The Practical Realities of Capitalizing a New Business
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Winter 2022
Each year, thousands of individuals open businesses across the USA. Most of these businesses are for-profit entities designed to earn a profit and establish shareholder value. The individuals running these businesses make valiant attempts to open the doors. This is the process that we will discuss today – opening the doors of a new business and keeping them open via capitalization.
Capital is the lifeblood of any business. Like the human body, a business will not survive without capital or minimum amount of capital. Thus, the business owner must give immediate consideration to capital. There are two types of capital in any business: 1) start-up capital and 2) working capital. These two concepts are very simple. Start-up capital involves money that gets the doors open. Working capital is capital that pays the bills. Let’s address start-up capital.
The typical business owner will raise capital to: register the business, secure business licenses, pay lease deposits, purchases furniture and equipment, secure marketing activities including website design and general advertising, among several other activities. A properly drafted business plan will have addressed these items and budgeted for them. If the business does not have sufficient start-up capital, it likely cannot open its doors to attract customers or clients. Thus, adequate start-up capital is crucial to getting the business off the ground. Many business owners typically have saved enough to start the business. The area that is given less consideration involves working capital.
Some business owners genuinely believe that “when the doors open, the customers will come.” Yes, this can be a truism for certain businesses where there is a high demand for a product or services. Such a truism is rare for most businesses. Instead, there will usually be some form of sweat equity to attract customers or clients to a business’ product or service. It can be unrealistic to expect customers or clients to suddenly appear at a business because of an attractive product or service. The business must make some effort to attract these clients or customers who become the lifeblood of a business and will offer the cash flow to sustain the business; thus, the need for working capital.
A business owner should plan for at least three (3) months where zero customers or clients will not appear. Yes, three months of zero revenue at a minimum. This standard can increase to six months or even a year if the business offers a unique product or complex set of services. Given this challenge, it is incumbent upon the business owner to budget for at least three months without working capital so that the lease gets paid, new employees receive their wages, taxes are remitted, and supplies are purchased. If proper budgeting does not address working capital, the business is potentially doomed to failure before it ever gets started.
In the end, working capital considerations must always be made as a part of the start-up process. If not, the business will be scrambling out of the gate for additional funding sources that could have been gleaned prior to opening the doors.
-- JER