Where Are The Grants To Fund My Start-up Business?
 By Kerry Woodson

One of the most common occurrences at the Small Business Development Center is people inquiring about government grants for their businesses.  They have seen the ads on TV or the internet and have high hopes and expectations that the government is handing out tens of thousands of dollars (or more) to anyone wanting to start a business.  It’s bad to be the bearer of bad news, but you probably need to develop another plan for funding your business because government grants for starting a normal, for-profit business are virtually nonexistent.

Now that your bubble has been completely burst, please don’t shoot the messenger.  It’s not that there is no such thing as a government grant or that nobody has ever received such a gift – it’s just that we at the SBDC have never seen anyone actually get one.   In addition, there was an interview on MSNBC with the head of a nation-wide government-funded business counseling organization in which he said he had not seen any clients get a grant in his 17 years with the group.  Those results don’t provide great confidence that pursuing a grant is a viable funding mechanism in a for-profit endeavor.  Please note the distinction about profit. Educational institutions and other nonprofit and research initiatives are in a different category and not the subject here.

We have been bombarded by all the talk about multi-billion dollar stimulus packages and the importance of small businesses.  We’ve even seen pictures of people holding checks supposedly of the grant they received and who, for a small fee, will share information with you about how to get yours as well.  Maybe someone receives a phone call from a person offering to write a grant request, guaranteeing an award of XX amount after you send them $2000 or more to do the paperwork.  My question is if they really had free money to give away, would they have to be calling strangers to find people to take it?  Probably not.  The best advice is to run from all these operations.

So, if you can’t get free money to start your business, what are the alternatives?  Of course, the starting point is a solid, viable idea that has a reasonably good chance of being successful, based on an initial feasibility study and adequate market research.  If your concept is sound, it’s more likely that someone will take a chance on you, putting you in the arena of looking for investors and/or lenders.  Friends and family are usually the first place to look because they already know you and lending from financial institutions for startups is very limited.  Investors are a possible option but the deal has to be lucrative enough for them to be willing to take the risk, meaning that you will probably have to give up some ownership.

Obtaining capital to start a business is one of the greatest challenges facing entrepreneurs, leading many to hope for a magic-bullet solution in grants.  It’s unfortunate that the myth is so widely disseminated.  The good news is that businesses get started every day so it’s not an impossible task – it just means that creativity, diligence, and flexibility are some of the prerequisite characteristics of a successful business owner.  

Marketing Your Small Business 
 By Kerry Woodson

One of the most commonly neglected items in small businesses is marketing.  Far too often, business owners mistakenly think all they have to do is open their doors and customers will beat a path to the establishment.  Unfortunately, it usually doesn’t work that way for most people.  As a result, marketing then becomes a critical part of the overall business strategy and one of the key elements of marketing is effective promotion of the business.  How can a small entity effectively get its message heard and stand out from the crowd when there is so much “noise” from national chains and big companies?

Utilize the big difference - YOU!  The one thing no other competitor has is you.  Most people prefer to do business with people they know and like as opposed to a faceless corporation or internet site.  Take advantage of this inclination by getting out and establishing a presence in the community.  Let people know who you are and what you do but don’t think that every activity has to be a self-promoting event.  It’s amazing how much goodwill can be created simply by getting involved in community activities that have no direct impact on your business.  Through these interactions, people get to know you and will think of you when they need your product or service.  A good place to start is your local chamber of commerce.  These organizations provide many networking opportunities as well as conduits to area events and causes you can support.

Narrow the Target Market.  When it comes to actual advertising, remember, it’s better to reach a thousand legitimately potential customers who can actually buy from you than it is to reach a million people who don’t need/want your product or are not in your service area.  With limited budgets, small businesses usually can’t afford marketing to the masses.  To be more efficient with your resources, identify and target very specific customer groups.  If your business is geography-based, you could target the area within a 1, 3, or 5 mile radius of your location.  Even better, identify likely customers within this area and find a way to get information directly to them.  Advertising in community newspapers and utilizing direct mail can be effective ways to reach specific areas.  If your business is lifestyle-based, determine where people with the common interest congregate, either physically or virtually.  For instance, do they belong to certain clubs/organizations, frequent particular websites, or attend specific events? If so, you can tailor your approach to reach these exact groups you’ve identified as most likely customers.

