For most entrepreneurs, obtaining capital seems to be the most difficult business barrier to hurdle. When in reality it is the easiest if approached correctly. Any potential investor or financing institution must first have faith that the entrepreneur has the appropriate knowledge and has been persistent in their respective industry. These two barriers are explained below. Once the knowledge is acquired and persistence achieved capital will flow to the start-up or new venture or to expand the existing business. The real dilemma for most entrepreneurs is understanding the various facets of capital.
Capital is the investment of funds into a business to either start, maintain or expand operations. The typical investment is in the form of cash; but, often new businesses start with an infusion of fixed assets. A very common method is for an owner to use his personal vehicle, tools and equipment to start a business. Flexibility is desired and cash is what is really needed to provide latitude. So capital may come in the form of investment by others (usually family) or via borrowing money (bank loans).
Investment of Capital
The usual method of capital investment is for the existing business to exchange rights of ownership in the business for cash. There are several different tools to legalize this exchange. The number one tool is stock. A stock certificate usually signifies this arrangement. Naturally there is more to this exchange as there has to be rules between the two owners (the original entrepreneur and the investor). The original entrepreneur brings the knowledge and persistence while the investor brings the cash. These rules are typically laid out via the following:
- By-Laws – Rules of conduct for the business
- Sshareholders’ Agreement – Sets the relationship guidelines between the shareholders
- Buy-Sell Agreement – Defines the terms and procedures for any shareholder to increase or decrease their percentage of ownership
- Cross-Purchase Agreement – Addresses the buyout of a shareholder in case of disability or death. Customarily this form of agreement is funded by disability and life insurance policies.
Rules of conduct also exist in other business arrangements such as partnerships with partnership agreements. Limited Liability Companies us a similar document but it is referred to as membership agreements (the term ‘member’ is used with limited liability companies and ‘partner’ with traditional partnerships).
The agreements specifically lay out the relationship between the originator and the person fronting capital. This relationship defines control and limitations for both parties.
Early on in the business life cycle, before there is enough history, the entrepreneur funds the development and early business stages. As funds run out the entrepreneur turns towards borrowed money to bridge the gap and provide enough history to find a capitalist to fund the venture for the long run.
Bank loans using collateral are the initial forms of borrowing money. Others include vendor accounts, supplier credit and credit cards. Over time many small businesses convert these short-term liabilities into a long-term unsecured debt as a function of expanding working capital. As total credit available is consumed, management turns towards high interest rate loans to provide the necessary time to prove the business model works.
Only with a true long-term equity position capital investment will the business have any real chance for success. Read the following articles for a more comprehensive understanding of the relationship between debt, equity and assets:
* Debt and Equity in Small Business – Basic Formula
* Economies of Scale
* Working Capital Cycle
* Fixed Assets to Debt Relationships
* Working Capital Management – Part I
* Working Capital Management – Part II
The key to success with getting capital is proving the business model works and works well. This only comes with knowledge and persistence.
Of the three primary business barriers I consider this the most essential. The average person thinks knowledge is an educational prerequisite. It actually comes in many forms depending on the industry. The following are the different types of knowledge:
A) Educational – In many cases a formal education is required to conduct the particular business. Often this means advanced degrees from accredited institutions.
B) Credentials – A formal document recognizing the individual for accomplishment and access to licenses, certifications and designations. This is very common in the professional business world.
C) Experience – This includes acquiring job skills and mastering techniques. Many modern-day businesses require extended amount of time commitment to master the intricacies. The most often stated rule of thumb is 10,000 hours of time (5 years).
D) Training – A formal path whereby instructors indoctrinate and tutor students in a unique skill or discipline; think of airline pilots, harbor masters, security agents, scientists, medical surgeons and others.
In many small businesses the owner or key man will have more than one of the above. Often, he’ll have all of them. This knowledge is what separates the business from others. It is one thing to be a cook, it takes a lot of knowledge to become a fine pastry chef with the ability to artistically decorate the edible delights.
One of the more interesting business attributes is the threshold of knowledge. The more difficult the acquisition of knowledge the more unique the skill. The long-term commitment reduces the supply of the skill and therefore the law of economics is magnified. Thus the price for this knowledge paid by the buyer increases at a faster rate. I always cite the surveyor and deep-sea diver as examples of why they can charge so much money per hour for their knowledge.
Even with knowledge, it is of no value unless exercised. Furthermore it must be applied for extended periods of time to fully maximize the return on the investment. This is persistence.
Many financial investors look for persistence from the start-up as a key sign of long-term success. Time in the trade is the definition of persistence. For many entrepreneurs it takes years of hard work before dividends begin to flow. Naturally, less skilled businesses can achieve persistence in a relatively short period of time. Look at the following examples:
– Landscaper – Auto Detailer
– Janitorial Services – Short Line Cooks
– Carpet Cleaners – Movers
– Taxi Drivers – Painters
Initially the jobs skills are easy to achieve, often in less than 500 hours. The business persistence including customer relations, problem resolutions, billing and collections take longer, over 2,000 hours to master. As the business models head toward more complicated ventures, both the skill achievements and the business acumen take even more time. Often the skills take upwards of 6,000 hours to fully understand and appreciate. Examples of these types of businesses include:
– Welders – Arborists
– Lower End Trades (Flooring, Tile, Concrete, Roofers)
– Hauling – Home Services
– Hydraulics – Auto Mechanics
– Food Service – General Retail
– Child Care – Temporary Housing (Hotels/Motels, Resorts)
As businesses head into the highly skilled tasks, the persistence period stretches towards 10,000 hours (five years). This is because the legal implications become more acute. In general, more legal documents are required due to the nature of the industry. In addition, most owners carry licenses and certifications due their knowledge and must comply with regulatory boards and state laws. The relationship becomes more intricate with customers demanding strict guidelines and rules. This is why the learning curve is so extended in these highly skilled areas of business. Think of the business dynamics for:
- Professionals (Architects, Engineers, Lawyers, Accountants)
- High-End Trades (HVAC, Electricians, Plumbers, Carpenters)
- Medical Practices
- Geriatric Care (Retirement Homes, Hospice Care)
- Social Services
This persistence is generally the most frustrating to business entrepreneurs because as soon as you have resolved on error or learned from this error another pops up. But over time, these errors occur less frequently and have less impact on the company. If the business owner utilizes the feedback loop , identification and resolution gets easier and faster with each successive event.
Persistence pays off with increasing profitability and reduced stress.
There are three primary business barriers for all businesses to be truly successful. The first is capital or financing of the business. This consists of equity investments. The entrepreneur needs to understand the various business entity models for outside investors to exchange cash for ownership rights. Alternatives include borrowing money to expand operations. However, in the early stages of business, lenders demand collateral as security thus limiting the growth of a business.
The second and most important barrier to surmount is knowledge. The more specialized the business the longer time and the broader the spectrum of acquiring this knowledge is required. Knowledge includes education, credentialing, experience and training.
The final barrier is persistence. This is merely the amount of time it takes to trudge through the mistakes and learn from them. The more common the business in society the less time is required to learn the nuances. As the skills and complexity of the business expand, the longer it takes to experience the mistakes and learn from them. In business, the general guideline is 10,000 hours. It takes someone that long to perfect their business. Act on Knowledge.
If you have any comments or questions, e-mail me at dave (insert the usual ‘at’ symbol) businessecon.org. I would love to hear from you. If interested in my services as an accountant/consultant; click on ‘My Services‘ in the footer of this article.
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