What Accountants Should Know about Securing Capital from Owners

By John A. Tracy

Every business needs capital. As far as accountants are concerned, capital provides the money for the assets a business needs to make sales and carry on its operations. Common examples of assets are the working cash balance a business needs for day-to-day activities, products held in inventory for sale, and long-life operating assets (buildings, machines, computers, office equipment, and so on).

A rough guideline is this: Businesses that sell products need capital equal to half of annual sales revenue. Of course, this ratio varies from industry to industry. Many manufacturers need a high ratio of capital to sales, so they’re referred to as capital intensive.

Where does a business get the capital it needs? Whatever the business’s legal structure, the answer comes down to two basic sources: debt and equity. Debt refers to the money borrowed by a business, and equity refers to money invested in the business by owners plus profit earned and retained in the business (instead of being distributed to its owners). No matter which type of legal entity it uses, every business needs a continuing foundation of ownership (equity) capital. Owners’ equity is the hard-core capital base of a business.

Start-up and early-stage businesses now have a new way to raise debt and equity capital over the Internet: crowdfunding. Internet portals (websites) have been set up to channel individuals to start-up and small businesses looking for capital. Individuals can invest relatively small amounts in the business (generally $5,000 or so).

Because this funding involves the Internet (which crosses state boundaries), the federal Securities and Exchange Commission (SEC) has issued rules for crowdfunding. States have their own requirements and limits as well. Generally, a business cannot raise more than $1,000,000 per year through crowdfunding — but things are changing at a rapid pace. If you’re interested in making such an investment or loan to a business through crowdfunding, check online for the latest developments.

In starting a new business from scratch, its founders typically must invest a lot of sweat equity, which refers to the grueling effort and long hours to get the business off the ground and up and running. The founders don’t get paid for their sweat equity, and it doesn’t show up in the accounting records of the business. You don’t find the personal investment of time and effort in a balance sheet.