Incorporate Social Media.  Social networking is all the rage right now and for good reason – it can be very effective.  Facebook, Twitter, YouTube, blogs, etc, when properly utilized, can yield good results on a low budget.  While these tools are nothing more than personal pastimes for some people, many entrepreneurs, and even large corporations, have harnessed their power for tremendous business applications.  You can create awareness of your product, provide real-time updates on your company, establish expertise by publishing information about your field, and even receive instant feedback from your customers.  If you have no idea about any of these items, ask your teenage kids or look into attending a class or seminar.  Many Small Business Development Centers and other business-assistance organizations are offering opportunities to learn more.

As a small business owner, don’t fall into the trap of thinking you can’t afford marketing.  The truth of the matter is you can’t afford not to include adequate promotion for your business.  It doesn’t have to be a high-dollar advertising campaign but it does deserve to be included in the budget, from both a financial and time standpoint.  Establishing an adequate marketing plan will be one more way for you to differentiate yourself from the competition.

Evaluating Business Projects (before spending the money!)
 By Kerry Woodson

A business owner is in a dilemma. She is trying to decide if a new project for her business is a good idea. The venture will require $150,000 investment up front and will generate $50,000 per year in net cash flow (after expenses and taxes) for the next five years, after which the project ends with no salvage value and no further income. Should she jump on the opportunity or pass? Let’s look at some tools an entrepreneur can use to evaluate potential business projects to determine if they are worthwhile investments or uses of the company’s limited resources.

One calculation many managers have used for years is a simple payback analysis. They would take the initial required investment and divide it by the annual or monthly cash flow and determine how long it takes them to get their money back. In our example, it would take 3 years to recoup the upfront cash outlay (150,000/50,000 = 3). Is this number an acceptable return and does it give a clear indication of the merit of the project? The short answer is that it depends on other factors and is what exposes the shortcoming of the payback calculation – it fails to take into account the time value of money and the cost of obtaining capital. 

All money has costs associated with its use.  These costs can be in the form of actual interest expense to lenders or dividends to investors. Even if it’s your own money, there is an opportunity cost because of the interest lost or by foregoing other investment options. For this reason, any endeavor should provide enough return to compensate for the use of money and any evaluation tool should include this facet in order to give a true picture of the relative merits of the proposed venture. The concept of net present value provides a great way to accomplish these goals.

Simply stated, net present value (NPV) is the difference between the present value of cash inflows and outflows associated with a project. It takes into account the time value of money by incorporating the timing of all the cash flows (1 yr from now, 2 yrs, 3 yrs, etc.) and uses a discount rate to value those future cash flows into today’s dollars. This discount rate can be thought of as the cost of capital or required rate of return and it captures the riskiness of the venture. The more risky the endeavor, the higher the required rate of return will be.  After it is all said and done, a positive NPV means that the initial investment has been recovered with the required rate of return and there was still money left over. The best way to perform this calculation is with spreadsheet software like Microsoft Excel.

Performing the calculation on our example would show that the project would have a positive NPV of $30,239 and indicates that it would be a good investment, assuming a required rate of return of 12%. What if her only source of funds was from an investor who expected a 20% return? Under this scenario, the NPV turns negative at -$469 and suggests that the proposal is not profitable and she should consider other alternatives.

Speaking of alternatives, NPV provides a tremendous tool to assess multiple options. Suppose that in addition to the initial example, our business owner had another proposal that would require a $210,000 initial investment but would generate $70,000 net annual cash flow over the same 5-year period (again with no salvage value). Which one, if either, should she implement? The simple payback calculation shows a 3 year payback for both choices. The NPV abalysis (12% required rate of return) shows the NPV of this option to be a positive $42,334. This number is higher than the $30,239 of the other choice and tells her which one is a better use of the firm’s resources because it adds more wealth to the company.

Utilizing quantitative techniques like NPV can help managers and owners make better-informed decisions based on data instead of relying on that “gut feeling.”  While there is still some subjectivity involved in projecting future cash flows, it’s better than blindly taking a leap and then trying to figure out after the fact why things didn’t work out.

This discussion provides a brief introduction to the NPV concept. Obviously, the full concept cannot be covered in such a short forum. 

