One of the topics I have been focused during this year has been the Foundational Structure of your business. Working together, we have looked at your foundational documents. We have worked to make sure your governing documents outline your vision, mission, and values. This month, as we focus on the Foundation of your company, let’s talk about capitalization. More specifically, let’s talk about what to do when your company needs more money. How does this work with the current owners.
Your company should have enough money to carry on the company’s business activities. This is, of course, an obvious statement of sound business practice. A less obvious reason to assure that the company is and remains adequately capitalized concerns the liability protection afforded by your new entity.
But, no matter how hard you work to make sure there is enough money in your company, there are times that you may need more money. You may want to expand. You may need to hire. Or, you may be having a slow quarter. Whatever the case, money will be needed at some point during your venture. To solve this, you have several options. Today, we will explore several of those.
Solving the Funding Problem with an Example
For today, we are going to use an example of a business that needs about $60,000.
Funding from the Owners
For this example, let’s say we have two partners. Up to this point, the partners have split everything for the foundation of the business. They are 50/50 partners. But, they need more money. One of the partners has extra cash that could be used to invest. The other has no cash available.
Funding Through a Capital Call
A capital call is where each of the current owners is asked to put in more money. Each owner typically puts in the amount of money equal to the amount of ownership. The problem with this situation is that one partner has money and the other doesn’t. The main issue is that the partners will not be able to agree on a capital call because one partner would be unable to meet the demand. The capital call could be met if the partner with the money loans the money to the partner who cannot meet the capital call. But, what security would be had? Though this might keep the business books clean, it might put the partners at odds with each other.
If we are trying to “keep it in the family” and not bring on any outside money, what are some other options?
In this case, it would make sense to have the partner with the cash loan the money to the company. The loan would be subject to a promissory note. Another option would be to create a credit line instead of a simple loan. Basically, the partner with the money would offer a credit line of $60,000 and you would only use what you needed in the business. As most estimates are on the high side, this would allow the money partner to keep his money earning some kind of interest, but keeps the business from paying on money it didn’t need. That will help to keep your expenses lower.
Funding Through Equity Offering
Sometimes, after capital calls and loans have been exhausted (or are not being repaid properly) there may be other options and needs to make sure the partnership is fair. In this instance, you may want to consider offering additional equity to bring in money. This option will cause each of the equity holders to be diluted based on the new equity brought in. The equity offered could have different rights or (depending on your entity type) be a different class of shares.
Of course, in the current scenario this would be the same as a capital call because one partner has the money. An equity offering may change the nature of the equity shares. It may adjust the equity percentages. But, sometimes when one partner is bringing a substantial amount of money to the table (all other factors being equal) there needs to be a change in the equity structure of the business.
This does not, however, mean that the government of your company has to change. This may be about being financially fair without destroying the dynamic you desire for the management of your company.
How This Plays Out for You
First of all, if you are planning to bring on any new money in your business, let me know. It needs to be documented properly. The options described are not the only way to handle this kind of investment, it is just an example to get you thinking about your own capitalization.
- If you are in a place where you need additional money in your business, let’s talk about it.
- If you are in a place where one of the partners has put in a substantial amount of money, but repayment is not working properly, let’s talk about it.
- If you are in a place where you could restructure some bank debt to be covered by the owners at better interest rates, let’s talk about it.
Of course, as always, don’t hesitate to ask me any questions you may have about this. It is such an essential part of getting your business off the ground and you want to get it right the first time.