This section is from the book "Business Finance", by William Henry Lough. Also available from Amazon: Business Finance, A Practical Study of Financial Management in Private Business Concerns.
One difficulty that often conies up at this point is that of estimating the amount of cash capital required. Among ama-teur promoters the strong tendency is to underestimate. Even where a new proposition is of quite a definite character - that is to say, where it involves buying a given property or properties at an agreed price, turning out a stable product for an assured market and selling it at a price known in advance - even under such conditions underestimates are frequent. They most commonly arise from two oversights: first, the neglect to provide sufficient working capital, the need for which will be fully discussed later; second, overlooking the incorpora-tion and selling expenses necessarily required to start - the corporation and dispose of its capital stock. Selling expense of capital stock may run as high as 25 or 30%, although a much smaller percentage, dwindling to nothing, is more normal.
A typical experience in organizing a small corporation with insufficient financial backing, has recently been related to the author in the following terms:
About two years ago I was induced to purchase stock in the Smith Manufacturing Company,* which owned the patents and intended to manufacture and sell an office equipment device. Only one other person was interested and he took an equal amount of stock and was to be the active man at $150 per month. It was nearly six months before we were able to get our dies constructed and sufficient stock on hand to go after business, and this work took a lot more money than we anticipated.
* The name is fictitious.
We also had trouble with our finish and replaced a lot of our devices which we had placed in the first few months. Manufacturing difficulties were finally overcome and we have had no other complaints on that score. Our difficulty now is to market the product. Sales for the year have been only about 2,500 units.
Up to this time about $20,000 has gone into the business and as yet we are hardly making expenses on average monthly sales of $1,000. It has come to the point now where we must find a more profitable method of merchandising, sell out, or liquidate. We would prefer to sell out, but we have nothing very encouraging to offer a purchaser, so it resolves itself into one of the other two. A first-class merchandising man, in whom both of us feel confidence, could be secured if we were in position to put in another $10,000 so as to make sure that the business runs for another year. Personally, I am convinced that with the right plan of sale, the whole project would be a tremendous money maker, but we haven't the cash ourselves, don't know where to turn for it, and haven't much of a record to fall back upon.
The stories of loss in handling enterprises that are known to be in themselves sound and profitable, are so numerous, that probably every reader can pick one or more out of his own experience or observation. It will take very little analysis of each one of these cases to demonstrate that the loss has been due to carelessness in one or more of the following features:
1. In not ascertaining all the available facts in advance of making investment.
2. In neglecting to clinch the legal rights of the organizer by means of contracts, options, or the outright purchase of some of the essential property.
3. In failing to establish close relations with financial houses which would be of assistance in carrying the enterprise through the construction stage and up to the point where securities could be sold as the issues of an established concern. 4. In making insufficient estimates of capital require- ments, having in view not only fixed capital, but also working capital and the necessary expenses of selling securities.
All these errors with a little judgment and foresight are easily avoidable.