Funding a Business - Debt or Equity? 
 By Kerry Woodson

You’ve discovered a great business idea, done your research, determined success is probable, and developed a great plan to launch and guide the endeavor.  Now all you need is the money to turn your dream into reality.  Raising the necessary capital for a new venture can often be the most challenging aspect of getting a new business off the ground.  Unless you are one of the fortunate few who can self-fund the project, you must find other sources of money, the proverbial OPM (Other People’s Money).  In the financial arena, this funding will usually fall into one of two main categories – debt and equity.  Which one is better?  The answer, like so many others, is – it depends.

Debt financing is the vehicle with which most people are familiar.  It involves getting a loan from someone and then paying it back at some point in the future, with interest.  It’s what usually first enters an entrepreneur’s mind when thinking about getting money for the business.  Sources can include friends and family, banks, and other entities.

The advantage of debt funding is that it is relatively low cost although it might not necessarily be cheap.  Interest rates can be quite high for a risky endeavor, if gotten at all.  The low-cost aspect is relative to the long term price of giving up a portion of ownership.  Assuming the company’s return on assets is greater than the interest rate, the owners make money even after interest charges.  Another aspect contributing to the low-cost nature of debt is that it is temporary and is eventually paid off and no longer a drain on the company’s cash flow, which brings us to the debt downside.

Debt financing has its disadvantages as well.  Not only can it be hard for a startup enterprise to obtain, it can be risky for the business.  The biggest drawback is the required repayment.  It’s funny how lenders expect to be paid back – on time.  This obligation is present whether the company is doing well or not.  The company must be generating enough cash to cover the interest expense AND the repayment of principal. Failure to make the required payments can put a company out of business due to foreclosure, etc.  Don’t be surprised if a personal guarantee is required, meaning that if the business fails, you are still personally responsible to repay the debt.

Equity, on the other hand, is generally less risky but can be more expensive to the founder.  The comment I repeatedly hear from would-be entrepreneurs is “I don’t want to give up any ownership.”  To which I ask, is it better to have 100% of nothing or 70% (or whatever) of something hugely successful?

The advantage of equity over debt is the relative safety to the company’s cash flow.  Generally, equity owners get paid only if the company is profitable and chooses to distribute dividends.  In other words, in a common arrangement, there are no obligatory monthly payments that can stress the business as it builds or experiences tough times.  While definitely not easy to obtain, a solid business opportunity can often attract potential investors even when the project is not yet “bankable” for debt financing.

So what’s the catch?  Will an investor provide capital and expect nothing in return? No.  If a person invests in a risky venture (they all are), he/she demands to be compensated for that risk.  Instead of a guaranteed interest-only return, an investor participates in the upside potential of the company in both profits and future valuation.  It’s not uncommon for a shareholder to expect a 25-50% annual return, obviously much higher than an 8% loan.  To help ensure those returns, the investor also might want to have input on the running of the company.  It can be like having multiple cooks in the kitchen so choose wisely when it comes to accepting someone’s money and consider all the ramifications.

The proper capital structure is unique to every business and depends on many variables like creditworthiness and business potential.  Organizations like The Small Business Development Center at many colleges/universities provide free business counseling to help entrepreneurs start and grow their businesses.  

By Kerry Woodson

Ever wondered how many sales are required to cover your company’s monthly or annual expenses?  What about calculating how much additional revenue would have to be generated to justify a bigger building or an additional staff member?  These questions and more can be answered with a very important management tool – breakeven.  In addition to being very helpful in assessing a business’ current situation, breakeven analysis can play an important role in evaluating future business decisions.

Most business owners are at least somewhat familiar with the breakeven concept – it is the point where enough revenues are generated to cover expenses.  There is no profit and no loss.  Is there a way to know this number ahead of time? Absolutely – but you must know some information unique to your business.  Most companies have some combination of variable and fixed expenses.  Fixed expenses are things that must be paid even if there are no sales (rent, utilities, salaries).  Variable expenses, just as the name implies, vary directly with sales (materials, sales commission). If there are no sales, these expenses do not exist. The first step is to divide expenses into these two categories. Next, calculate variable costs as a percentage of sales and then use this number to determine the contribution margin. Contribution margin is the amount left after variable expenses are paid and is what is available to pay fixed expenses and provide profit. To arrive at the breakeven number, divide fixed costs by the contribution margin percentage.  It’s sounds complicated but let’s look at an example to see how simple it can be:

Company Y has $100,000 (1,000 units @ $100 each) in monthly sales with $60,000 variable expenses and $30,000 fixed expenses.

