Small Biz’s Capital Challenge, Facing Cash-Strapped Reality

Capital is the fuel that makes a business run and allows it to grow.  Although there are many definitions of the term capital in business, for small business owners it generally means one thing: Cash!  A business needs cash to pay its bills, pay its employees, purchase assets and to pay the owner! Capital reserves are essential during times when sales are lean and equally important when there is opportunity to expand the business.

Capital & the Start-Up Stage: Another period when capital is vital but is often lacking or even non-existent: the Business Start-Up Stage.  The Start-Up Stage begins the day a new business opens its doors and continues until it generates enough sales revenue to be self-sustaining. 

The Start-Up Stage is the most dangerous stage of business development, often lasting two years or longer.  It is so dangerous, in fact, that we call it the weeding out stage because, on average, 44 out of every 100 new businesses will die within three years of opening their doors.  Why? One of the most common reasons is a lack of capital needed to pay the bills while waiting for the business to generate a profit.

A new business needs cash to get started: cash to pay rent, advertising, payroll, other expenses and the owner’s personal bills.  Most small businesses open their doors with very little, or even zero, start-up capital – Owners leap into business on a whim and a shoestring with very little planning or access to capital.  

The Capital Challenge: When these new entrepreneurs finally realize they are going to need to find some cash to survive they must face another reality: the unlikelihood of obtaining it from investors or banks.   This should be expected, especially if the owner and business have no track record of business success.  Investors will demand proof that your business idea will work.  Banks will want collateral and proof the owner can pay back the loan if the business flounders.

Common Failure Scenario:  The inability to successfully plan for the capital challenge forms the genesis of many small business failures.  Here is a common scenario:   

  1. An employee making a $40,000 per year (money he needs to pay his household bills) leaves his job to start a business,
  2. Excitement runs high as the business opens its doors and starts to serve the public!
  3. The owner soon realizes that the new business cannot immediately generate the cash flow needed to pay both its expenses and the owner’s household bills,

  4. Household debt, not to mention stress, increase drastically to pay both business and personal expenses,

  5. As credit-lines are maxed-out, the ability to obtain financing is further diminished.
  6. The business continues to struggle but fails to generate enough sales to cover both its costs and the personal expenses of the owner.  Eventually, the owner – in much worse financial condition than the day they started—- is forced to close the business and return a regular job to pay the household bills.

Meeting the Challenge:  The good news is that your business does not have to follow this common trajectory.  To drastically increase your start-up’s chances for success while avoiding the scenario described above, consider the following advice:

1. Objectively evaluate risk:  In economics, entrepreneurs are called “risk-takers.”  This may be true.  However, most successful entrepreneurs - while eternally optimistic and enthusiastic about their ideas and ability – take highly-calculated risks, not whimsical chances, by realistically evaluating the challenge ahead of them. 

If you’re a first-time entrepreneur preparing to start a new business, ask yourself four basic questions:

  1. How much money do I need to pay my personal bills and the overhead of the business?
  2. How many customers (i.e. sales) will the business need to pay these expenses?
  3. How long will it take for the business to generate enough sales to pay both its expenses and personal bills? 
  4. How will I pay for these expenses until the business generates these sales?

2. Don’t expect a windfall of capital: Many start-up owners spend their most precious resource - TIME - seeking investors or lenders to finance their great idea before they have shown the idea will even work.  Planning is important but, remember, most investors and financiers will want to see results before they will take a risk on your venture.  Instead of going door to door soliciting your idea, invest your time testing and refining the plan in the marketplace.  This will allow you to work out the kinks and show investors what they want to know: 

  1. There is a demand for your product/service,
  2. Profit will be generated by your product/service,
  3. Your business has a competitive advantage that will allow it to maintain this profitability, and
  4. That your business is scalable – it can achieve sizable growth.

3. Start small - but think scale: Most small business owners start their business with very limited resources.  To compensate for this limitation, develop a plan to prove your business is profitable in one location or with a stream-lined product offering.  Remember that your customers are buying the experience of obtaining that product/service as much as they are the product/service itself.  As you refine the systems that deliver that experience and your product/service, ask yourself the following question:  How can these systems be duplicated to provide the same experience and quality to 10, 20, even 1,000 times more customers?   

4. Don’t quit your day job (at least not yet): Countless large companies started off very small – In the proverbial garage, in evenings and weekends on a shoestring budget.  If you don’t possess the independent wealth to self-fund your start-up while sustaining your lifestyle, start with a small, part-time venture.  This will greatly reduce your financial risk.  Starting part-time will also allow you to continue working your regular job, avoiding racking up debt to cover your personal costs.  It will also allow you the opportunity to refine and test your idea/business model with maximum flexibility and without the distraction of employees, investors and lenders.

5. Think creative financing:  If you are lucky enough to find lenders early in your venture, try to work out repayment arrangements that do not interrupt cash flow.  For example: Borrowing $20,000 over five years will cost you over $300 per month, every month.  This may not sound like a lot of money, but during months when sales are low it could break the bank. 
Instead of traditional, fixed payment financing, try to structure repayment as a percentage of gross sales or gross profit.  This will make the payment a variable rather than a fixed one.  Payments will be lower in lean months and higher in months when sales revenue is up.  If things go well, the lender will be paid off early.  When times are lean, the reduced payment will allow you to put food on the table.

6. Get everyone on board:  Chances are, times will be financially lean in the beginning of your venture.  There will also be limited time to participate in many family activities.  These two factors can create a great deal of household stress.  Before you leap into business, make sure everyone knows and agrees to the challenge ahead of them.  If possible, consider getting them personally involved in the business.  This will help create a team-like culture that will greatly reduce the chances of family and interpersonal crisis. 

One of the greatest challenges facing new business owners is finding the money, the capital, with which to finance their venture.  Following the advice listed above will help you face this reality head-on and meet the financial challenge that will accompany your start-up.  It will also help you to refine your idea into a provable business investors will want to be part of.


Brett Hersh's avatar
  • Author: Brett Hersh
  • Bio: Brett Hersh, EA, MBA, is the owner of HBS TAX & Small Business Experts. He is an Enrolled Agent (EA) with the IRS and licensed by the US Treasury Department to prepare all tax returns and represent taxpayers before the IRS for audits, collections and appeals. He is also Dave Ramsey’s ELP for Tax and Accounting, a continuing education instructor for tax professionals through Lorman Education, and a local speaker/presenter on the topics of tax and business growth. He can be reached at (304) 267-2594.