Businesses need capital to grow. Besides what you invest, capital can come from profits you leave in the business, from investors or partners who put money into the business, or from money you borrow. This last source has some use and repayment constraints, which must be met in order to really be capital.

To keep it simple, money borrowed which doesn't have to be repaid for several years and which can be used for any legitimate business purpose can be part of the business' capitalization. An installment loan, say to finance a truck, or a mortgage to help with the purchase of a building does not count.

A good way to think of capital is to compare it to the horsepower of an engine. Small engines with minimum horsepower have to strain to handle the slightest problem. They tend to wear out quickly and often need lots of care as they go about their work. Big engines with lots of horsepower almost loaf through normal use; they have plenty of reserve power to take advantage of the opportunities a wide, clear road offers and to get around or over unforeseen difficulties.

The biggest mistake a new entrepreneur makes is failing to understand what the documents for a loan or the sale of a portion of the business really mean. For example, if you accept a line of credit from a bank the documents will usually require that you pay off any outstanding draws against the line once each year (usually the anniversary date.) This could be a real problem if it occurs at a time when you are short of cash and also have plans for an expansion of the business. Banks are willing to work with their customers in such situations, but their new terms might be a lot more onerous.

The documents will probably state that the bank will file a lien on everything the business owns. This lien goes on top of any vehicle installment loans or mortgages on real property. In legal terms, it goes in second, or a third or whatever is next -- position. This also includes the business' accounts receivable. Many businesses don't realize that they have no credit capacity left after they take a line of credit. That's right, they can't arrange financing using their accounts receivable, without going back to the bank that provided the credit line and renegotiating.

An investor in your business may also place restrictions on what you can do. The documents covering the investment could make it difficult and expensive for you to bring in another investor. One way this is done is through a non-dilution clause.

Here's how it works. Suppose you own 100% of the business (all the shares of a corporation), and you make a deal with an investor that gives him half the business. His money goes into the checking account and the corporation issues him the same number of shares that you have. You and he are now equal partners. If his investment provides that his position cannot be diluted then the only way the business can bring in another investor is to issue the first person free shares so he will always have fifty percent ownership. Guess whose ownership percentage gets reduced -- that