1.       $60,000(variable expenses divided by)$100,000 (sales) = 60% variable cost percentage

2.       100% - 60% = 40% contribution margin percentage

3.       $30,000 (fixed expenses) divided by .40 (contribution margin %) = $75,000 breakeven

Under this scenario, Company Y must have $75,000 (750 units) in sales to cover expenses.  That’s good information to know but the application can be expanded to evaluate “what if” scenarios.  What would happen if prices are reduced or increased?  How much sales would be required to cover an additional staff member or a larger building? These areas provide examples of where breakeven can be used as a great management decision tool.

Reducing/Raising prices 5% - Without goingthrough all the calculations here, a 5% price reduction would result in the need to sell about 853 units (almost 14% more units!) to reach breakeven while raising prices 5% would decrease the required unit sales to about 664 units (approx 11.5% reduction).

Increasing fixed costs – What if a manager is considering adding a worker and moving to a larger facility, adding $5,000 to the monthly fixed cost. How would breakeven be affected? A simple calculation would show that an additional $12,500 in monthly sales revenue would be needed to cover the extra expenses.  Would the proposed changes result in at least this much more income?

Other applications exist for breakeven. What would happen if variable expenses are reduced? A target profit level can even be included as a fixed expense to calculate a sales goal necessary to reach a desired profitability. Don’t get too bogged down in the math at this point but realize that there is a concept that can be incorporated into your business toolbox that can help you quantify some business decisions instead of relying on subjective feelings. Not every business decision can be reduced to a numeric equation but the more guesswork that is removed from the scenario the better are the odds of making the right choices. 

Cash Flow – The Forgotten Financial Statement

By Kerry Woodson

Ask most small business owners how their business is doing and they will usually respond with some version of an answer relative to sales.  “Sales are up” or “sales are down” are typical comments.  A few will take it a step farther and talk about profits but rarely will you hear a small business owner or manager talk about cash flow, one of the most important measures of business efficiency.  The cash flow statement, unknown to some and ignored by others, is a critically essential instrument to determine a company’s true performance as well as a valuable tool to project future cash needs.

A cash flow statement is simply a financial report that shows a firm’s sources and uses of cash.  Think of it as almost like a glorified checkbook register for your business – dollars in the door and dollars out the door are summarized in the report.  This type of report is important because the profit and loss statement (P & L) can sometimes be misleading if not used in conjunction with the cash flow statement (and also the balance sheet).  How can this be?  Many business owners often wonder why they can be in a cash crunch when they show to be making significant profits.   Some of the answer can be found in the way the P & L reports revenue and in some instances, not capturing certain expenditures.  Let’s look at a couple of items.

One of the largest “discrepancies” is sales.  An accrual P & L generally recognizes revenue at the time a sale is made, even if no money was received (an account receivable).  At the end of the period, the boss is happy to see great performance but wonders why he/she is struggling to pay the bills.  The answer is that the company has not yet received the payment for the sale, even though the costs required to deliver the product have been realized.  Think of this scenario: A business is ecstatic to make a $100,000 sale but had to give the client 90-day terms.  Let’s say the costs to the company are $70,000, which must be paid as incurred.  On paper, the P & L would show a $30,000 profit and everybody’s happy.  But the reality is that the company had to fork out $70,000 cash for this job this month and carry it until payment is received from the customer.  It is situations like this one that can get a business in a bind even when business is “good” if proper preparation is not taken.

Other things the P & L doesn’t capture are items like debt principal payments and asset purchases.  These items are not “expenses” and thus are not on the P & L, even though they definitely require cash.  If a company has significant debt obligations, the payments can be a huge drain on cash.  Likewise, if assets such as equipment must be purchased, without financing, cash will be depleted but there will be no entry on the profit and loss (other than depreciation).  The cash flow statement will show these uses of cash.

