The Importance of Capital When Starting a Business

As a banker, I often hear the lament of new entrepreneurs facing challenges in some of the aspects associated with starting a business.

First let’s recognize that any business, whether new or established, needs cash to pay the bills. So, where does it come from? At startup, the owner as the risk-taker has to furnish cash to capitalize their project. Most people understand they need to have cash available so their bills and rent get paid. If, however, the target assumptions are not met, the owner may have to put forth their own funds to help get past the point of sustainability.

Sustainability occurs when profits are sufficient to replenish the cash account. If this does not occur for an extended period of time, then the question arises, when will this business become profitable?  If the answer is unforeseeable, it may be time to reevaluate your business plan.

Why don’t lenders immediately jump in and assist with cash shortfalls? Because adding debt to an enterprise with unsustainable cash flow and profits is a losing proposition. That aside, lenders do not own shares of the business or receive future profits as a return on investment, nor do they participate in day-to-day management decisions. While the entrepreneur seeks independence he or she may forget they need to ensure they have enough gas in the tank to get across the desert.

The single biggest reason for business failure is a lack of capitalization. Even when established businesses suffer economic downturns, experienced owners know they are the ones responsible for refuelling their working capital. Sure, banks can help at that stage because there may be a demonstrated track record, fixed hard collateral assets and strong resources in the form of personal assets behind the owner. However, at startup, it is unrealistic for a financial institution to place depositor’s money at risk when the owner has not invested enough to carry the load.
Besides your articulated business plan, you might consider the following to ensure you have enough capital at startup:

1. That your cash investment covers all plant, equipment and leasehold costs PLUS at least six months of fixed operating costs including allocation for heat, power, rent and salary to owner. This will help cover external living costs such as mortgage or rent, food and other necessities (spousal income helps here).

2. Leveraging personal assets such as home equity to compliment cash investment; the idea here is that when the business becomes sustainable, it can repay the owner.

Planning out the capital you have available at startup is essential to ensuring your business has a chance at success, as you build and strengthen it during the early stages. Be sure you consider not only how much money you need at startup, but how much you will need to keep it going.

Roger Downie is a Commercial Account Manager with BMO in Kamloops, B.C.