Learn about identifying which assets you need to buy to start a small business. Also learn about the costs of getting a business started, and the detailed financial information that must be provided to attract money from lenders.
- As you know, I am now in the long-distance trucking business. Yes, I own one of those big rigs that you see rolling down the freeway. I have an operations manager who takes care of the daily details for me. - Well, let's hope you do better in your trucking business than you've done in some of your real estate deals. - Yeah, yeah, well, let's not talk about that right now. Trucking, that's what we're here to discuss, trucking. - So if I understand this correctly, your operations manager finds customers in companies that want to ship goods long distances, but don't have a big enough need to hire one of those large trucking companies.
- Correct. Now, the most difficult part of the business is finding the right customers who want their good shipped to the right place and are willing to pay the right price. - Okay, so how much does it cost to get into this business? What assets do you need to buy? - Well, to buy a used tractor, that's the front part of the truck, the part where the driver sits, it costs $52,000. Now, I paid a little extra so I could get a tractor that was compliant with California emissions standards to make sure we could take shipping jobs into and out of California. - So what about the back part, the trailer? - [Instructor] Well, the trailer costs another $10,000, plus $2,500 for tarps and straps and chains.
- [Instructor] So let's see, that puts you at $64,500. - Almost. I also needed to inject some up-front cash to make the initial payment for insurance as well as for fuel, driver compensation, and repairs, while I waited about two months for those initial customers to pay me in cash, that was another $10,000. - So you needed a total of $74,500 just to get this thing off the ground. Now, most potential small business owners often don't think through all the costs of getting their business started. Unlike you, most entrepreneurs don't make a detailed asset list, as you've done.
Now, where did you get this $74,500? - Well, similar to all small business owners, I had three general choices for financing my business. I could, one, get all of the money from my personal savings. Two, use my personal savings supplemented by some investments from other partners. Three, use my personal savings supplemented with borrowing from a bank or other lender. - [Instructor] Okay, for the sake of illustration, let's assume that you put up 34,500 of your own money and then you looked for an additional $40,000 either through borrowing or through finding a partner.
Let's explain the difference between borrowing the 40,000 and finding a partner who will invest the 40,000. - Okay, so if I borrow the money, I must guarantee to repay the $40,000, with interest. If I fail to make those payments, the lender can haul me into court and use the power of the law to force repayment. - Now, on the other hand, if your company does very well and you generate more than enough cash to repay the $40,000 plus interest, the lender does not get to share in your success. For example, if you had loaned $40,000 to Bill Gates for Microsoft's expansion back in 1975, that's the year that Microsoft started operations in Albuquerque, New Mexico, you would not have become rich from Microsoft's amazing success.
Instead, you would've been repaid just your $40,000 plus a little interest. - So a loan is characterized by a fixed, legal obligation to repay a specified amount, whether the borrowing company performs poorly or performs well. - In contrast, if you receive $40,000 in investment funds from a new partner, the partner now shares in your company's failures and successes. If business is bad and the investor is never able to recover her or his $40,000 investment, well, that's the way it goes.
The investor cannot recover the investment because the risk of losing everything is part of the nature of making investments. - However, in exchange for accepting this risk, the investor also gets to share in the success if the company does well. If you had invested $40,000 in Microsoft back in 1975, your investment today would be worth billions. - Thus, from the standpoint of the investor lender, an investment is characterized by a higher risk of losing your money balanced by the chance of sharing in the wealth if the company does well.
- From the standpoint of the entrepreneur, that's me in this case, the benefit of borrowing the $40,000 is that I'm not giving up ownership or control of my business to a new partner. I still own the whole thing. - But the downside is that you now have a fixed, legal obligation to repay the $40,000 with interest even if your business makes no money at all. If the business goes bankrupt, you will have to reach deeper into your personal savings, if you have any left, to repay the loan plus the interest. - If a new partner gives me the $40,000, I don't have the legal loan obligation hanging over my head.
If the business goes bankrupt, my partner and I share the loss. - Yeah, but with a partner, you now have to share the profits if the business does well. And depending on what kind of agreement you've negotiated with your partner, you may no longer have control of the business. For example, in 1985, Steve Jobs was forced out of his leadership position at Apple, then known as Apple Computer, because he and his founding partner Steve Wozniak had sold so much of their initial ownership of the company that the other owner shareholders had the power to force Steve Jobs out.
- 10 years later, Steve Jobs returned in triumph to Apple. But the return was at the invitation of the other Apple shareholders. He himself did not own enough of the company to force his reinstatement. - Now, whether my brother here gets the $40,000 from a bank or from a partner, he's going to have to provide detailed financial information to convince the lender or the investor to put the money into his trucking business. - Exactly. To attract the money from outsiders, I need to provide them access to detailed accounting numbers, like the ones I used to convince me in the first place to launch the business.
- Now, back to my original question. Where'd you get the 74,500? - I'll tell you off camera. - Ah.
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- Summarize the two forecasting techniques used to create a complete business plan.
- Analyze the five methods for maintaining financial records for a company and explain what kind of company would require each method.
- Calculate payroll expenses with accuracy.
- Apply the entity concept to hypothetical situations.
- Describe the process for obtaining financing from third-party sources.
- Explain the process for valuing a company.