The Importance of the Break Even Point in Startups
One of the biggest challenges faced by startups is money. Where does it come from? And how much do I need? Both can be answered if you know when you will reach your break even point. The sooner you reach it, the stronger your chances of growing and attracting larger capital.
For a startup business, there are only two places where money comes from: customers and owners. As your business grows, you will be able to get money from other places like an SBA loan, micro-loan, capital loan, or money from angel investors and venture capitalists. But those options aren’t available to a startup that’s just set the ball rolling.
Raising capital before you break even
Initially, money comes from the owners or partners of the business. Any money that is owned by them and put into the business is your capital. It is used to cover all initial expenses until revenue starts to come in from customers for using your services.
Investors shy away from businesses that are just getting off the ground and prefer to invest in businesses that show visible growth. In other words, they will invest in companies going from level 1 to level 2, but not those trying to reach level 1, and need help paying their utility bills to keep the business afloat. If approached, they advise newly formed companies to come back when they have actual results demonstrating growth and success.
Each week, month or quarter, the business has to pay expenses like rent, bills, and variable costs like the payroll of employees. If your customers are not paying enough in revenue, then the owners will have to cover the shortfall in additional capital. The smaller the revenue, the more owners have to contribute to keep the business on life support.
Make a list
Before the door to your first dollar of revenue opens, who has to pay all those expenses? The owners. At this point, they fund 100% of expenses. A good tip given by business expert and author, Cliff Ennico, is to begin by making a list of all the things you need to spend money on before you can expect revenue. After that, ask yourself: can I afford to keep this business running? If the answer is no, you need a financial partner who has the money to cover expenses until revenue starts coming in.
Reaching the break even point
When you make enough revenue to cover expenses without support from the owners, your business has reached the break even point. When you break even two things will happen:
- The people funding the business will finally be able to breathe, and
- other people will want to invest in your company if you broke even fast.
They want in because they will take that as a sign of a quickly growing company. If you are looking for investors, one of the most important questions they will ask you is how long will/did it take you to breakeven?
It’s all a matter of the verb tense you use to describe your company. Very few people will invest in a company that is “going to happen” someday, but many will invest in something that is “happening” right now. The best way to show that something is happening is reaching your break even point in a very short period of time.