Startup costs: When lean isn't all that lean

- December 17, 2013 3 MIN READ

We hear a lot about people who have successfully launched businesses on a shoestring budget. Many aspiring entrepreneurs set themselves up do the same, only to realise that starting a business with only $200 is actually not that easy or common. This is because business plans aren’t static or definitive. The reality is most entrepreneurs pivot, not once, but many times during the evolution of their business.

Most startup stories say that aspiring entrepreneurs need to have a business plan. While this is true, business plans aren’t definitive when it comes to figuring out startup costs. According to Jeff Shuman who directs entrepreneurial studies at Bentley College, “The conventional wisdom is that an entrepreneur sees an opportunity, comes up with a business plan to capitalise on it, determines the capital that needs to be raised, raises the capital and then applies it to building the business described in the business plan.”

He acknowledges one major problem with this model. It all hinges on getting the business right the first time, and that doesn’t often happen: “In reality, it’s likely that some of your initial assumptions are pretty good and others aren’t going to be worth the paper they’re written on.”

Figuring out startup costs involves regularly reviewing assumptions and adjusting the initial business model. Writing a business plan is good because it forces an entrepreneur to write down everything they are going to need to start their business. But that initial plan is likely to change repeatedly and more costs will come into the picture. Unfortunately, we hear less about people who end up burning holes in their pockets, spending exponentially more than initially expected.

Many things can, and most likely will, come up. A software developer might not be able to execute the concept well. There may be hidden costs in certain services. There may be more resources needed than initially predicted. Legal troubles may arise. These are just to name a few.

While it’s inspiring to hear about success stories, the whole ‘If I can do it, you can do it too’ principle is a marketing fad. There’s a lot of preamble to that notion that we’re overlooking. Some people have all the skills necessary to start a technology business. They may have contacts who owe them favours. They may be the kind of people that have luck following them around.

Entrepreneurs who have experienced the reality of starting up a business say the most important thing is to test consumer demand before jumping into a full-fledged business – before it gets to the stage where aspiring entrepreneurs are left to finance their ventures by running up big balances on their personal credit cards or tapping equity in their homes.

Shuman, for instance, says that consumer testing reduces initial startup costs and the result is that the initial cycle of a person’s business is dedicated not so much to generating profits as to generating information.This includes determining the right price for products or services.

“With this, you can fund your business on a cycle-by-cycle basis. When you go for the second cycle and for expanding your business, the numbers are now based not on focus groups or surveys but on real-world experience,” he says.

What’s often not taken into consideration is the cost of time. When beginning a business, time can be money. There may be fixed costs such as a monthly lease on an office. If improvements need to be made to a space before moving in, those fixed costs are going to be additional startup costs. Many entrepreneurs draw up a timeline for their ventures and get tripped up on the safety and inspection requirements imposed by local agencies.

There also appears to be polarised views when it comes funding. Some are anti-VC and all for bootstrapping. Others don’t quite see the benefits of bootstrapping when there are investors with big bank accounts. There’s very little gray area.

Self-financing isn’t a practical option for larger projects, and investment isn’t suitable for projects that don’t have empirical evidence suggesting future success.

Tom Emerson, who directs the entrepreneurship centre at Carnegie Mellon University in Pittsburgh, says startups should figure in the cost of capital when determining initial expenses and cashflow: “The cost is usually based on what the interest would be, were that cash invested in something with similar risk on the market. It’s usually a figure that is a few percentage points or more above the prime rate.”

When it comes to estimating startup costs, measuring risk and being realistic rather than being hopeful and optimistic may prevent disillusionment.