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CHAPTER TWO:

FINANCE YOUR NEW SCHOOL

Starting a new business is not cheap. With the privileges of being your own boss, you will also be taking on the financial risks of being your own boss. Small business statistics show that those risks are great. But they can be minimized by careful advance planning.

The tool you use to do this advance planning is called a business plan. Putting together a business plan involves making accurate estimates of income and expenses, profit and loss. It involves setting financial and personal goals for the business. It involves choosing a legal form for your business, setting up a preliminary marketing strategy, assessing your competition, and charting a path for the next several years of your business life. A business plan can help you obtain start-up financing. It can help you see where your own business skills may be lacking. It becomes a framework for future action. But most importantly, it can help you get a realistic picture of the financial risks and rewards inherent in owning your own martial arts school.

Start with Estimates

The first step in putting together a start-up business plan is making estimates. Estimate how much money you will need for start-up costs. Calculate your break-even point. Then make some financial plans for your first two years in business.

Start-Up Capital

Start-up capital is the money you need to set up your business. To put it another way, start-up capital is the money you will need to spend before you can open your doors to do business.

Unfortunately, no simple formula can tell you how much start-up capital you will need. The only way to come up with that figure is to list all your expenses. As a start, consider these costs:

If you’re making these estimates only to satisfy your own curiosity, you can make educated guesses. If, however, you are trying to calculate start-up costs for a loan application, guessing can get you into big trouble. Many lenders, especially those associated with the Small Business Administration (SBA) program expect you to know precisely what you will need to purchase and what it will cost to do so. If you’re building anything at all on these numbers, even if it’s just the assurance that you can make a school work financially, don’t cheat yourself. Do the research. Make estimates you can rely on.

Remember, too, that these expenses are only the ones you can anticipate. Starting a new business usually takes more money than you expect. Allow yourself a buffer for unforeseen expenses.

Break-Even Point

Another crucial step in planning for the financial health of a new business is calculating your break-even point. Your break-even point is how much income you need monthly to pay all of your bills including payroll.

Monthly Break-Even

To calculate your break-even point, begin by adding all your obligatory expenses.

Some expenses, such as FICA and SE taxes, are annual expenses. Others, such as insurance premiums, may need to be paid semiannually or quarterly. If an expense comes due annually, divide that annual expense by twelve to calculate monthly break-even. If an expense comes due quarterly, divide by three. In other words, calculate expenses on a per-month basis.

Some people like to add their own monthly salary into this equation. Others figure it separately. If, just to stay afloat, you must get some money out of the business for yourself, add a minimum salary into your calculations. If, at least at first, you have other sources of income to meet your personal needs, calculate your salary separately.

Always estimate expenses a little on the high side if you want to avoid unpleasant surprises. The sum of your expenses is the minimum amount of money you will need to take in each month. It is your “break-even point.”

Number of Students Needed to Break Even

Another way to keep track of your break-even point is to think of it in terms of how many students you need to pay the bills. That number, of course, depends on how much you expect each student to spend. Besides tuition, several other expenses come into play in this calculation. How many seminars or tournaments will each student be participating in? After expenses, what could you expect to earn per student on these events? Will you have a formal ranking or certification program? If so will you charge for each promotion? How much do you expect to earn from promotion fees? Do you plan to have a retail area? If so, how much can you expect each student to spend on uniforms and gear each year? How much of that income can you keep as profit?

Add each of these additional sources of income to your yearly tuition to get your annual per student income. Then subtract any per-student expenses you might have. For example, you may get $200 per student in testing and promotion fees each year, but spend $50 of that on certificates, registration with the state or national organization, or emblems-of-rank belts, patches, or a plaque on your school wall. Subtract these annual per-student expenses from your annual income. Then divide the remainder by twelve to get your monthly per-student income.

To calculate the number of students you will need to break even, divide your total monthly expenses (your break-even point) by your monthly per-student income. For example, let’s say you need $3,000 each month to break even. Your monthly per-student income is $100. You need thirty students just to break even. Those first thirty students pay the bills. Every student beyond thirty (your break-even number) adds to your profit.

