Starting a Business is Challenging

Starting a Business is Challenging – Starting an Undercapitalized One 10X So

Most entrepreneurs lack adequate savings and access to capital to start their businesses. As a result, many start their businesses undercapitalized and are unlikely to succeed. That’s because a great idea alone is not enough to sustain a business.

An under-capitalized business lacks the financial flexibility to handle the financial demands associated with starting and growing a business or the unexpected financial demands likely to occur in the daily course of business. While the entrepreneur should fully fund their start-up costs, including operating costs required to get to breakeven, their limited savings and access to capital forces them to start without meeting that goal.

Undercapitalization has serious consequences for the entrepreneur. It basically means their business lacks sufficient capital to support its founding and/or operations. Without adequate funds, it may not be able to cover its start-up costs. This means the business cannot fully implement its start-up strategy, impeding its growth.

What’s more, the business will lack the funds to cover its monthly operating costs and any debt obligations it may have, increasing its risks of bankruptcy.

From the outside looking in, it may be easy to see starting the business is a no–go. But from the inside looking out, for the entrepreneur, with visions of customers rounding the corner waiting to buy their product, it is easy to see starting the business is a sure–go.

In essence the entrepreneur bets that her business’s sales will grow fast enough to offset its start-up capital shortfall. To be fair, this scenario may happen, but usually doesn’t. Building a business takes time, and usually more time than reflected in one’s financial projections.

The bet is made, and the entrepreneur starts the business undercapitalized. The strong belief that customers will round the corner waiting to buy fuels unmitigated enthusiasm for the business’s start-up. The entrepreneur is brimming with pride as she opens the doors of her newly founded business.

She’s implemented her start-up plan as best she can given the constraints imposed by her undercapitalized start-up budget. Planned advertising and promotion efforts are trimmed to match actual budget dollars. Capacity falls short of planned levels because some equipment couldn’t be purchased. But not to fear, adding another worker may bridge the capacity gap.

Customers show up, but the line they make barely reaches the front door. The actual cash cushion she started the business with may cover 2, maybe 3 months of fixed expenses but what happens after that is anyone’s guess.

Days turn into weeks, weeks into months, and the line still hasn’t reached the door. Sales are growing, but much more slowly than projected. Sales taxes collected and employee payroll taxes withheld provide somewhat of lifeline, albeit an expensive one given the penalties and interest taxing authorities impose.

With sales not even covering fixed cost, our entrepreneur is forced to borrow from family and friends where she can, and to work a job to generate cash to put into the business. This alleviates some of the pressure, but working a job means she has to leave operating the business to her employees. With the business still so new, they lack the skills to manage it well. As a result, operations suffer as do sales. Our entrepreneur is now spending time she doesn’t have correcting the problems caused by her employees.

At this point, four months in, it likely makes sense for her to shutter the business and cut her losses, but how does she turn a blind eye to the vision of customers rounding the corner? She’s on the treadmill now.

Life on the treadmill is not fun and really not what the entrepreneur expected running a business to be. Instead of developing strategies to grow sales, too much time is spent figuring out how best to allocate the company’s limited cash balance to its growing cash requirements. Instead of developing employees, too much time is spend figuring out how to solve the problems created by inexperienced workers. Instead of spending time working on the business, time is spent working to generate cash to keep the business afloat.

Once on the treadmill it’s difficult to get off. For a while the hole gets deeper and deeper with each passing month as cash needs grows faster than cash sources. Then, for many, a point is reached where things seem to stabilize.

The hole stops getting deeper, and the entrepreneur sees a light at the end of the proverbial tunnel. Reaching this milestone – cash coming in equaling cash going out – strengthens the entrepreneur’s resolve. The entrepreneur clings to her belief that the line will round the corner, and all will be well.

But will it?

At this stage of the game, despite operating cash coming in equaling operating cash going out, bankruptcy is a very real possibility. The hole, while stable, begins to shift as creditors, mainly the taxing authorities, begin demanding payment and promises to stay current.

Meeting these demands is impossible without an infusion of capital. But banks won’t lend to a business whose liabilities exceed its assets, and angels won’t invest in a business with limited growth prospects. While sales have grown, it’s been organic. To address the current situation sales growth would have to be exponential, and exponential growth costs money.

At this point, can bankruptcy be avoided?