Start-Up Costs: How Much Does it Cost to Start a Small Business?
The old adage, “You have to spend money to make money” is often true when it comes to entrepreneurship. Before starting a business, owners may need to make a number of investments, often called start-up costs, to get things off the ground. Calculating start-up costs involves a number of variables and a significant amount of research. It’s important to completely understand what your start-up costs will entail, the estimated total and how you will secure the money to pay for these costs before launching a business.
In this post, we’ll explore what it really costs to start a business.
Average costs to start a small business by industry
General start-up costs
One-time vs. ongoing costs to consider
Essential vs. optional costs
Fixed vs. variable costs
Tips for calculating your start-up costs
Deducting start-up costs on your business taxes
Determining financing methods for your start-up
The Small Business Administration tracks statistics on start-up businesses across the country. While the majority of small businesses (15.1%) begin with less than $5,000 capital, the amount required differs widely depending on the industry and business type.
According to Dr. Robert Kovacev, professor of entrepreneurship at California State University, Fullerton, some of the biggest variables include whether the business offers products or services (products require more start-up capital) and whether the product or service offered is new and unique in its market (introducing something new requires more start-up capital).
|Start-up costs by industry|
|Industry||Number of Small Firms||Amount of Start-up Capital Most Required||Examples of Business Types in Industry|
|Other Services (Except Public Administration)||4.2 million||15.1% required between $10,000 and $24,999||Machinery repair, laundry services, dating services|
|Professional Scientific and Technical Services||4 million||25.4% required less than $5,000||Legal advice and representation, accounting, veterinary services|
|Construction||3 million||19.8% of required less than $5,000, but 14.8% required between $10,000 and $24,999||Prime and sub-contracted construction at job sites|
|Real Estate and Rental and Leasing||2.7 million||16.9% required less than $5,000||Real estate agents and brokers, commercial equipment rental companies, establishments that license patents|
|Health care and Social Assistance||2.6 million||11.8% required $50,000 to $99,999, 11.5% required $250,000 to $999,999, 11.1% required less than $5,000||Hospitals, nursing homes, child day cares|
|Retail Trade||2.5 million||14.7% required between $100,000 and 249,999||Gasoline stations, clothing stores, grocery stores|
|Administrative, Support and Waste Management||2.3 million||23% required less than $5,000||Employment services, travel agencies, waste collection|
|Arts, Entertainment and Recreation||1.3 million||17.5% required less than $5,000||Performing arts companies, talent agents, amusement parks, casinos, museums|
|Transportation and Warehousing||1.2 million||15.4% required $10,000 to $24,999||The National Post Office and its subcontractors, the airline industry, the freight trucking industry|
|Finance and Insurance||939,578||15.4% required less than $5,000||Fiscal agents for the government, securities and commodities brokers, insurance policy underwriters|
|Accommodation and Food Services||848,356||19.4% required $100,000 to $249,000||Hotels, RV parks, restaurants|
|Wholesale Trade||716,037||12.1% required less than $5,000 and 11.1% required between $100,000 and $249,000||Wholesale electronics market agents and brokers, paper product wholesalers, motor vehicle merchant wholesalers|
|Educational Services||702,103||20.2% required less than $5,000||Private and public elementary schools, trade schools, universities|
|Manufacturing||591,180||10.6% required $100,000 to $249,999, 10.5% required $10,000 to $24,999, 9.5% required $50,000 to $99,999, 9.2% required less than $5,000||Textile mills, plastic production, food processing|
|Information||397,319||17.5% required less than $5,000||Web hosting, music recording, publishing|
|Agriculture, Forestry, Fishing and Hunting||261,186||11.7% required $50,999 to $99,999, 11.2% required $100,000 to $249,999, 10.8% required less than $5,000, 10.6% required $10,000 to $24,999||Ranches, orchards, hatcheries|
|Mining, Quarrying, and Oil and Gas Extraction||128,204||12.9% required less than $5,000||Petroleum mining, well drilling, mineral exploration|
|Utilities||25,059||10.4% required less than $5,000, 10.2% required $25,000 to $49,999, 9.9% required $250,000 to $999,999||Electric power distribution, sewage removal, water treatment|
“There are a lot of things a small business owner needs to take into consideration before even launching or opening a business,” said P. Simon Mahler, a certified small business mentor with SCORE, the nation’s largest network of small business mentors.
