Raising funds is an integral part of owning and operating a small business. In order to make your ideas become a reality, there need to be enough financial resources available to assist in the process.
Gaining funding for a small business is notoriously difficult as they may not always have proof that they can yield profits. In order to be successful when securing funding there are a number of steps that need to be taken.
In this article, we will give you all the information you need to finance a new product for your business.
![Financing A New Product [What You Need To Know]](https://www.business101.online/wp-content/uploads/2022/11/Financing-A-New-Product-What-You-Need-To-Know-1.jpg "Financing A New Product [What You Need To Know]")
Analyze The Costs Of New Products
No matter how good your idea for a new product is, it must be extensively tried and tested to be the best possible product it can be.
When the product is ready, it’s important to analyze this and create a detailed business plan to determine how much it will cost to produce the product on a large scale and determine the potential profit margins. To do this you are going to have to make some assumptions about the number (volume) of products sold per period. You should consider a ramp up period to see how long it takes to get to a volume where the financial returns are adequate. Of course each product should have a positive gross margin, but once you allocate overheads it could be a different story - so it's really important to understand your breakeven point and then work out what sort of funding run way you need.
Once the detailed analysis has been drawn up, it will help to determine how much more money is needed to fund the product. This money could be money the business has already or the amount of money the business needs to secure from other sources.
Controlling Product Development Costs
Controlling the costs is essential for small businesses, especially when developing a new product. It’s easy to let these costs run away with the process when it comes to a new product, but there are a number of ways to cut costs that we will indicate here:
- Set a budget that you want to stick to in advance
- Keep track of spending throughout the process
- Introduce phased investment for each new development stage
These costs include anything from hiring out a factory to market research efforts. There can be a number of hidden costs during this time which is why planning is so important.
Estimating Costs
To estimate the costs of a new product there are a few ways to go about it. One is to take a top-down approach in which previous similar projects are compared and used as a benchmark.
Looking at competitors and analyzing their financial plans and performance is a good way to do this.
The opposite is to take a bottom-up approach, this is where the costs the business will incur are agreed upon by everyone, and then one project manager estimates the total.
Funding Options
There are a number of different funding options available for businesses, these include:
Bank Loan
Bank loans are an obvious place to start when it comes to securing funds to create a new product. Business loans are a common way to gain funding and there are a number of different kinds to choose from (see also 'Can I Loan Money To My Own Business?').
Unfortunately, these loans are difficult to obtain especially when you are a small or new business. This avenue is the most difficult as the business doesn’t have a history of running a successful business to prove they can repay the loan eventually.
Another downside to going down the bank route is that these processes usually take months to go through, which can mean a lot of work must be done for a potentially negative outcome.
Angel Investors
Angel investors are individuals who will provide funding from their own personal finances. In return, these investors will receive shares in the business in return.
This is often referred to as ‘seed funding’. Seed funding gains its name from the idea that it’s an early investment.
These types of funding can come from wealthy individuals who are interested in the product or even friends and family that can afford to provide this funding.
Venture Capital
Venture capital is a form of financing that investors provide to small businesses with capital that is believed to have long-term growth and potential.
This private equity doesn’t always have to come in the form of monetary gain, it may also be in the form of technical or managerial experience.
Contrasting to angel investors, these are usually larger businesses and corporations that specialize in small business growth. To impress these investors, you’ll need an impressive business plan and a solid idea that will yield on their investment.
Grants
Government bodies and funding schemes are a great way to raise capital for a small business. Although often overlooked, the wide variety of grants available can help out any kind of business.
Depending on how much money the business needs to borrow and the type of business it is will influence the type of grant it may be eligible for.
It is important to research the grant in depth to ensure the business qualifies. All the relevant information is available on the corresponding websites. There are usually tools that allow you to find quick answers to any eligibility questions.
Crowdfunding
Crowdfunding has become an increasingly popular way to create a startup business. Originally made popular due to charitable organizations, many realized this would be beneficial for new businesses.
There are a number of websites that facilitate this idea such as Kickstarter, Crowd2Fund, and Funding circle. Businesses must make a case for their products or services and appeal to the public to prove that their business is worth investing in.
Those that donate to these causes will not receive anything in return.
Purchase Order Financing
Purchase order financing is an effective and popular option for businesses that can follow this model as they are quick and effective. These methods provide funding for businesses with purchase orders by paying suppliers and helping get the product to the customer.
For example, a business will receive an order for one t-shirt which will entitle them to the amount of money it costs to get the product from creation to shipment. As long as the orders are coming in then the business will continue to receive funding.
Pre-sales
Similar to the crowd funding option this method involves you going to your customers with the prototype or idea, then getting them to commit to buying it when it comes out. You could be creating a new digital marketing course but want to see if your idea is something customers want to buy. So you make sales funnel, and get instant feedback from your existing client base to validate your idea, the price point and what they want to see in the product. A business that does this well is Thrive Themes. You can read their case study here.
The best part of this option is that you get paid in advance to create the product or service!
Personal Investment
Personal investments are not practical for many small business owners as creating a product can be extremely expensive. The scale and type of product will heavily influence whether or not personal investment is a feasible option.
Funding your new product with your own personal finances can be a risky choice as many people lose their hard-earned savings and have nothing to fall back on.
On the plus side, those investing all their own money will be in sole charge of the business and any profits that it will generate. Those that have a large personal fortune will find it much easier to personally invest in their business.
The Bottom Line
When planning any investment, identifying how much the business has to gain from the new product is the most important decision. If the new product will not be viable or profitable for the business, then it will waste time and money in trying to get it off the ground.
Frequently Asked Question
What Are The Three Methods Of Financing?
The three methods of financing that help to fund a business are internal funds, organizing debt finance, and arranging equity finance. Each of these methods has positives and negatives and should be thoroughly researched before deciding on which will work best for your business.