The term “capitalization”is substituted as accounting to define the cost of equipment written off as depreciation over the years of my business. It is also described as the conversion of retained earnings into capital and the conversion of an operating lease into a capital lease.
In this situation, capitalization translated to generating money allowing a business to pave new ways. It can also be referred to as backing, funding, capital investment, and owner’s stake.
The way you capitalize on your business can have long-term impacts on the success of the company. Funding business expenses, operations, and inventory is a challenging task for numerous business owners. It is essential to understand and explore various available options to entrepreneurs, along with their pros and cons.
Capitalizing Your Business
Capitalization is the initial investment or seed money for a startup business, and it is typically the investment that the business owner and any other investors make in the company. Along with operating cash flows, it allows you to start, continue operations and grow the company by:
- Paying for assets like vehicles, equipment, and real estate.
- Funding growth by buying inventory, hiring staff, financing receivables, and others.
- Providing reserves for the inevitable rough situations.
Capitalization can include both debt and equity, although companies usually prefer to keep debt to a minimum.
Forms of Capital Come at Varying Prices
Business would be convenient if the providers of capital expect you to pay an equal price for it. However, it is not the case and there are no free buffets in the deal. Unless you have a friend or family member granting you an interest-free loan, there will always be a cost of capital you are required to pay.
The entire reason you require capital is so that you can grow, but that does not imply you should be willing to pay any price for the capital. If you overpay, you will not grow as fast as you aimed for. Thoroughly weigh the cost-benefit analysis before you sign anything and ensure to create a realistic sense of the general objectives.
Carefully Carve Your Objectives
Mostly, the business owners in need of capital can be categorized into two groups.
- You are running a lifestyle business. You want your business to certainly grow, but you are not trying to hit a huge home run. If you do grow, you are not rigid on growing as quickly as possible. There is nothing wrong with this, it is your business so you can decide you are not trying to operate the next big company. As capital equals growth, if you need less growth, you’ll need less capital. As you are not trying to create a huge company, you cannot afford to pay a high capital cost.
- You have high ambitions. You are willing to go all the way to grow your business and create something big. You want the whole world, and it is urgent. If this is your objective, you are on the other edge of the equation: More and faster growth requires more capital. If your business is going to grow, you can afford to pay a higher price of capital.
Select an objective, urgently. You might be able to get away with changing your perspective. Each objective needs a unique business model and therefore a different approach to increasing capital.
Now that you have understood there are some ways to increase capital are costlier than others and that your capital-increasing strategy should show your objectives. While you are choosing an objective, you may fall victim to an entrepreneurial trap, i.e., too much optimism. Business is a challenge, and it is even more challenging if you have never operated a business before. Entrepreneurs, especially first-time entrepreneurs, are prone to overestimate their sales and underestimate the expenses.
If you overestimate the numbers, the tendency to make scenes more rose-colored than they actually will spread to how you manage your whole business. It will show that, at some point, you are not open to feedback you get, and it may represent that you do not have the courage for entrepreneurship. The odds of success for your business are higher if you accept the truth from others and more importantly to yourself.
Seeking the Money from different Sources
Start with an extensive business plan that includes the educated, best guess on the objectives and goals of your business, your target market, how to get customers to purchase from you, how much money you require, when revenue will start to generate, and how much will be it.
Model your financial scenarios to predict your business will turn out to be cash-positive, and thereafter, you’ll be able to pay back your investors, no matter if they are family, friends, or yourself.
It is effective to assess your funding sources. If you can finance the project out of your wallet, you can retain complete control over the venture. A bank loan implies monthly payments, interest expenses, and debt covenants. External investors like angel investors, individuals who are willing to invest in your business with promise, venture capitalists, and private equity groups all need equity in the business in exchange for their invested capital.
The investors need proportion ownership of the business since they have individual financial goals that for them are more valuable than your goals. If you are interested in pursuing external investors, it is expected that your business plan will be required to show considerable growth within three to five years for them to offer these kinds of investors an exit strategy.
Equity financing shows that an investor is purchasing a stake in your company. Unlike the debt, there is no loan you are required to repay—by investing in your company, the investor is along for the ride, no matter how rough. Equity suggests ownership, which could be in shares or stocks, partnership interests, or if an LLC, equity is given in the form of interests.
An equity investor will also have a say in your business’s decision-making. If you are confident in the investor and they bring skills to the table that address your weaknesses, this can be a great thing. When you invest in a company, they bring discipline to every aspect of the operations.
It is great to get an equity investment from an experienced investor who knows how risky it is. However, if it is not an experienced investor, or it is a friend or family. They need to know that there is a good chance they could lose the whole investment. It is best to be straightforward and transparent to manage their expectations—equity investments in private companies are risky business. If they expect they won’t lose all the money, they will be infuriated if they do.
You can’t get equity financing from a bank. Your best bet is to ask people in your network about potential investors. You may also use LinkedIn to find and get introduced to the locals who invest in private companies.
As obvious, the drawback of equity is you are no longer in complete control of the business as you are given a proportion of your equity in exchange for funds. In some cases, equity investors may also be entitled to a proportion of profits.
There are various ways to bring on debt in a business, but for most small business owners it will be through working capital or taking out term loans/not. Remember that working capital is supposed to be for short-term uses of money against a term loan/note which is supposed to be for longer-term use of money. If you decide to take on extra debt through a term note, then you need to consider how that may affect your monthly cash flow. You should ensure you have created a healthy business cash reserve just like you would do personally. Some business owners also seek loans from friends or family, but that’s a complicated option. Establish a good overall total banking relationship with a bank and look at the types of loans including SBA loans, regular term notes, and equipment loans.
Cash Flow Financing
When you grow a successful business, you are expected to arrange a type of salary that you take for paying your basic bills. Each month that you have excess profitability, you’ll be shown the option of taking a shareholder distribution, growing your business bank account, or using the money to make strategic decisions to increase your business. You are essentially investing the profit you have based upon each month or a decent level of predictability of what can happen the next month. Mostly, business owners run this way with a monthly mentality against a longer-term business approach because they were used to earning a biweekly paycheck in their old career.
In a nutshell, there are three major approaches you can increase capital for your business. They have got different weaknesses and strengths—the first step is to know your business is extremely well and decide on your objectives. Many businesses will use more than one approach. Hence, you can use the combination of these approaches to capitalize your business depending on the available resources.