Though your exact start-up expenses will depend on your business’s type and unique needs, here are some general cost categories to plan for:
- License and permit fees
- Equipment, including computers, software, development equipment and furniture
- Office and storage space
- Inventory or the materials needed to manufacture inventory
- Office supplies
- Website design and hosting
- Business cards and other hard-copy marketing collateral
- Accounting and/or legal services
“You don’t need a tremendous amount of supplies to start a business,” Mahler said. “Run your start-up the best you can using the least amount of tools you need to have an effective start.”
Once you’ve established the types of start-up expenses your business will likely incur, it’s important to determine if they are one-time costs or ongoing costs.
“One-time costs are really capital costs,” said Kovacev. “That includes such things as machinery and equipment, lease costs, facility improvements and software licenses. You spend once and benefit from these expenditures for long periods of time.”
Ongoing costs are comprised of things you pay monthly or as needed over time; for instance, salaries for labor, materials for new inventory or maintenance on machinery.
“There are far more ongoing costs than one-time costs,” Mahler added. “Oftentimes, the one-time costs have a lot of ongoing costs that business owners overlook, like utilities and maintenance. I don’t actually know many one-time costs of starting a small business, because no matter what you think is one-time, there’s always some ongoing expense to keep it going.”
When creating your start-up’s financial plan, account for one-time costs and also budget for ongoing ones for at least a year ahead. If you can, forecast ongoing costs even further into the future to help you understand and plan for those needs.
When starting a business, it can be a challenge to weigh the “must-haves” against the “nice-to-haves.”
But, when you are in start-up phase and not yet generating income, it’s even more important to spend only on what you need.
“I advocate for the ‘lean’ methodology. How lean can you go to generate that first dollar? Be frugal,” advised Mahler.
Kovacev echoes this sentiment.
“If it’s not absolutely essential for you to conduct the business, don’t spend it. That’s the simple rule,” he said. “Go through whatever costs you can think of and say, ‘Can I do without this? At least for the first year?’ If you say, ‘Yes,’ then you don’t spend it.”
Essentials are the things you must have to actually run the business, like a place to work, core staff and materials. For example, a hair salon would need a storefront, chairs, mirrors, hairdryers and basins to wash hair.
Optional costs are things that you don’t really need, but make running the business easier. Using the salon example, a receptionist would be optional, as would dryer chairs that allow stylists to process clients more quickly. These things are considered optional because the business can operate without them, though it may operate more efficiently with them.
Some business costs always remain the same, while others fluctuate based on certain factors. Fixed costs, also called indirect costs, are the same no matter what is going on with the business. These costs are not linked with creating a product or providing a service.
Kovacev said, “Whether your business is selling one item or 1,000 items, you still have to pay rent, you still have to have a phone, you still have to pay people to come to work in the morning.”
Variable costs, also known as direct costs, change depending on how much you are making or selling. They are directly proportional to the number of units you build or sell. Variable costs include materials, freight and commissions.
“The variable costs are what people sometimes miss,” said Mahler. “For example, if you pay salaries, which are a fixed cost, you might offer quarterly commissions, a variable. That’s easy to forget about and then all of a sudden, it’s time to pay them out and you didn’t save enough money.”
When calculating your start-up costs, be sure to plan for both, and keep fixed and variable costs distinct. Doing so will allow you to conduct different calculations to determine how to maximize efficiency and resources within the business.
Both Mahler and Kovacev agree, the top tip for calculating start-up costs is to do research.
“For whatever reason, small business owners put together their business plan and their pitch deck, and when it comes to estimating start-up costs, they throw a number on the paper and hope it sticks,” Mahler explained. “They really need to determine why and how they have come up with this number. You need to know not just what it will take to open the doors, but what you will need to stay open for six months of ramp-up.”
List your expenses
Make a list of your essential investments and figure out what they will actually cost. To do this, you can get in touch with others in the industry or ask potential vendors for quotes.
“Connections are an important aspect of starting a business. You need to have an advisory board of people in the industry who are supporting you and telling you what you need to know,” said Mahler. There are also free online calculators and resources from organizations like the SBDC and SCORE to help small businesses with expense planning.
