Many entrepreneurs, when asked how much funding they need, might jokingly reply, “As much as I can get!” However, both overestimating and underestimating your business’s capital requirements can lead to significant problems. Underestimating your funding needs can force you into repeated, time-consuming fundraising efforts or, worse, lead to shutting down due to lack of funds. Returning to investors for more money can damage your credibility and dilute your ownership stake.
Conversely, securing too much capital might seem ideal initially, but it can foster a lax approach to expense management. The “if you have it, spend it” mentality is dangerous for startups. Moreover, if the investment is in equity, over-funding unnecessarily reduces the founder’s share – a crucial point for entrepreneurs to avoid.
Common advice suggests creating a cash flow projection or budget and adding a contingency buffer of 10% to 50%. These “contingencies” account for potential setbacks and unfavorable events common in startups. However, effective contingency planning is challenging, even for entrepreneurs with financial backgrounds. How do you encourage an inherently optimistic person – a prerequisite for starting a company – to prepare for potential negative scenarios?
To improve contingency planning, consider the common reasons why startups run out of money:
* Underestimating the costs of launching a new product nationally, especially for consumer goods.
* Misjudging the time required for market acceptance of a new product.
* Experiencing delays in regulatory, zoning, or patent approvals.
* Assuming small startups receive the same payment leniency and favorable terms as large corporations.
Entrepreneurs must anticipate these challenges. Contingency planning is more than just adding a financial cushion. It’s a mindset that acknowledges the inherent difficulties of the entrepreneurial journey. Anticipating potential problems isn’t about losing faith; it’s about acknowledging obstacles on the path to success.