On the money: figuring out how much cash you really need to start your business

Entrepreneur, Sept, 1998 by Bob Weinstein

Lovero recommends new companies start out with enough capital to cover projected expenses for at least six months. "It's foolish to expect to generate revenue immediately," she says. "It's best to play it safe and plan for all contingencies."

The type of business you start plays a critical role in determining the amount of start-up funds you require, says Lovero. "A retail business, for example, can generate revenue immediately, whereas service businesses typically have to wait between 30 and 90 days before they're paid," she explains. "These facts give you some idea [as to] how much working capital you'll need during the early months."

The following four scenarios provide a window into situations you may someday face - and might help you avoid mistakes when predicting your start-up expenses.

PROCEED WITH CAUTION

Nick Yonano, 31, spent his money carefully when he launched Tea Body's Inc., a Turlock, California-based gourmet iced tea company, in 1995.

The former attorney financed his company through his savings and modest borrowing from friends and family. His vision? To develop iced teas and market them to specialty food stores throughout the United States. To achieve that end, he watched his pennies, meticulously planning each step.

The tough part, he says, was determining how much money he'd need. "The idea was to eliminate nonessential expenditures," Yonano says.

When he reviewed his estimated costs, he figured $60,000 should allow him a modest start. So he sold his Porsche 911 for $18,000 and tapped into his savings. Soon, he was in business.

Yonano's most significant costs were in product development. "About half the start-up money was apportioned to buying quality teas," he says. The rest of his costs were allocated to marketing, promoting and packaging.

It didn't take Yonano long to realize that his business would cost more than he imagined. Originally, he thought he could finance his company's art, graphics and logos for around $5,000. But once he began getting estimates starting a $25,000, he increased his own estimate to between $10,000 and $15,000. Fortunately, Yonano was able to find an artist who worked from home to create the graphics for his fledgling company. The job's final cost: $12,000.

And when it came time for market research, rather than paying rates of up to $10,000 for the help of an expert, Yonano did it himself for only $1,200.

Rent? That was easy: Yonano converted his garage into a blending facility. Later, he moved to a small, rent-free office in his parents' company until he could afford the $600 monthly rent payment for his first official office.

Even with such meticulous planning, $60,000 in start-up fees barely covered it. To keep the company afloat, he borrowed $20,000 from his parents.

Today, Yonano's cautious financial strategy is paying off. Last year, sales jumped 250 percent, from $50,000 to $175,000. This year, he's confident sales will reach the $300,000 mark.

Even though things are looking better, Yonano is still a cautious pragmatist when it comes to projecting his finances. To save the business money, he didn't take a salary until last year. "My salary ranges between 2 percent and 5 percent of sales," he says. "I plan on keeping it that way until we're well on our way."

WAKE-UP CALL

As careful as Yonano was in estimating his start-up costs, entrepreneur Gerald Chamales, 47, was downright careless when it came to estimating how much money he'd need to launch Omni Computer Products, a Carson, California, manufacturer and recycler of computer supplies.

Chamales launched the business without a financial plan and evaluated his costs through trial-and-error. "I didn't have a clue [as to] how much money I'd need," he says.

With a meager $7,000 in savings, in 1980, Chamales leased an office in Santa Monica, California, and started Omni. He rented office furniture and phones, hired two salespeople, and contracted with a company to label his products and then drop-ship them to customers - allowing Chamales to start quickly without investing in inventory.

But other expenditures crippled Chamales during that first year in business. "I was paying way too much rent," he says. "Tack on expenses for office equipment and supplies, and I burned through the $7,000 in just a few months."

Six months after launching Omni, Chamales found himself running his company out of his apartment in Venice, California. With just $1,200 left on his credit card, he was forced to rethink his strategies.

"When I was down to the proverbial wire, I wised up fast," says Chamales. "I realized I'd better get my financial act together or I wasn't going to make it."

Fear is a powerful motivator, as Chamales soon learned. "I lived simply and turned everything I made back into the business," he explains.

He says the whole experience has taught him many lessons. "Before you launch a company, [make sure you] have enough money to cover all your projected expenses for a year," Chamales advises.

As for determining accurate cost estimates, Chamales says a good rule of thumb is to assume everything will cost more than you expect. "My telephone bill, for example, was three times higher than I imagined, and the same went for my travel and gas expenses," he says. "Until you're generating predictable sales, you'd better be prepared with flexible money strategies."