Overcapitalization to the Rescue

Posted on: October 9th, 2017

overcapitilization

Winning in business involves having enough resources to create and innovate. Whether you are acquiring or expanding, crafting the proper capital plan is a challenge. Having extra capital on hand costs more, yet having too little money can result in a tragic fate.

A cost of capital calculation often omits a huge, subjective variable – the opportunity cost of not achieving your plan. When you have a very profitable growth path ahead, not having enough capital to get to the finish line is a costly proposition that far exceeds the incremental cost of overcapitalization. Overcapitalization is a word rarely discussed but one that should be central to all acquisition and organic growth planning exercises.

As Oscar Wilde once quipped – “you can never be overdressed or overeducated.” So too can a deal never be overcapitalized. It is the very essence of growth that it is a capital consumptive activity.

Whether it is more costly acquisition integration, a longer working capital cycle, or a longer sales cycle, extra liquidity is a valuable insurance policy. In my 30 years of middle market M&A, I’ve learned that it is rarely the cost of the capital that determines success or failure. It is the availability of capital, and having that extra liquidity cushion, to deal with the inevitable adversity. The key is understanding the traps people fall into when they underestimate their capital plan.

Lack of Proper Due Diligence or Planning

Whether these are increasing sales, reducing costs or streamlining working capital, it can prove disastrous if these details are not clear and concise while planning the budget. Don’t make assumptions or guestimate, gather the most accurate numbers possible and take in every factor you can account for. Having accurate, historical financial data is essential as is bottoms-up financial budgeting discipline.

Overly Optimistic Decisioning

With all the excitement and positive possibilities for the future, it’s natural to think optimistically, but it’s also destructive. In efforts to forecast the realistic outcomes of projects, decision makers should consult with rational outsiders who can help you avoid a casualty of money and financial investment. Stress test your budget and realize that the path is not always in a linear direction, but more likely a circuitous one.

Revenue Ramp up Overestimation and Cost Underestimation

Financial modelling lulls one into a haze of direct causation thinking. When revenue goes up, margins stay the same. When revenue goes down, margins also stay the same. Often, the drivers of gross margin levels or operating expense levels are not revenue fluctuations, but independent non-related factors. Its human nature to attribute more causality to these financial assumptions than real world experience would suggest. However, capital planning requires one to think critically and objectively.

Whether you miss a few things, or make overly optimistic decision, or fall into the trap of sophomoric financial logic, overcapitalization will save the day. When you have more capital on hand, you can cover these mistakes and power your way to success. It is always the amount of capital, not the cost of the capital that will determine your ultimate success.

For assistance in calculating your capital plan, Attract Capital is a highly regarded firm with years of success in the growth capital market. Contact us to begin preparing for success or reach out for a free consultation with our advisors.

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