As can be seen, there is much more to running a business than simply monitoring profits.  Cash flow must be adequately managed to maintain a viable operation.  When analyzed regularly, trends can be identified that might warrant further investigation.  In addition to serving as a historical document, a cash flow projection can prove to be a valuable planning tool.  It can help new businesses determine how much money they need to get started and survive the early phases.  Existing companies can use it to identify potential shortfalls ahead of time and proactively plan to arrange access to additional capital before a crisis occurs.

Choosing a Legal Structure for Your New Business 
 By Kerry Woodson

In the midst of the excitement of planning a new business, many entrepreneurs fail to adequately evaluate and determine the best type of legal organization they should form for their particular circumstances.  Ask an attorney what is the best business entity and you will probably get an “it depends” answer.  No single structure is best for all situations, which is why a potential business owner should educate himself about the pros and cons of the various business structures available today.  Most businesses choose one of the following arrangements: (1) sole proprietorship, (2) partnership, (3) S-Corporation, (4) C-Corporation, or (5) Limited Liability Company (LLC).  While we can’t cover all the intricacies of each one, let’s look at some of the highlights of these popular organization types.

The sole proprietorship is the most basic structure, the easiest to set up, and therefore the one that many people choose almost by default.  It is also the one with some of the biggest drawbacks.  In a sole proprietorship, there is basically no distinction between the business and the business owner in the fact that the owner has unlimited liability.  If the business can’t meet its obligations, the owner’s personal assets (home, car, savings) are at risk of being lost.  Profits are passed directly to the owner to declare on his/her personal tax return.  This option is for the person looking for a simple entity with few legal requirements and who is not concerned about liability.

A partnership shares many of the attributes of a sole proprietorship except that there are multiple owners.  While partnership agreements can be structured to accommodate various scenarios, one thing to keep in mind is that a general partnership commits and binds all the participants to actions made by other partners.  In other words, if one partner enters into an agreement on behalf of the company, everyone is obligated, even if they had no knowledge of the action and, like a sole proprietorship, each one has unlimited liability.  It’s been said that the quickest way to lose a friend is to enter into a partnership with them.  Although the financial costs can be substantial, they sometimes pale in comparison to the relational tolls extracted on a friendship.  Money matters and control issues have a way of turning congenial people into combatants.

A corporation differs in the fact that it is considered a separate entity from the owner(s) and offers a certain level of liability protection.  Corporations are more complicated to create and require more formalities and record-keeping but can be well worth the extra effort.  Depending on the situation, companies will elect between a C-Corporation and an S-Corporation.  An S-Corporation pays no corporate income tax as all income is passed directly to the shareholders.  A C-Corporation is taxed directly on the company’s profits and only dividends (if any) are taxed at the individual level.  Of course, any salaries are reported on a W-2.  An S-Corp has a few limitations while a C-Corp offers more flexibility so it’s important to consult an attorney to help decide which option is best for you.

A Limited Liability Company (LLC) is a relatively new type of organization.  It combines some of the best features of the other options like the limited liability of a corporation, multiple owners as in a partnership (a single owner is also allowed), and less formality like a sole proprietorship.  The company can elect the pass-through type of taxation like an S-Corp or can choose to be taxed like a C-Corp.  There are still some initial filings that must be made to create the entity and other annual reports filed but the burden is much lighter than the typical corporate requirements.  Many entrepreneurs are deciding that this route is the best choice for them because of its combination of benefits.

Obviously, these descriptions are very brief and not meant to serve as your final source but to provide a glimpse of some of the options available to you.  Nothing can replace taking the time to seek the advice of a competent professional attorney and tax advisor.  Doing things right initially can prevent headaches later.

What is a business plan? Is it necessary? 
 By Kerry Woodson

After a potential entrepreneur has performed an adequate feasibility study and determined that the prospects for the new venture look promising, the next step in the process is to prepare a business plan.  Although there are many examples of businesses that started and succeeded without a formal business plan in place, a well-researched and thoughtful plan can positively contribute to the overall chance of success and will almost always be required if you are seeking financing from banks or capital from investors.  The business plan is the place where you tell your story about who you are, what you want to do, how you’re going to do it and why the project is going to be successful.  It serves as a blueprint for your business and forces you to think about and address the many factors that comprise the environment in which you must operate.

