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The Importance of Business Capitalization and Methods to Achieve It
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| The Importance of Business Capitalization and Methods to Achieve It |
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More than six out of seven businesses fail in the first two years of operation, in the best of times and in the worst; the leading cause of failure for most businesses isn't that their product or service had no place in the market. It stems from inadequate cash flow, and inadequate capital reserves.
Standard business school metrics say that a business should have cash reserves equal to three years of projected operating expenses before starting. Most businesses don't see this at all, which is one reason for the "business failure" metric cited above; as a result, most businesses run into cash flow issues.
With tightening credit markets, and banks becoming more and more reluctant to take on new debt, cash flow issues can become toxic to a small business that's undercapitalized.
There are several ways to secure adequate capital; most of them start with a meeting with your local Small Business Administration. The Small Business Administration is a federal program administered through counties to help small businesses get the capital they need to launch successfully; there are federally guaranteed loans, and programs to get grants for certain types of businesses. To get an SBA loan, you need to present a solid business plan that will be presented to members of your local business community for evaluation.
An SBA loan is the first choice for a small business capitalization effort, but it's distinctly limited – an SBA loan cannot go above $20,000. There are grant options for business started by a minority member or a woman, often to the tune of $5,000 or so.
Another service that you can get from the Small Business Administration is a SCORE consultation. SCORE is an acronym for a group of retired executives who talk to small business owners as they're starting out, and make sure that their business plans are based on sound logic and reasoning and clear understanding of financials, rather than dreamy eyed "If we build it, they will come."
Your initial marketing effort can also be used to generate positive cash flow, if it's done right. If your business involves regular contact with customers, tying some of your business communications into a business affiliate program can help underwrite some of the costs; while there are lots of sites on the web talking about the miracles of affiliate marketing, the short answer is that it's only an adjunct source of income.
The second type of business investment is personal equity; this is capital you put into your own business. In most cases, due to tax liabilities, this is a suboptimal solution for financing your business. However, for small businesses, or businesses with low operating expenses, it can be made to work. A related way of doing this is to recruit an equity partner or investor. This can be a friend, a collaborator, or a family member, or you can simply look for small investors. The drawback of having investors is the loss of perfect autonomy; you're now responsible to your partners to maximize their return on investment.
The ultimate equity investment is selling shares of stock in your company. Most companies that are capitalizing through stock investment have established themselves in their niche, they've demonstrated both positive cash flow and profitability, and they've built up their brand, or have a product that is capital intensive to bring out, but that they expect to do well in the market. There are lots of regulations on taking a company private, and it's beyond the scope of this article to give more than the basic guidelines on this. Weigh the options carefully; a privately held company is much more flexible, but has pre-defined boundaries to how far it can reach and the scope of its business ventures due to capital limitations.
The last type of capitalization plans are loans from private lending institutions. These come in two forms: Secured and unsecured loans. Secured loans to businesses require that you put up some sort of collateral, which may or may not be a tangible asset, such as a building, or a piece of equipment. It may also be intellectual property, though this is rarer. Unsecured loans require that your business reveal financial records to the lender, describing income, expenses, and where the general revenue sources are. It's not quite as invasive as going public and selling shares, but it's up there. Unsecured loans to small businesses have all but dried up since September of 2008, because of the credit market implosion. When General Electric has to pay 10% on an unsecured loan to make payroll, it's almost impossible for a small business to get a loan at all.
If you find yourself short on capital, and your quarterly financial paperwork should give you a clue on this, you'll need to make some hard decisions. Some generalized advice: Focus on what is and is not generating revenue and cash flow for your business. Talk to your customers and assess their needs, and focus on what sort of products will meet those needs.
If you have to make painful decisions, like downsizing departments, or cutting back spending, assume that it's worse than you think, and cut deeper than you think you need to. If you expect to lay off 15% of the work force to make your expenses work, lay off 20%, and make sure some management is in there. When laying people off, focus on the least productive ones. Your A list and B list employees will be grateful that the deadwood has been cleared out.
Be honest, and ask lots of questions about what is and is not working. Everyone expects to tell the boss what he wants to hear, not what he needs to hear, especially when finances are bleak.
In the end, the best way to avoid capitalization issues is to be constantly aware of your business' financial aspects, and its place in the market. You may be in an untenable situation; buggy whip manufacturers are all but out of business these days. Be honest about that as well, and know when it's time to make the painful decision to walk away.
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