If you eventually also want to make a salary for yourself, you’ll need to figure that into your calculations, as well. Divide the monthly salary you would like to be making by your monthly per-student income, and that will tell you how many more students you will need to pay yourself. Add the two numbers to get your target enrollment number.

Be aware, however, that “target enrollment” is not the number of students you will need to sign up. Target enrollment is the number of paying students you need every month to pay your bills and yourself. To keep your school at its target enrollment, you’ll need to sign up not only enough students to pay the bills; you’ll also need to sign up new students to compensate for those who drop out. Remember, too, that we’re talking about paying students, not training students. If they don’t pay, they aren’t a part of your target enrollment.

A word about the future: While you’re figuring out expenses, also look at “optional” expenses. For example, you may eventually want to be able to hire an employee. You may want to expand your school. Consider, too, your own continuing education: you may want to set aside money for seminars and teacher-training classes. Sure, at the beginning, you will probably be glad if the business makes enough to support itself. Eventually, though, you may want to run not just a self-supporting business but a thriving one. To figure out how many students you would need to support additional expenses, you can use the same formula. Monthly expenses for your optional projects divided by monthly per-student income equals number of students needed to support the optional projects.

Calculating your break-even point and additional expenses in terms of target enrollment makes those expenses “real” in a way numbers can’t: “I need thirty students to break even. No more than twenty of my regular students have been training this month. I need to check to see if I can repair the problem before next month’s bills come due.” “To hire a part-time employee to manage the office, I need ten more paying students.” “To afford the expenses at a new location I need another twenty-five students.” In other words, if you think of your break-even point in terms of number of students, you can look at your monthly sign-up, attendance, and payment records and get an immediate, intuitive sense of whether you are getting closer to your financial goals.

Your First Two Years

In the early months, while you are still building your student base and trying to reach your target enrollment, you will need outside funding to meet your monthly expenses. As a rough estimate, assume that for the first six months you will be paying nearly all your monthly expenses out of pocket. That means before you open your doors you need to know where you will get those first six months’ operating expenses.

Assume that after those six months are over, you will still have to pay out of pocket for some of your operating expenses for up to two years. Why? Statistically, you will not be making a regular profit for two years. Sure, you will have profitable months before then. But you may need two years to figure out what your annual business cycle will be. You will probably need two years to learn to anticipate slow months. And you will probably need two years to save enough reserves to weather them. In short, it normally takes two years before you are out of the building stage of your business and into the maintaining stage. Of course, you might hit a steady target enrollment before then. Some businesses are self-supporting in a year or less. But though you can hope to be out of the building stage in a year, though you can work toward that goal, you should plan to have backup funds available for two years.

How do you handle the financial demands of those first two years? One way is to get a business loan for just start-up costs. You then set up a revolving credit line with a bank or private lender for initial operating expenses. You can draw money from the credit line as you need it, and repay the debt as you have extra profit. Another option is “bootstrapping.” You borrow the start-up costs and keep your day job to meet your living expenses, maybe even to help pay some monthly business expenses, while you’re growing the business. Whichever option you choose, make sure you know where you will get the money for those early operating expenses. You don’t want to get desperate and eat up your family’s nest egg.

Discover Sources of Money Available to You

You will probably finance your business from two sources: equity and debt. Equity funding is the owner’s cash contribution to the business. It can include personal funds and also funds invested by family and friends. Equity funding is money that remains in the business indefinitely. Unlike a loan, it has no set pay-back schedule.

If you don’t have enough money to start a business on your own, you can turn to various kinds of lending institutions. Generally, you will need to be willing and able to invest most of the initial equity in your business. Lending institutions are typically reluctant to provide more than half the start-up funds for a small business. Any loan you get from a lending institution will have a predefined repayment schedule. Under that schedule you must repay specified amounts of principal and interest within a specified amount of time.