Some things will have clearly defined costs, like business licenses or computer hardware. Others will need to be estimated, like salaries and marketing campaigns. Determine which investments require ongoing expenses and be sure to calculate at least a year’s worth.
“Pretend you’re really in it and think about what you’re going to face,” added Kovacev. “It’s probably the hardest part of starting a business.”
Assess your assets
Determine what you already have that you can put toward starting your business. This can be personal savings, retirement accounts or other valuable assets like cars or property that you can sell off if necessary.
Even if you do not plan to put personal resources toward your business, you might need to use your assets to sustain your personal life so you can continue to afford things like your mortgage and car payments when you are not yet making a steady income from your business.
Project your cash flow
Cash flow measures the money you have coming in versus the money you are spending. Making cash flow estimations will help you know when the business should become self-sustaining.
That will become an important milestone in your planning.
“Also, investors in small business look at when you are going to start having positive cash flow when deciding whether or not to invest,” explained Kovacev. “If it takes too long to start making money, they may not be willing to invest.”
Connect with funding sources
Now that you know how much start-up capital you need and for how long you’ll need it, the next step obtaining that money. Depending on your unique situation, you may prefer to borrow from family and friends, use a crowdfunding platform, secure a business loan, seek venture capital financing or use another funding method.
Something would-be entrepreneurs may not be aware of is that they can deduct some business expenses incurred while in start-up mode. Start-up mode technically lasts during the business planning and development phase. As soon as the business is operational and you are conducting transactions with customers, that phase is over.
What can you write off?
Development costs are one of the biggest categories where start-up businesses spend. These costs include competitive analysis, travel for research purposes and employee salaries. “You can write off the labor and materials for product development,” said Kovacev. “It’s important to keep track of all your labor and material costs, because you can write these things off many years in the future. You can get an investment tax credit for when you are actually making a profit. Many companies don’t think of this until it’s too late and they can no longer resurrect that data.”
Start-ups often spend on business organization costs when launching, which can also be amortized and deducted.
Kovacev explains there are other business expenses that can be written off once the business becomes operational.
“Under the new tax law, now you can write off any capital investment in the year it’s made, which is huge. It used to be depreciable, but now you can write it off as you spend the money, which is a big plus on your taxes.”
He also noted that businesses can write off operating costs such as labor, materials and overhead as they are incurred against revenue.
How much can you write off?
If your start-up costs are less than $50,000, you can deduct $5,000 of business start-up costs and $5,000 of organizational costs. If your start-up costs are more than $50,000, your deduction is reduced by the dollar amount above $50,000. For example, if your start-up costs are $51,000, you can write off $4,000. If your start-up costs were more than $55,000, you don’t qualify for a tax deduction.
How do you claim start-up cost write-offs?
Businesses generally claim start-up cost deductions in the tax year the business officially opened, though some costs can be amortized over the lifetime of the business. Consult with your CPA or tax attorney when determining the most advantageous way to file your taxes.
Now that you know how much money you need to start your business, where do you find it? There are many options for small business funding, some of which include:
Personal savings or assets
Some entrepreneurs choose to tap into their personal savings and retirement accounts to fund their start-ups. Others might take a second mortgage on their home. While this type of cash is comparably easy to access, the risk of losing these assets and damaging your personal credit in the process is great.
For a relatively low fee, start-ups can launch a campaign to fund their projects. Crowdfunding campaigns inherently help businesses build awareness and market validation while securing financing. However, they are typically “all or nothing,” meaning that if you don’t meet your fundraising goal, supporters won’t be charged and you’ll receive nothing from the campaign.
Line of credit
Business lines of credit let companies borrow against a set amount as needed. They function much like a credit card in that you only pay interest on what you borrow and the amount is revolving – once you pay it off, that full amount is available again. A line of credit will help a new business establish a credit history, which will be invaluable as the company grows. But, if the owners don’t have good personal credit, a business line of credit can be difficult to obtain or the interest rate may be too steep.
Small business loans give companies the ability to make investments to fuel their growth. Traditional bank loans may be difficult for start-ups to obtain, because many banks require robust credit and operational histories. Alternative lenders offer more relaxed requirements and can fund loans quickly, but their interest rates are generally higher than banks.