrow money could cost you your reputation. ‘Your reputation is like a shadow, following you wherever you go,’ said author and small business expert Frank Sonnenberg. The reality in Australia is that only 60% to 70% of micro businesses survive four years. If your business is one of the businesses that fails, and you can’t return the capital you’ve borrowed to get the business off the ground then you lose your reputation as well as your money.
Andrew Joyce, Co-founder, Found Careers: One of the biggest traps I’ve seen first-time business operators fall into is overly-optimistic assumptions in their business case. The area this typically plays out is over-estimating revenue and under-estimating the cost of achieving this (particularly in sales and marketing). Many people take the view of “build it and they will come” – this can be correct, but only if your target market is aware of the product. Generating this awareness is incredibly expensive in an over-crowded (and arguably over-funded) online marketing environment.
Dale Hurley, Innovation Director, CreditorWatch: Businesses experiencing growth funded by debt can be blindsided by a lack of understanding debt’s effect on cash flow. While revenue and profit may grow, cash-flow may deplete as the cost of the business’ growth exceeds the newly created revenue. Therefore, working capital is tied up in accounts receivable and inventory. Before seeking debt in order to grow, you want to make sure your business has done everything possible to increase cash-flow without new funding.
- Reduce your accounts receivables by offering shorter payment terms and asking for payment up-front.
- Be in regular contact with all of your overdue debtors to understand when and if they will pay you.
- At the same time ensure you are not paying your accounts payable earlier then the due date of your creditors.
- Depending on your industry, try reducing your inventory to free up cash and reduce the cost of storage.
- Understand the elasticity of your offerings so you can increase prices.
- Look for opportunities to reduce the cost-of-goods sold.
Once you have exhausted all of these opportunities, ensure your working capital percentage is less than your gross-margin to ensure the growth is going to keep cash in your business and grow the equity of the shareholders.
Adam Welsh, Debt Advisor, CreditSME: Two of the biggest traps that we see is businesses putting up the home as security and not understanding the true terms and conditions of a loan facility.
Putting up your home as security may be a robust strategy, particularly in single shareholder/director businesses, as it will inevitably result in more favourable terms and pricing though this decision should only be made after a full consideration of the alternatives. As more and more business lenders enter the market, there is an increasing number of loan options available to business, most of which don’t require property assets as security. Although these loans might attract a higher rate, many business owners will prefer this option given the peace of mind of having the separation between the family home and the business.
Not reading or understanding a loan agreement is another major trap for business owners and one that can have a major impact on the earnings of a business. There are certain terms that are often ignored or misunderstood such as all in costs, minimum terms and early repayment fees and these can have a major impact on the cost or suitability of a certain loan product. All terms need to be understood up-front to determine if the selected loan facility is the best fit for your business.
Leo Tyndall, CEO and Founder, Marketlend: The single biggest issue that hits small business owners when it comes to finance is that they don’t spend the time to investigate and understand the options. They think bank first and when that doesn’t work, they go for quick financial fixes which can seriously damage their businesses.
Mandeep Sodhi, CEO, HashChing: A common mistake is failing to consider the impact that the funding will have on your company’s direction.
With many early stage companies, it can often be a scramble to find some funding – any funding – that will enable you to scale the business and take it to the next level. But it’s crucial to consider who you’re getting into bed with, and whether they’re aligned to your mission statement and core values. Third parties with a significant stake in your business can have a material impact on its management and direction, and if their vision is at loggerheads with yours, then you can expect major conflict whenever a significant decision needs to be made.
This is an issue we’ve been grappling with at HashChing, and why we ultimately decided go with equity crowdfunding on the Equitise platform for our most recent capital raise. We wanted to remain completely independent of the big banks, and instead offer stock to the people who actually use and love HashChing. For startups who need capital and don’t want to go down the debt financing route, equity crowdfunding – which has only recently become an option for publicly unlisted companies in Australia – is a route that’s well worth exploring.
James Coyle,Chief Customer Officer, SuperEd: If we look at this from the perspective of business operators looking to raise capital, one mistake would be assuming that everyone buys into your vision. It’s a trap and it’s worth remembering that just because you see this fantastic opportunity and your solution absolutely realises that opportunity in the market, it doesn’t necessarily mean that others will see the same opportunity. Your prospective investors may not necessarily have the same passion or knowledge of the problem, but what they offer you is real insights and value. They can be really pragmatic and think about the key challenges that you face as a business, such is where the revenue is coming from and how are people paying for it, important questions and considerations that some first-time business operators may overlook. They want to look at the financials and something really tangible and want the confidence that your business potential can result in tangible outcomes. The key thing to remember is that it could be a good idea ahead of its time, the technology might not be available or the market may not be ready for you product yet and there are plenty of examples of that.
Brian Barreto, Principal, Austbrokers City State: It’s no secret that starting a business is an expensive venture, so there are always compromises when it comes to budgeting allocations.
Under-insuring a business or forgoing insurance altogether can sometimes seem like a risk that is worth taking, but it is a dangerous gamble that can certainly cause greater costs in the long term.
“The greatest pitfall of not insuring a business that you have finance on is that you still have the financial obligations whether the business remains up and running or not,” says Austbrokers City State Principal, Brian Barreto. Therefore, the financial burden continues to deepen without any prospect of regaining ground.
Starting a business is riddled with risk. Ultimately, all risks (whether directly related to finance or other areas of the business) will end up having financial implications. Many business owners are unaware of business risk management assessments, which can save money and heartbreak on a grand scale.
James Wakefield, co-founder, InStitchu: Many founders give away far too much equity early on. Spend some time getting a detailed understanding of the businesses cashflow and only seek finance for what you actually need. Raise the minimum amount required and at increasing valuation points, as the funds are needed. This will limit the amount of dilution the founder experiences for their business. I would look to loans from family and friends initially to get a head start and build from there.
Terry Gold, Managing Director, Techstars Adelaide: Many first-time founders, especially technical founders, think they must have a perfect product before they start to talk to investors. But investors have told me that they almost never invest after the first meeting and that they would rather develop a relationship over time with the founder before writing a big cheque. Most of us wouldn’t buy a house after one look, so it isn’t reasonable to bet everything on getting a cheque in the first meeting. Doing that will almost always get you a quick no.
There is a saying that has been going around the startup community that goes, if you want a lot of advice, go ask people for money, but if you want a lot of money go ask people for advice. Don’t wait until the product is completely done and you are almost out of money to start building relationships with your potential investors.
Ryan Parsons, Chief Financial Officer, GO1.com: Have conviction in your plan – it’s not meant to be perfect yet and you can’t address every variable so don’t overanalyse the tail. But you must understand the basic unit economics of your core proposition, even if they aren’t yet as efficient as they could be.
Be selective about who you are bringing on as investors. Just because someone has the funds doesn’t mean they are right for you. Working with investors who can assist in facilitating business growth in the right areas is critical. In the same way, only raise for what you need to avoid dilution and misuse of funds.
Finally people underestimate the time it takes to secure the right financing. Lots of people won’t align with your vision so there’ll be a lot of ‘No’s’ before you get the yes that you want.