New business series - adequate capital

Over the past few weeks our business strategist Barry Mosely has been sharing some tips and pointers for people who are thinking about buying an existing business, or starting from scratch. He's shared statistics about the lifespan of New Zealand businesses, and covered the question of experience and capability.


Barry Mosley Winstanley Kerridge Business Strategist

Over the past few weeks our business strategist Barry Mosely has been sharing some tips and pointers for people who are thinking about buying an existing business, or starting from scratch.  He's shared statistics about the lifespan of New Zealand businesses, and covered the question of experience and capability.

This week we're talking about adequate capital.

The topic of adequate capital in a business is one that is often rigorously debated, particularly between business owners and lenders.

The term adequate capital or capital adequacy has gained more prominence since the global financial crisis with many Central Bank’s world-wide increasing their capital adequacy ratios to lending institutions in the wake of significant financial industry failures over this time.

In New Zealand we did not experience any of the major lending institutions getting into difficulty, but we did see significant failures of finance companies who operated under different capital adequacy rules to the major bank’s at the time. This prompted changes to regulations to all within the finance sector in a bid to strengthen these businesses.

These changes were designed to ensure businesses in this sector had an adequate capital base to sustain down-turns in the market when they occurred and protect shareholders and investors.   This rationale is no different for individual businesses.

Adequate capital is about having sufficient capital to finance your business assets, and provide appropriate working capital to enable the business to run smoothly.


Businesses will traditionally have a mixture of capital (your cash) and debt. The key is ensuring that the mix doesn’t get out of balance one way or the other.

Debt can be a good thing as it allows you to expand or undertake projects for the benefit of the company that may not otherwise be achieved. However too much debt is obviously not a good thing. Higher debt levels can be sustained in good times but businesses with higher debt are the first to suffer when trading or economic conditions deteriorate.

$10billLenders generally have scaling ratios for lending against specific assets. For example, a commercial property may have a scaling ratio of 60% of the registered valuation of the property. This tends to be due to the fact that in a forced sale situation this is generally an accepted level of recovery against the asset. However this is also an accepted level of debt against these assets, and lending at these levels means they can be adequately serviced from a cash flow perspective.

A saying that I encountered year’s ago (in my previous career as a banker) was "quid pro quo" – you put in a dollar and I will put in a dollar, or a borrowing Vs equity ratio of 50%.  Some would say this is overly cautious, however I have yet to see a business with a structure like this fail when trading conditions deteriorate.  A more traditional level is a borrowing Vs equity ratio of 60:40, however this depends on the business and the strength of the cash flow and for some businesses this may be too high, and others it may appear to be too low.

The key message is that there is no magic number when assessing how much of your own money Vs borrowing you should have in a business when starting out. Each situation needs to be carefully assessed, and the start-up costs and time to get the business and cash flow established needs to be factored in.My recommendation is that the more you own of a business the better, especially if you are starting from scratch.

 If you are contemplating going into business, either purchasing an established operation or starting a business from scratch. Seek strong advice before you make any firm commitments. A well-researched and thought out proposal at the outset which includes forecasts and budgets, sensitivity analysis and “what if” scenarios is more likely to succeed over a proposal put together on a shoe string.

Have you ever set up a new business, or are you looking at going out on your own?  Let us know the challenges you've come across, we're interested in providing information to help new and aspiring business owners.