It’s great if you’ve got a business you’re trying to get off the ground, but you might need founder capital in order get your fledgling business up and running. Keep reading to learn why founder capital is so very crucial.
It won’t matter how much planning you did unless you have the breathing room to carry out your plan successfully. When a business sells to its customers or clients on terms, then the working capital that is available will be based on the timing of the cash flow. In the majority of instances, a company is going to incur some kind of cash flow gap between the times that cash might be needed for payroll, inventory, and other operating expenses, and the time that payment or cash is received from the customers. Consider the following example of the timing difference which can create a cash flow gap where the founder’s capital is necessary to bridge the gap:
On the first day, your company orders the materials it needs from suppliers using N/30 terms. Two days later, your company gets the materials and starts production that takes another five days. Once finished, your company ships out your product to your clients, again on N/30 terms. When the 14th day hits, you have mid-monthly payroll due. By the 30th day, the month-ending payroll is due, as are supplier invoices. Your customer doesn’t remit payment to you until the 48th day.
In this particular scenario, the illustrative cash gap runs for 34 days. That’s going from the 14th day when the first payroll happens to be due, until the 48th day when the customer finally remits payment. This cash gap obviously encompasses not one but two pay periods, as well as a payment to a supplier. If you have a small business that’s just getting started, your revenue might not be at a high-enough volume to cover that kind of cash gap, unless you started up with enough founder capital to cover all of this until customer payments coming back in.
Founder capital brought to the table by the company founders and anyone they convinced to partner up with them would be what covers the payroll and supplier payments in this example. When the customer pays, that money is put back into the pool of capital from the founders.
When you plan for your business to grow, it’s crucial to assess what the working capital requirements will be to cover cash flow gap so that you can be sure your plans actually happen. Once you get big enough, you can start other funding series that draw in venture capitalists and other investors, possibly even leading up to an IPO later. However, early on, founders are on their own with just the capital they have at the time.
Having enough breathing room to handle your normal operations isn’t enough. You need to also have capital available to handle customers that pay late, suppliers who don’t deliver on time, and getting enough resources to expand operations when you can.