Commercial Loans

Commercial loans are the most common kind of small business loan. They come from your local bank, savings and loan, or credit union. The terms and requirements of these different institutions vary widely. If you’re interested in a commercial loan, familiarize yourself with basic lending terminology and read the pamphlets various lending institutions have available. Then make an appointment with a loan officer. Show up on time, professionally dressed for the business world (not the martial arts world), and present your well-thought-out and professional-looking business plan. After you sell the lender on the potential of your business and your ability to run it, they can help you get started on the loan application process.

Government Loans

Another possible source of funding is government loans. Government loans come in two kinds: guaranteed loans and direct loans. Guaranteed loans are loans made by commercial lending institutions backed by a government loan loss guarantee. In other words, the government program functions something like a cosigner. Direct loans are loans made by the government, typically to members of a specific group or for specific purposes.

The SBA loan program offers guaranteed loans. The SBA has a congressionally mandated program whose purpose is helping small businesses gain financing. Most SBA loans are made through the 7(a) Loan Guaranty Program. These government-guaranteed loans are made by banks and other lending institutions. The average SBA loan is for 50 to 75 percent of the start-up costs of a small business, typically around $175,000. The average maturity is about eight years. The SBA also offers a “MicroLoan” program, in which the amount borrowed is less than $10,000 and the repayment period is less than six years. Sometimes (but not always) these loans have a higher interest rate than what the bank offers. Usually, however, they have fewer qualification requirements than the bank’s conventional loans. If you don’t qualify for a loan directly from a bank, you may be able to qualify for an SBA loan.

Be aware, however, that the SBA loan program is a government program and, as such, has government-style quirks. For example, if you borrow money from your uncle Fred, he will probably write you a check and you can spend the money as you see fit. If you borrow money from Uncle Sam, however, the process is not that straightforward. Most SBA loans don’t make payments directly to you. They pay the people you are buying goods and services from. If you want to use the money to buy, for example, a desk, you have two choices. You can go out and buy the desk, submit the receipts, and have the lending institution reimburse you. Or you can go out and get an invoice for the cost of the desk, and the lending institution will pay the store directly.

Furthermore, an SBA lending institution will earmark percentages of the money for specific categories. If you estimated in your application that you will need $3,000 for inventory and $5,000 for fixtures, don’t expect the SBA to allow you to spend $2,000 for inventory and $6,000 for fixtures. Also, you need to make sure that when you say “inventory” and “fixtures” you mean the same thing the SBA program means when they use the terms. The government is not thinking, as you are, about how you will use these things; they’re thinking about how they could sell them and get their money back should you default.

One special SBA program is the Minority Prequalification Loan Program. If your business is at least 51 percent owned and managed by a member of an ethnic minority, the SBA will find you an intermediary to help you put together a loan application and find a lender.

The government also offers direct loans to special groups. For example, the SBA has a loan program for disabled veterans and for Vietnam veterans. The Handicapped Assistance Loan Program offers start-up loans to business owners when either the owner is disabled or disabled individuals work 75 percent (or more) of the staff hours. Special loan programs for women or minority-owned businesses are also available. If you think you might be eligible for a direct loan, check with the SBA or your state lending agencies. SBA offices are listed in the telephone directory under “U.S. Government,” or you can call the Small Business Answer Desk at 1-800-8-ASK-SBA.

Private Family Loans

In your investigation of commercial and government loan programs, don’t neglect one of the most common sources for loans: friends and family. Many, perhaps most, new businesses are funded by family members. Often, the best place to borrow money is from relatives. But sometimes, the worst place to borrow money is from relatives. On the one hand, who is more likely to appreciate your vision or to want to see you succeed than your family? On the other, if your business doesn’t succeed, you will lose not only your money but that of the family member who invested in you. Think through the long-term implications of borrowing from family.

If you decide to use a relative’s or friend’s money, treat the loan as an “arm’s-length transaction,” the same as you would if it were from a bank. Give them your business plan. Decide the amount of interest and the payback schedule. Make sure the arrangement is in writing. Then stick to the terms as though your future family relations depended on it.

Sometimes a family member who cannot give you cash will be willing to cosign a commercial loan. Again, be sure you don’t stick them with your bad management. A cosigner is equally responsible for the loan repayment. If you can’t repay your debt, they must.

