Capitalization New Year Resolutions
This is the second article in a series where I am discussing the 2002 Small Business New Year resolutions I have suggested. The category of this week's topic is "Capital," or more importantly, finding the capital needed to maintain and grow your business.Resolution One: I resolve to spend more time considering my company's long-term capital requirements, and develop a strategy to meet those requirements.
The operating environment of a small business often looks more like a reactionary black hole than a proactive supernova. Far too much of our matter and energy are pulled inward by the insidious gravity of the crisis-of-the-day (sometimes, of-the-hour), leaving precious little mass for the long-term strategic planning required for you to boldly go where you want to go.
The first challenge is to be disciplined enough to resist the gravity of crisis management and allocate the time necessary to think about and create a plan for where your business is going over the next 3 to 5 to 10 years.
The second challenge, and this is the big one, is figuring out how you are going to fund that trip. Growing your businesses with a healthy capitalization plan can't be accomplished during a retreat or one Sunday a month. It requires daily attention to detail on everything from purchasing to gross margins to employee and owner compensation, and so on, all of which help you maximize profits - the very best source of capital.
When you accomplish this resolution, you will be aware of capitalization issues every day, not just the day it hits you that you need cash.
Resolution Two: I resolve to identify new opportunities to capitalize my business, especially those that rely more on retained earnings and less on debt.
The three traditional ways to capitalize a small business are:
• Invested capital from the founder or other investors
• Borrowed funds from banks or individuals, including from the founder
• Retained earnings, which are profits left in the business
The challenge is to have the discipline to capitalize your business with a healthy ratio between these three sources.
Virtually every small business uses borrowed funds from banks for growth capital more than from direct investment and profits. The primary reason is most of us don't start our businesses with lots of personal investment, and operating profits, when there are profits, are typically not significant enough to fully fund even modest growth. Consequently, we get the big bucks from the bank.
The good news about investment capital is there is no debt service, as you have with a loan. The bad news is, outside investment capital comes with humans whose ownership position dilutes yours, who will want you to be accountable to them, and who will want an exit strategy. Having said all of this, I still see outside investment capital becoming a more prominent factor in capitalizing small business in the future.
Two other ways to capitalize growth that should be considered are:
1. Creative relationships with vendors, including consignment, vendor financing, and Just-In-Time shipping so you don't have to buy a product until you have it sold.
2. Leasing opportunities may be available when you need to add equipment, technology, or rolling stock. Instead of borrowing the money from the bank or paying cash, lease the stuff from the manufacturer. This frees up your borrowing base with your bank, and depending on how the lease is structured, it may not show up as debt on your balance sheet.
Don't put too many of your capitalization eggs in any one basket.
Resolution Three: I resolve to identify how much working capital could be available if I improved my accounts receivable and inventory management practices.
In this space last week, I talked about the importance of managing with current accounts receivable and inventory information. This resolution is about using that information to help you fund growth.
Accounts receivable and inventory are both excellent examples of assets that contribute to the equity in your business. But every penny you have tied up in aging A/R and unproductive inventory is cash you can't use to fund growth. If you have a lot of A/R in the "Over 30 days" category and significant dollars tied up in inventory items that aren't selling, that means capitalizing your growth will have to come more from other sources, probably a bank loan.
Before you go to the bank for a loan, take a hard look at these two line items on your balance sheet and determine how much less you would have to borrow if these areas were cleaned up. That thump you hear when you add the numbers up may be your jaw hitting the top of your desk.
Resolution Four: I resolve to determine what the next level of growth is for my company, and create a plan to fund that growth.
Do you need to add inventory lines? Is there a chance you could acquire a competitor? Should you expand to another location? Do you need to hire more people? Acquire more technology? If any of these are a possibility, how are you going to pay for it?
Even if you don't know what the opportunity will be, there probably will be one. The challenge is to have a financial plan in place that will allow you to move fast if you have to. The plan will likely include some debt - probably from a bank. That's cool. But you will have a better chance of getting the loan if you can demonstrate to your banker that you have been building a strong balance sheet in anticipation of this opportunity.
Banks can be very handy in helping you react quickly to an opportunity. But they like to know that you are committed, too, and are prepared for this step. For example, if you need new equipment that requires you and your staff to get new training, your banker will likely be happy to lend the money for the equipment if you show that you are paying for the training out of profits you left in the business.
If you show up at the bank with a "great opportunity" you want the bank to fund 100%, your chances of getting that loan are, as an old mentor of mine would say, "like the chances of a wax dog chasing an asbestos cat through hell."
The best way to make a bank move quickly is to show them that your capitalization plan is already in place, and their participation is just the final step.
Resolution Five: I resolve to be better prepared for a potential economic shock by having more working capital reserves.
As horrific as the events of 9-11 were, another act of terrorism is not the most likely thing that could threaten your small business. Here are more likely possibilities:
• Your untimely death, of a debilitating illness or injury.
• The state or local highway department could decide to conduct major construction in front of your store, causing customers to stay away in droves.
• There could be some bad press on one of your major lines, like the folks who sold Firestone tires.
• A major customer could take bankruptcy and take a big chunk of your A/R with them, plus the loss of future sales you were counting on.
There are many threats that could be looming out there in your business's future, and a good chance that you will experience one of them. Make sure your business is not one surprise announcement, phone call, bulldozer, or press release away from failure. The only way to protect your company from these events is to have working capital reserve. And the best way to do that is to maximize retained earnings and minimize debt.
Write this on a rock... In the future, small business owners will have to be more sophisticated and creative in capitalizing their businesses. This includes more reliance on retained earnings and other funding sources, and less on debt.
