Vested Capital: What It Is, Why You Want It, and How to Get It

By Scott Allen on 27 August 2010 (Updated 5 January 2011) 0 comments
Photo: lightkeeper

vested (adj.) — Settled, fixed, or absolute; being without contingency

"Money talks," especially when you're talking about vested capital. It's that private form of equity that successful businesses enjoy having, particularly when it comes to expansion. It's what some aspiring entrepreneurs would die to have in their possession. Vested capital gives you the utmost in negotiating power, and being able to say "NO" to a deal (or control it) empowers the business.

Vested capital can be funds that are readily available or those that will be available in the future. It's not to be confused with venture capital, although it can be likened to it based on what it's used for. Venture capital is funds solicited from investors — venture capitalists (VCs). Vested capital normally results from an accumulation of money deposited into the fund from quarterly or annual profits. Venture capital has to be repaid; vested capital is earned within and does not result from an investment or lending situation. Venture capital needs to be located; vested capital is already in place.

Venture capital is normally used for two reasons: to help a company expand or to help a company get started. Typically, there is no vested capital accumulated for the new entrepreneur. Both types of companies will only receive venture capital infusions if the investors feel that they can count on a good return on investment (ROI). VCs commonly look for minimum annual returns on the order of 40 percent.

So what's so great about vested capital?

Besides the obvious fact that it means your company is consistently profitable? Vested capital doesn't have the limitations on its use like venture capital does. Should a company want to absorb or buy out another existing company, it can be easily done with vested capital (and Board of Directors approval). However, if you approach a potential venture capitalist with the same proposition, he's less likely to afford you the funding if he doesn't feel strongly that buying out that other company will result in significant growth and/or that healthy 40 percent return on their investment.

When it comes to vested capital, the single most important aspect of its use would probably be for investing in growth, or to help the company step up to the next level. Having the cash to assist in growing pains is a blessing that not all companies have. Acquiring needed equipment, more office space, and hiring more employees are some of the areas where vested capital can be used, depending on how much is available.

Vested capital can continually be added to or withdrawn from — unlike venture capital, which is most likely gone as quickly as it comes in. When it comes to having sufficient capital to purchase land or buildings, the main benefit to having vested capital is that it gives a great deal of negotiating power. Nothing in business could be more satisfying then purchasing something for, say, 20 percent less than the asking price, simply because you have the cash to do it and don't need the help of a lender.

Sometimes, unfortunately, companies do have those periods where business slows down and things get quiet. The economy gets soft, sales are on a downswing, and there are seasonal issues in some businesses, as well. If you have some vested capital available, it could be enough to see you through the tough times. If you don't want to run your cash reserve down to zero, it can be used to demonstrate your ability pay back a loan, improving your chances of getting the loan and saving you money with a better interest rate. Or if it's tied up in long-term instruments, such as T-bills or certificates of deposit, those can be used as collateral for a loan at a very low interest rate. Any way you cut it, the vested capital will work to your advantage.

Sounds great! Now what?

First and foremost, recognize that your business needs a savings plan, just like you do. You have to commit to contributing to it on a regular basis, and resist the temptation to dip into it whenever you feel like it. Here are a few simple steps to help you start building your vested capital:

1. Decide what you're saving for. Make a list. At a bare minimum, it should have an entry for "rainy day fund" and another for "strategic growth fund." If you can be more specific, by all means do so.

2. Create accounts for each item on the list. They don't have to be separate bank accounts. They certainly could be, if you're talking about sufficient money to justify it, but at least make a ledger account for each "fund" on your list.

3. Budget. How much can you contribute to each fund on a monthly or quarterly basis? There's no point in making it so painful that you won't stick to it, or will almost certainly have to tap into the saving fund for operational expenses. Do, however, make it a stretch. You can get to it if you absolutely have to, but the more you can commit, the more opportunity it creates down the road.

4. Talk it over with your CFO, CPA, etc. There are, of course, tax ramifications to all of this. If you're the major shareholder, you have to look at the cost of saving money inside your company vs. saving it as an individual. You must do some saving inside your company, if it's consistently profitable, but do a side-by-side comparison to see how much it really makes sense to keep inside the company.

5. Review the plan with your leadership team and investors. It's not going to work unless you have their buy-in. Everyone with a vested interest in the company needs to be committed to making this work. Of course, your investors (yes, even your Uncle Ned who put in $1,000), have a right to know why they're not getting paid back a little sooner rather than later.

6. Make it a little bit difficult to get to. You really should set up at least one separate bank account (business savings, NOT checking) for your vested capital. If it's in the checking account, or even your main savings account, you'll be tempted to use it when you shouldn't, regardless of what the ledger says.

7. Make some of it even harder to get to. Let's say one of your funds is the "new office fund," and you're planning to move in, say, two years. Take your first contribution to the fund and put it in a certificate of deposit, or maybe a 2-year Treasury note. You can get at it if you absolutely have to, but your willingness to "lock it up" will earn you interest.

You have big goals for your business, and many of them require capital. Accepting venture capital means giving up control, as well as equity, and waiting for a windfall isn't a strategy for business growth. If your business is profitable, create a plan to build your vested capital and stick to it. Before you know it, you'll be able to realize those bigger goals you have for your business.

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