Categorized | Financial Structure

FINANCE, TAXES, AND BANKING 2.1. Financial Structure

Shoestring Venture: The Startup Bible (1st Edition)How much money you need to start and run your business.We’ll start with the most basic, bald-faced definition of a business: a business is about money. That’s what differentiates a business from a hobby or any other activity. You may love to knit and spend hours doing it; you may be so skilled that your creations are worth hundreds or thousands or dollars. But you’re not running a business. Once you start selling your magnificent knitting creations on eBay so that you can make some serious money, you’re running a business. You’re still knitting every day, but now it’s about money. And to make money, you have to have money, even if it’s just a little bit to start with.

Finance answers the basic questions about how your business uses money to make money. Finance tells you:

  • How much money you need to start and run your business.
  • Where you plan to get that money—either through investors (some combination of you, angel investors, venture capitalists, or corporations), loans , or grants.
  • How much you, or your investors, stand to lose if the business fails.
  • How the cash flows week after week, month after month, and year after year; if you want to stay in business, you have to make sure that more cash flows in to your business than out.
  • Whether you’re profiting or losing from running your business.
  • What you need to buy ( assets) and what you need to spend ( expenses).
  • What investors or lenders should reasonably expect by allowing you to use their money.
  • What you should do with your profits—give them to yourself, bank them, spend them on your business, invest them, or start another business.
  • How to account for profits and expenses to minimize the taxes you pay.
  • How the economy, business climate, and investment climate affect your business financially.
  • What the value of your business is if you were to sell it.

As the owner and chief officer of your business, you should be able to answer these questions readily and knowledgably on any day of the week. The decisions you make about financing will in many ways be the most consequential for determining the success of your business.

Let me repeat that previous paragraph. What makes your business a business is that the person in charge—you—can quickly, easily, and accurately answer all the questions above and, above all, make smart and informed decisions in each of these areas.

The first two questions relate to the financial structure of your business; whether you are looking for investors or bootstrapping your business, the financial structure is the most important aspect of your start-up. Financial structure basically tells you where the money to start up your business comes from from. Any money you put into the business, whether it’s money you’ve saved, money you earn from your business, or money an equity investor has pumped into the mix, goes into the financial structure as an equity investment. Any money you borrow, say, with a second mortgage or a credit card, goes into the financial structure as debt. This combination of equity and debt is officially the financial structure of your business.

EQUITY AND DEBT

Most small business entrepreneurs think of debt as a necessary evil, that onerous keep-you-awake-all-night horror you need when you can’t pay bills. In terms of financial structure, however, debt is just another investment in your business and a lender just another investor. Equity investors, including yourself, own the business and can participate in profits and the gain in the business’s value—the return is potentially unlimited. Lenders ( debt investors) help to fund your business in exchange for part of your revenues in the form of interest on the loan . Their return is limited to the interest, but unlike equity investors, they have first claim on the company’s assets (or your assets, if the business is a sole proprietorship or general partnership). It is more often than not desirable to have a portion of the business’s financial structure represented by debt. For most corporations, 30% to 40% of the financial structure is debt. Why? A debt investor only gets their interest; any profits and capital gains above that go to the equity investors, thus increasing their return. From the very beginning, you need to consider debt as part of your financial structure and how it increases, or decreases, the equity return.

2.1.1. SCOREhttp://www.score.org – We’ve had many occasions to mention SCORE as it’s probably the most valuable online resource for startups and small businesses. SCORE is an organization that has gathered together retired and working executives, business owners, and corporate leaders to provide free mentoring and advice to entrepreneurs starting their own business. SCORE boasts over 10,000 executive volunteers—representing some 600 business skills—who will correspond with you or meet with you to give you advice based on their years of business experience. The mentor list, as of publication of this book, includes 229 counselors nationwide who specialize in financial matters, twenty-four counselors who specialize in new business funding, and forty-five counselors who specialize in banking issues. SCORE offers:

  • Finance, accounting, and banking counselors that will meet you face-to-face or answer your questions over the Internet.
  • Workshops in creating a profit/loss (or income) statement and pricing products.
  • Sales forecast and twelve-month cash flow templates.

2.1.2. Inc.com How To: Finance & Capital - http://www.inc.com/guides/finance – Inc.com is a business news Web site geared exclusively to entrepreneurs and small business owners. It provides news and resources across the entire spectrum of issues that you’ll confront as a business owner: finance, technology, innovation, sales, ecommerce, marketing, human resources, leadership, taxes, and so on.

Among its valuable resources is a fairly complete and easy-to-read guide on how to finance your business and acquire the capital you need. This guide includes:

  • Starting Up on a Shoestring—tips and strategies for starting your business with very little or no money.
  • Raising Capital—writing a good business plan and finding the financial resources for your company.
  • Financing: Where To Find It
  • Angel Investors—how to find investors who will invest at the beginning, so-called “angel” investors.
  • Venture Capital—finding and securing venture capital.
  • Compensation—compensating yourself and your investors.
  • Equity as Compensation—how you should calculate the equity you offer to an investor.
  • Banking and Loans
  • Cash Management Basics—your business will sink or swim based on your cash flows, not your profits or losses. This is your basic survival guide.
  • Improving Cash Flow
  • Track Your Critical Numbers
  • Controlling Cost
  • Tax Strategies—a basic guide to tax planning and structuring your business and accounting to minimize your taxes.
  • Getting Paid—your basic guide on collecting what people owe you.
  • Selling a Business
  • IPOs

Most valuable to you is Inc.com’s angel investor directory (http://www.inc.com/articles/2001/09/23461.html), a list of U.S. angel networks. The site organizes this directory by region with a separate category for angel investors willing to capitalize businesses anywhere in the U.S.

2.1.3. CCH Financial Planning Toolkit - http://www.finance.cch.com/tools/calcs.asp – CCH offers a variety of personal finance calculators and a few highly useful small business calculators including a business valuation calculator:

  • Buy vs. Lease
  • Consolidate Debt
  • Sales Volume Breakeven Analysis
  • Business Valuation
  • Working Capital Needs
  • Cash Flow Calculator
  • Credit Assessment
  • Commercial Loan Calculator
  • Inventory Analysis
  • Profit Margin Calculator
  • Financial Ratios
  • Amortizing Loan Calculator

In terms of financial management (2.3), the CCH toolkit has one of the best introductions to financial analysis of your business in its Business Ratios section (http://www.toolkit.cch.com/text/P06_7100. asp). Financial analysis is how you look at your assets, revenues, and cash-flows to determine the actual financial condition of your business. While you didn’t go into business to be a bean-counter, to be truly successful you should understand these ratios and be able to calculate them from your business’ financial statements. Why? Because you’re going to be dealing with other entities, like banks, who do know how to calculate these numbers. Besides which, you’re in business to run your business. Financial ratios are the “reality” of your business.

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