SMALL BUSINESS : FINANCING & INSURANCE : Key to Growth Is in the Way You Use Capital

For the entrepreneur, financing a business start-up is a tough do-it-yourself affair fraught with danger. In almost every case, the entrepreneur must use personal resources to get the enterprise up and running, scraping together money from personal savings, friends and family, a second mortgage, credit cards and, on rare occasions, an angel investor.

Most start-ups fail--and soon--because as a rule these resources don’t come close to cushioning the new enterprise against the hazards of chance in the world of commerce.

Lessons about the use of capital can be drawn by looking at the two categories into which most survivors fall:

* The prototypical mom-and-pop businesses employing a few workers and generating enough profit to pay the rent and maybe send the proprietors’ children to college.

* Growth companies that employ hundreds of people, often more, and generate revenues and profits in the millions of dollars.

What accounts for the difference? Why do some businesses reach a certain level of activity and stop growing, whereas others reach that level only to jump to the next?

To be sure, luck--along with the discipline and hard work of the entrepreneur--plays a role in getting any business past the throes of birth. And although capital is crucial to every enterprise at every stage of development, it does not itself make the difference between the business that reaches stasis and the one that keeps growing. What makes the difference is the way each business uses capital.

For the mom-and-pop business, capital is a simple thing: You subtract expenses from receipts, use some of the excess to buy supplies, and keep the rest for yourself and your family. Put another way, the mom-and-pop business uses capital for immediate needs.

For the growth company, capital is a complex thing taking many shapes and guises--debt capital, equity capital, working capital, expansion capital and so on.

Whatever its form, the function of capital for the growth company is long-term: The business uses capital to get itself to another level of activity and then to yet another. Put another way, for the growth company, capital looks to the future, and it is patient.

Not surprisingly, because the mom-and-pop business and the growth company look at capital in different ways, they meet with different fates.

The mom-and-pop business--a distinctive feature of the American economy in general and of the economy of Southern California in particular--does not survive mom and pop, as a rule. The growth company takes on a life wholly distinct from that of its founders.

You must master the use of capital if you want to turn your mom-and-pop business into a growth company. Above all, you must play the finance game according to rules set by others--namely the lenders and investors who stand ready to back growth companies with ever-increasing amounts of capital year after year.

These lenders and investors insist that you run your business as though it were a public company, with a full and complete disclosure of your operations as measured by standard accounting and business practices.

In plain English, they insist that everything you do be transparent so that they, looking in from the outside, may know what you know, seeing things from the inside.

The lesson here is that if you need the help of outside lenders and investors to create a growth company--and you do--you can get it if you resist the impulse to keep the secrets of your business, starting with your financials, to yourself.

This means you must see your enterprise as a thing distinct from yourself. You must also become a student of the capital marketplace, learning who has capital and what you must give up in order to get the use of it. And you must manage your business professionally, hiring a team of solid colleagues skilled in the sometimes humdrum exercise of running a business with an eye toward the long-term future.

That’s a tall order for the business owner who deals fairly with the people who want the enterprise to prosper--employees, customers and suppliers--but who cannot delegate responsibility and runs something less than a transparent operation when it comes to money matters.

But if you make the transition, you reap the reward when you go looking for outside capital to grow your company, for you make it possible for lenders and equity investors to understand your enterprise. And you discover that there is no shortage of capital eager to back the growth company. You play by the rules and you win.

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Juan Hovey can be reached at (805) 492-7909 or at [email protected].