How Much Should You Save to Start a Business?
Like many topics in finances, there is no one answer for how much you should save to start your business. But we have a simple 4-step method to help you find the right path and set realistic savings goals.
But before we get to the 4-step method, I want to answer a few common business savings questions:
Should I borrow money to start a business?
There are times when borrowing money to start a business can make sense, but borrowing increases risk and the need for income to cover costs. When possible, I recommend saving money before starting a business, especially ones that are starting out as small side gigs.
Should I mimic a friend’s business savings plan?
Don’t just copy what someone else says they needed to save for their business. Make sure it makes sense for your business. A business building sheds will have different startup expenses than a tax prep business. A remote business will have different startup expenses than a business with a physical office or storefront.
How long do I need to save?
If you aren’t starting the business as a small side gig and you are going to be depending on that business to pay your bills, you will need a lot more money before you get the business going.
It often takes businesses two to three years to produce enough income to cover living expenses. If your startup business is going to be your only source of income, it is usually best to have enough money set aside to cover two to three years of expenses, in addition to what is needed to start the business.
But what about the business itself? How much savings is needed?
4-step method for saving for a small business startup
Having a formal business plan is a great idea to stay focused and help you determine costs, but the fact is most small businesses and side gigs don’t develop a plan. This 4-step saving method will help you create a saving and spending plan for a small business or side gig startup for which you are not dependent on the income to pay your bills:
1) Create your spending vision for the business.
Research the minimum spending needed to start the business (including the initial year of operating expenses). Think about what you need versus what you want based on how you would like to operate the business.
For example, let’s talk about what I’m familiar with, the tax prep business. You could start the first year rather minimalist with as low as $1,000 startup costs. However, if you need to purchase a computer, the expenses increase. I like having a research service and a library of resources available, but it isn’t absolutely necessary. I like to have an electronic client management system, but it isn’t absolutely necessary and there are less expensive options than what I prefer to use.
Sort out your “needs” versus your “wants” and do price comparisons before you start buying, or you could end up spending more than you planned.
At the end of step one, you have a decision to make. Do you want to start with the absolute minimum so you can get started sooner and put the minimum amount of money at risk? Or would you prefer to make sure you operate the business the way you envision it. The closer you are to the perfect vision, the more money you will need to save.
2) Make a list.
Now that you have a clear picture of what you want your small business to look like, develop a thorough list of all the equipment, tools, resources, and services you need to purchase and how much it all costs. This is known as your startup costs. Here are some examples of possible costs:
- Licenses and certifications– For tax prep, you need a preparer tax identification number (PTIN) which costs $35 to renew. You may need to get a business license. If you create a business entity that will have a cost.
- Training– For tax prep, you may need to pay for tax training courses.
- Equipment– For tax prep, that could be a laptop, a printer, an electronic signature pad.
- Software – For tax prep, this cost can be small initially with a pay-per-return option or it could be several thousand dollars for more expensive options.
- Business insurance – Liability insurance may be needed, and in the case of something like tax prep an Errors and Omissions insurance policy could be needed.
- Office– You may need office space, office furniture, and office supplies. If you lease a space, you’ll probably pay for utilities too.
- Advertising and marketing– You often have to pay to reach your target customers. With the internet, there may be no or low-cost options available.
- Supplies or inventory– Sometimes you need stuff to operate the business. You can choose to keep your startup costs low by keeping this stuff to a minimum to get started.
3) Project the monthly cost for ongoing minimum expenses.
Ongoing expenses could include things like insurance, software, internet, and rental costs – anything that isn’t a one-time fee. Once you have the monthly cost, total it for the first year.
Why a year? A lot of costs, such as software subscriptions and leasing space are either annual contracts or they are less expensive paid annually.
4) Total the startup costs and the projected first-year costs. Add 50%.
Usually, you spend more than you plan. So if your startup costs and annual costs add up to $1,000, then $1,500 becomes your savings goal.
I hope this simple 4-step method helps you determine how much to save for your small business startup.
If you would like a little more detail, the Small Business Administration offers great advice and resources to help you determine the costs of a business startup.