Show Me The Money

Finding Startup Capital

I’ve advised many people on opening game stores. A few have opened their doors. Most have not. The largest single cause for not making the jump from the asking-questions stage to the opening-the-door stage is an inability to finance the business.

I refer to a couple of terms from last week’s article, so if you haven’t read that, go read How Much Do I need?

The primary sources of opening money are a) you and your family, b) private investors, and c) bank loans.

You and Your Family

It helps to build up as much cash as possible before you begin, so you’ll probably want to use at least some of your own money no matter what. Cash helps in three ways. First, you don’t have to apply for it. It’s yours. It’s not contingent on a business plan or a credit check.

Two, you don’t have to pay it back. By deleting the line item called “Loan Repayment” from your break-even analysis, you reach positive cash-flow sooner. By starting with money, you’re not repaying interest on your startup capital. Depending on how much you start with, the lack of interest alone could save you $10,000 or more.

Three, cash can help you get a loan. A bank will be more eager to lend to you if they see that you’re taking a risk. It’s far easier to get a loan for $80,000 if you’re putting up $20,000 of your own than it is to get a loan for $100,000 with no cash out of pocket.

I recommend that anyone thinking about opening a store get a second job, preferably in retail, for the six months or year it might take you to open your doors. You get used to working long hours, you learn some valuable skills, and you have a chance to bank up some cash. If the hours are not manageable because of family demands or health reasons, you can quit without losing a six-figure investment.

If you consider family money, I recommend treating prospective family members just like unknown investors. Show them a business plan. Write up an agreement, including your repayment schedule and penalties for late payments. Your professionalism will reassure them and your attention to detail might prevent an unpleasant family dispute later.

Private Investors

Whether you meet them through your current job or through a newspaper or magazine ad, or seek out angel investors online, investors will want to see many of the same things a bank will. Usually, though, they’ll look at the viability of your plan more closely than they will your personal financials.

Although you might find a single investor willing to finance the whole business, it’s more likely that you’ll have to seek out more than one, each contributing a certain amount in exchange for partial ownership. You can set up these “shares” for investments of $5,000 or $10,000, or any amount you wish to establish. You will almost certainly want to include buy-out options for your investors so that you don’t have to pay them indefinitely.

You might wish to involve a different kind of investor, one who brings talent and labor in addition to cash. This investor would be an active partner in the business (as opposed to a silent partner, who provides only financing). When you consider a partner, you have to consider more than just how much cash he brings with him. You’ll want to compare skill sets; if he knows the Warhammer 40k line and you know collectible card games, you’re a good match. Ideally, you want someone whose knowledge and experience complement yours. If you wish to have a partner, you need a clear delineation of duties, expectations, percentage of ownership and rewards.

If you involve investors, the relationship will probably dictate your business structure to some degree. Business format is a huge decision and one size does not fit all. Talk to your lawyer about exactly which structure best fits your needs.

Bank Loans

As a small business owner, you are the business. The bank is interested in ruffling through your business plan and making sure the numbers don’t contradict each other, but what they really want to see is your personal credit. They’ll run a credit check on you. They’ll want your personal income tax records for the past 2 or 3 years. Your loan application will have your personal name on it.

The bank’s reasoning is that when (not if) you fail, you’ll return to the field you’re in now. They want to see how well you can repay them doing what you’re currently doing. That second job comes in handy here, too. If you didn’t spend all that money, then you’ve built up a nice income. That higher income figure should improve your debt-to-income ratio substantially.

If you’re thinking about opening a store, go get a copy of your credit report today. Fix any errors on it. Address any legitimate issues on it. Talk to your banker about whether you should open any new lines of credit or close some off. Between now and the time you apply for a loan, make sure you pay every single bill on time. If you have something bad in the past that’s due to fall off the credit report, don’t apply for a loan until then.

Subtract your cash on hand from your pre-opening capital, because that’s the segment on which you’ll pay the greater interest (in dollar amount, not percentage). If your pre-opening capital is $50,000 and you’ve saved up $8,000, you need a term loan for $42,000. The difference is $425 off your monthly break-even and a total of $2,200 in your pocket over the life of the loan.

How about terms for that loan? You might not have much to say about the interest rate, but you can negotiate the repayment term. If your banker doesn’t offer it up front, ask about a balloon payment. Banks are often willing to calculate the payment rate based on a 7-10 year term but write the loan as a shorter term (3-7 years) with a balloon payment equal to the balanced owed at the end of the term. They have no expectations that you’ll pay the balloon; they assume that you’ll refinance it. That could cut your loan payment almost in half, lowering your break-even by another $840 per month.

Your best bet, in terms of likelihood of approval and interest rate, is a home equity loan. If that’s what you end up applying for, you might want to use the extra cash you make with your part-time job to pay down your mortgage instead. At the interest rate you’ll get from a home equity loan, the relative value of cash goes down.

What about the capital reserve? You prefer a line of credit for that. It can be a BLOC (business line of credit), HELOC (home equity line of credit) or some other option; ask your banker which option works best for you. The advantage here is that you’re not paying interest on funds you haven’t withdrawn yet. In your first month of operation, you might only withdraw $5,000 from your LOC, as with our sample store from last month. That means you’ll make a payment on $5,000 ($200) in month 2 when you withdraw another $5,000. If you took out a loan for your entire $60,000 burn amount, the interest element alone of your first payment would be $500—that’s almost 60% of the payment! The interest rate is often higher on the LOC, but the dollar amount you pay will be much less.

Loan Application Tip

To a bank, loans have a cost associated with them, which mostly represents the amount of labor that goes into generating and maintaining your loan. Because of this cost, banks don’t like small loans. It’s strange, but they’d rather loan you more money than less. If your loan request is close to an even dollar threshold (say, $94,000), round it up. If they only approve you for a lower dollar amount, you’re still covered.

Other Loan-Related Issues

While we’re on this topic, let’s answer some of the immediate follow-up questions.

What about the Small Business Administration?

Here’s a shocker—the SBA doesn’t make loans. You hear about “SBA loans” all the time, but here’s how that works: the SBA guarantees a certain percentage of a loan made by an approved lender if that lender meets certain guidelines in investigating and processing the loan.

A bank originates the loan, but the bank is more likely to lend you money if you meet the SBA’s criteria, because they know that if you default they can still recover most of the loss from the United States government.

How about Venture Capitalists?

Sorry, Charlie. VCs want high-yield returns with an unlimited cap. They prefer for you to take your company to an IPO within a few years. If your business plan doesn’t have the figure “$20,000,000” on it anywhere (and, barring a typo, it won’t), they’re not interested.

That should answer the basic questions about where and how to find starting money. If you have specific questions, drop us a line. Next week we’re going to compare opening a new store to buying an existing store.