One of the few certainties in starting a business is financial risk. According to business researchers, the typical new company requires about $25,000 to get off the ground. If you have a more ambitious business plan, you will need significantly more startup capital.
Though venture-funded startups tend to garner more publicity, the vast majority of entrepreneurs fund their businesses from their own savings. Unfortunately, this initial investment likely won't make returns anytime soon: one study found that only 11 percent of new businesses are able to make a single sale by the end of their first month of operation.
So, is it wise to get a second mortgage or dip into your retirement account to pay startup costs? How far should you go to fund your business?
Your personal finances should be in order first
I asked this question of a Silicon Valley financial adviser who advises both corporations and individuals. "If you don't have your own financial house in order, you should think long and hard about how to finance your business," he told me.
If you have no savings or are already in debt, now may not be the best time to start a new venture. And as tempting as it may be to take funds out of your retirement accounts, it's not recommended. The taxes and penalties you'll pay will far outweigh the benefits of having access to these funds.
Perhaps most importantly, according to the financial adviser, be as realistic as possible. How long do you expect your business to be cash-negative? What, as best as you can predict, are your chances of success in the long run?
It's not always easy to know what the future holds for your business; studies have found that only one-third of new business founders have something "up and running" within seven years.
Know how much you may need to sacrifice
One helpful approach: map out different financial scenarios and how that would impact your personal budget.
That's exactly what one group of students in the Startup Garage class at Stanford's Graduate School of Business did. The course simulates the startup experience and lays the groundwork for students to launch new ventures when they graduate.
According to GSB associate director Ryann Price, who previously oversaw the class, one team of aspiring entrepreneurs created a detailed spreadsheet of lifestyle choices they would make based on how much funding they could raise. If they raised all the investment they were looking for, they could rent their own apartments and regularly eat out. Lower amounts of investment resulted in different scenarios, all the way down to living with their parents and subsisting on instant noodles if they couldn't raise any funding at all.
While I wouldn't recommend anyone try to live off of ramen--true story: the only person I ever heard of actually doing this broke out into painful boils after a few weeks--making a detailed model of your quality of life options is an excellent idea. This is especially important for entrepreneurs with families.
Test your limits before you take the plunge
The financial adviser I spoke with recommends the following steps for establishing a personal budget:
- Based on the business plan, set a timeline for the season of financial uncertainty.
- Set a monthly line-item budget for the family, spending only as much as you can afford based on existing savings and anticipated income.
- Before committing to the business, do a dry run on this budget for three months.
- Evaluate how you did with the dry run, and adjust budget as needed.
On the last two steps, he explained, "It's one thing to say you can do it, it's another thing to actually do it."
In other words, we'd all like to think we could tough it out for a while to pursue our dreams. But it's hard to know how much you and your family are really willing to sacrifice, and for how long, until you try it.
"Prove that you can do it sustainably for an extended period of time," the financial adviser recommended.
We all have different tolerance levels for financial instability or meager living. If you're determined to launch your venture, it's important to find that happy medium between the capital required by the business and what you're willing to sacrifice for it.
Bottom line: most entrepreneurial dreams aren't worth breaking the bank for. But with a realistic outlook and some intentional planning, it's possible to pursue your entrepreneurial dreams without sacrificing your financial future.