The Buckets

Following our recent blog post Before the B Round we’ve had a lot of feedback regarding the distinction between the two “buckets” of capital mentioned. In essence, the questions boil down to clarifying the difference between “working capital” and “everything else”.

 

The good news is that there is a simple and equally reliable way to tell the difference. If you look at the assets on the balance sheet of an operating company, you will find that (with a few limited exceptions) most every asset is either cash, accounts receivable, inventory, equipment, IP, and/or real estate. If you have accounts receivable and/or inventory then you have a “working capital” requirement.

 

If you don’t have much in the way of accounts receivable and/or inventory then the inverse is also true – that you don’t have a “working capital” requirement – and therefore by default your capital requirement is “everything else.”

 

Sticklers for corporate finance purity will certainly quibble that we have taken a few short cuts in the explanation above, and while they would be technically correct doing so – we would argue that this simple exercise is not only generally accurate – but is indeed materially accurate.

 

For those interested in a complete answer on “working capital” I’ll put a finer point on it.

 

“Working capital” is technically equal to accounts receivable plus inventory minus accounts payable. The sum of this simple addition / subtraction formula is the true “working capital” investment of an operating company. To the extent that the sum is a positive number, it is always a net asset that must be financed – either with a liability and/or equity.

 

As to the “everything else” bucket, there is a little more nuance involved. Generally speaking, it is equipment, real estate, investment in intellectual property assets, and/or if the company is reporting losses that make up the bulk of the “everything else” bucket. Just as with “working capital” however, any and all of these items must also be financed – whether it be with a liability, equity, or both.

 

We finance many fast growing companies that have not yet become profitable and also have a large “working capital” requirement. From a cash flow point of view, this scenario is what one our great clients referred to as the “double whammy.” Phraseology aside, the point is an important one – that the combination of losses and a “working capital” requirement are additive and that any operating company in this situation has a heightened need to access outside capital to finance it.

 

A final note: For those that will inquire about my use of the term “operating company,” please note that the ideas in this post apply to companies that make a product or provide a service. The balance sheets of financial institutions (i.e. banks, insurance companies, etc.) are different – and that is a topic for another post.