Proper business funding/capitalization are an issue to all small businesses at all stages of the business cycle. Those businesses that are organized as corporations and LLC’s are required by the state granting the business charter to be adequately capitalized. The challenge here is there is really no clear definition of adequate capitalization.
The purpose of requiring adequate capitalization is to ensure that the business entity has the ability to carry out its business operations without subjecting those working with that business, including employees, to financial loss. Proper protection against financial loss also requires a business to address potential liability issues.
Funding requirements will differ significantly from one business to another as well as what stage in the business cycle the business occupies. One of the most difficult stages to fund is typically found with start-up small business ventures. New business ventures may have great ideas and potential for success but have no history of success nor have they produced financial results. These realities make securing funding difficult. Funding challenges, however real, do not relieve the business owner from the responsibility of providing adequate capitalization for their business enterprise.
There are many sources of funding available in the market place for small businesses and LLC’s, each with unique advantages and disadvantages. The best source for funding will depend on the particular circumstances of the business seeking the funding and may include using a combination of several different sources. Start-up funding in particular is a very specialized world and seeking experienced and competent help is strongly advised.
Here are the four most common sources of funding for businesses:
1. Cash investment from the founders of the business – Typically the easiest to obtain and the least expensive of all forms of capitalization.
2. Income from business operations – This is perhaps the best source and usually the least expensive, after the founder’s investment, source of funding and capitalizing a business. This is typically more readily available to businesses that have been operational for some time whereas a start up business may find this source difficult or even impossible.
3 Bank Loans – If available to the business bank loans are relative inexpensive in today’s environment but may be difficult to obtain. This is especially true for start up businesses and those who are not financially strong with good positive cash flow.
4. Venture Capitalist and Angel Investors – These sources of funding can be good and are available to those businesses that able to demonstrate a strong business and product that also has excellent potential for high returns. The trade off with these sources is that often they require a large percentage of ownership in the company to induce them to invest. This is not necessarily bad, just be aware of that fact when you start. Also, in many cases they may require a business they fund to go public within a specified time period. Again, not necessarily a bad requirement.
As with all funding sources, it is a financial necessity to carefully examine the conditions and structure of the funding.
Lack of adequate capitalization/funding has caused many promising business to fail before they have a chance to get started. In addition improperly structured funding has been the cause of both new and mature business operations to struggle financially and in many cases fail.
One of the often overlooked factors in adequate capitalization of a business operation is proper and adequate insurance coverage. If inadequate insurance exists in a business, a damaged claimant could potentially pierce the corporate veil due to under-funding. Most business owners will have property and casualty insurance for buildings, vehicles, equipment but do you have general liability insurance sufficient to cover claims not otherwise covered by property and causality policies. In addition, Directors and Officers insurance, as well as Errors and Omissions insurance, are an important part of those businesses that require these policies and qualify for them. The important key here is to seek advice from a highly qualified insurance/ risk management specialists for your small business or LLC.