The Risk of Undercapitalization

By: Toby Dahm

A horrible week came to an end with the worst moment of all - Jay had to inform his employees that he could not meet payroll that day. Instead of focusing on quoting new work, Jay had spent this week fielding calls from angry suppliers seeking payment and tracking down his company’s own balances due from customers.  His business had run out of cash.

I see this scenario played out all too often, in companies big and small across the country. The whole world watched it unfold as General Motors and Chrysler came to the brink of financial disaster. What enabled Ford to continue executing its business plan while General Motors and Chrysler endured seemingly endless scrutiny, extraordinary professional fees, and months of distraction?  In a word: CAPITAL.

Having sufficient capital enables a company to sail through rough seas and
concentrate on steering out of the storm rather than fighting the storm itself. It doesn’t matter how good your product is, how many sales opportunities are around the corner or how efficient your operations are if you can’t pay your bills. That’s right – if you can’t pay your bills, it’s all for naught.

Having capital is as important as having a keen grasp on every other of business management that inspires an entrepreneur to go into business and succeed.

Step 1
The first step in establishing capital is to know how much you will need.  A good business plan will address the capital need conservatively.  It’s important to have contingency reserves because Murphy’s Law is very real – if something bad can happen, it usually will.  There are many resources that provide assistance with a business plan including State and County Agencies that do this at no cost or low cost. You may want to check out your local SBTDC or SCORE office.

Step 2
The next step is to approach funding sources that are appropriate to your life cycle stage and industry.  Trusted advisors, such as your accountant, attorney, mentor, as well as the above mentioned government agencies can also help you with this. You may be asked to give up substantial ownership, which you will have to weigh against the risk of operating with insufficient capital, as our friend Jay did.

If you find that capital is limited, you will need to adjust your business plan to succeed on the smaller capital base.  This usually translates into slowing your growth trajectory.  If you find yourself in that position, remember that slow and steady usually wins the race.

As you build your business, keep in mind that capital is critical to making the entrepreneurial equation work.