Apply for a Loan

One of the best ways to boost your chances for getting a bank loan is to do some groundwork before you apply. Learn about banking procedures, policies, and constraints. Put together a business plan that anticipates what the loan officer will need from you. Banks typically have an application form they want you to fill out. But applying for a loan involves more than just filling in all the blanks. Put some time and effort into your business plan. Doing so will help you stand out from other loan applicants.

Compile the evidence you need to present yourself as a good credit risk. What does a good risk look like?

1. You are someone of good character. You are willing to work hard. You have a proven reputation as a responsible citizen.

2. You have what it takes to run the business. Your credit report shows you have a good track record when it comes to handling money. You have the business skills—acquired through education, practical experience, or both—that you need to make the business a success.

3. You have quite a bit of your own money invested. By investing your own money, you show that you are likely to work to build your investment and theirs.

4. You have collateral to support your primary repayment source.

If any of these statements aren’t true, you may need to find an alternate source of funding. If all of them are true, make sure you have the evidence to show your lender.

A word on credit reports: Expect your lender to check yours. Before you apply for a loan, before your lender points out credit trouble, order a copy and address any problems that might be on it. The largest supplier of consumer and business credit reports is Experian (formerly TRW Information Systems). If you wish to purchase a copy of your credit report using a credit card, you can call them 1-888-EXPERIAN. They can get you a copy in about a week. They also have mail-order forms available on their Web site. If you need help reading your credit report, or if you need to repair poor credit, the Experian Web site (www.experian.com) has information to get you started.

When you’ve thought through the questions your loan officer might ask and put together your loan application in a neat, easy-to-read format, it’s time to present it. Make an appointment. Dress professionally. Show up on time. Allocate enough time that you don’t need to be looking at your watch during the interview. Present your request clearly and honestly. Ask questions if you don’t understand something.

Expect your lender to ask for three sources of repayment: standard repayment, collateral, and a personal guarantee. You probably plan to repay your loan with the proceeds of your business. Expect to prove that you can do so. Expect also to be asked for collateral. Loans in which assets are pledged as collateral are called “secured loans.” If yours is a secured loan, and you aren’t able to pay off the loan, the bank takes over ownership of the asset you’ve pledged. Small business loans are often secured loans. If you don’t have collateral, you may find that getting a loan is more difficult. Don’t necessarily assume, however, that it’s impossible.

Besides collateral, your lender may also ask for some form of personal guarantee from you, the owner of the business. In other words, if you cannot repay the loan from the proceeds of your business, you must repay it from personal funds.

You may ask, “Do they really need three sources of repayment?” Perhaps not from a mere bookkeeping point of view. What they really need, what they secure by asking for three forms of repayment, is the assurance that you are motivated to repay your loan. You have to admit that the thought that they could tap into your assets or even your personal bank account is a powerful motivator. By allowing them three sources of repayment, you prove that you are both able and highly committed to repay your loan.

When applying for a loan, you will, of course, want to be as persuasive as possible. But never do so at the expense of the truth. Do not inflate your assets or your projections. If anything, underestimate your projections. Why? Not only is it unethical to overstate your financial status, it’s illegal.

On the flip side, the federal government has protected your right to apply for credit. The Equal Credit Opportunity Act (ECOA) says no one may deny you credit based on sex, marital status, race, national origin, religion, age, or receipt of public assistance income. Neither can the bank refuse to lend you money based on the personal traits of potential customers. The ECOA doesn’t guarantee that you will get a loan, only that you will not be discriminated against in the loan process. If you want more information, contact the Federal Trade Commission.

A little advance planning can save you a lot of financial worry over the years. First, make careful, realistic estimates, always allowing enough buffer for emergencies and unforseen expenses. Break down your budget in terms of number of students needed and target enrollment. Work up a detailed business plan, and develop both short-term and long-term goals. Then find the most appropriate financial partner available to you. If you learn the basics of financing a small business before you start spending money, you can build your school on a solid financial foundation right from the start.