First and foremost, a useable plan must be realistic.  I’ve seen plans with such outlandish projections that they serve no purpose other than to create a nice fantasy.  Be sensible.  Maybe you want to create a best case scenario but offset it with a worst case scenario followed by a most likely situation.  Improbable forecasts will cause you to lose credibility with outside sources and establish useless data for your internal assessments.

Although there is no single format that all business plans must follow, there are certain categories of information that should be included in most plans.  Some of the main items you will need to cover are (1) environmental analysis, (2) company information, (3) marketing strategy, (4) operation plan, (5) management team, and (6) financial plan. 

The environmental analysis will include data pertaining to the industry you seek to enter as well as your target market/customer and also discuss the competition you will encounter.  The company information is where you detail the information about your specific company.  What are you selling? Where?  The marketing strategy section is where you outline how you plan to sell your products or services.  How do you plan to position your product?  What’s your pricing strategy?  The operation plan is like the nuts and bolts of your daily activities.  What type of facility will you have?  What equipment is required?  How will you hire and train employees?  The management team profile is a very important component in the sense that many investors/bankers will first look to see about the experience and capabilities of the people running the business enterprise.  This section is where you present the credentials of the key personnel and why they are qualified to lead this endeavor.  The financial plan includes a disclosure of the financial resources needed for the project and the proposal of how those will be raised and spent along with projected financial performance for at least the next three years in the form of pro forma profit and loss statements, cash flow forecasts, and balance sheets.

Even if no one other than yourself ever sees the business plan you create, it is a worthwhile exercise.  It requires you to seriously analyze the entire scope of your proposed venture.  Is there really a market for your product?  Who is your customer?  Can you win against the competition?  What makes your idea better?  How profitable is the business and what are the cash flows, taking everything into consideration like loan repayments, etc.?  The knowledge you gain through the process will probably make you adjust your original ideas, which is much better to do it now before you launch rather than finding out after you open your doors and wonder why something isn’t working.

Evaluating a Business Idea
 By Kerry Woodson

“I have a great idea, how do I get my business started?” 

It’s a common question asked by countless would-be entrepreneurs who are anxious to take the plunge into business ownership.  Too often, people jump right to the “starting” part and leave out some very important intermediate steps.  Not every good idea translates into a bona fide business opportunity.  There are many factors that should be considered when evaluating a possible business venture.  It’s best to explore these issues before significant resources are spent on the endeavor.  The feasibility process can be used to determine the potential merit of a business proposition.  Negative findings can prevent a costly mistake but positive results will provide confidence that the idea is sound and that it warrants further development and pursuit.

The first step in the feasibility process is to develop a well-defined idea.  A nebulous plan is hard to research.  Really think about what you want to do.  Are you offering a product or service?  Who is your target customer?  Is your business going to be a physical brick-and-mortar type store or a virtual, internet-based effort?  For example, don’t just say “I want to open a restaurant” but expand the definition to something like “I want to open an upscale Italian restaurant serving moderately-priced food to busy, working couples and business people in Kingwood.”

A well-crafted concept paves the way for the next step in the process, the market analysis.  In this phase, you will determine if there is an adequate market (customers) for your product/service but also, and just as importantly, research the competitive environment in which you will operate.  Small Business Development Center (SBDC) consultants can assist in compiling this information and there are other public resources as well.  Demographic information for a particular area can be obtained from the Census Bureau and other online sources.  Detailed competitor information can be obtained through a “Reference USA” report available at most local libraries.  You can create a list of all similar businesses in a certain area to get a better feel for how many people are already doing what you want to do.  Everybody has competition, even if it is in the form of substitute products/services.

After determining the market and competition for your idea, it’s time to investigate the requirements of the proposed venture.  Requirements can be in the form of knowledge/experience, time, legalities, and finances.  Do you need to have a certain technical capability or industry experience?  What about time? Will it require you to devote a full-time effort to the project or can you start out part-time and keep another job?  Are there any permits or licenses necessary for your type of business?  How much money will it take to fund the operation through the startup phase and until it can reach a positive cash flow?  Do you have the money?  If not, where/how will you get it?  You must know the answers to these questions in order to properly evaluate the opportunity.

After gathering all this information, you should have enough data to make an informed decision.  If things don’t look promising, you can nix the idea and you’ve saved yourself a lot of time and money pursuing a losing proposition.  Conversely, if the information points to success, you can move to the next stage, developing a comprehensive business plan.