undercapitalization: Undercapitalization Wex LII Legal Information Institute


Between the equity, the entrepreneur contributes and the money they are able to raise from outside investors, the business should be able to be sufficiently capitalized. When starting a business, entrepreneurs should conduct an assessment of their financial needs and expenses—and err on the high side. Common expenses for a new business include rent and utilities, salaries or wages, equipment and fixtures, licenses, inventory, advertising, and insurance, among others. Since startup costs can be a significant hurdle, undercapitalization is a common issue for young companies. A company may issue bonus shares which would have the same effect as in the previous point. The company may issue bonus shares by capitalising its accumulated earnings.

In an article for Inc., Norm Brodsky noted that many entrepreneurs fall into an «image trap,» trying to present an image of success with fancy offices, expensive but unnecessary equipment, and personal perquisites. Spending valuable funds on such luxury items is a sure invitation to business failure. Instead, Brodsky recommends that entrepreneurs put off such expenditures until the business is successful, and instead concentrate on making good decisions to build the business while making their capital last.

Bankruptcy of an undercapitalized subsidiary

A situation in which a company does not have enough cash available to carry on its business. This is the British English definition of undercapitalize.View American English definition of undercapitalize. These example sentences are selected automatically from various online news sources to reflect current usage of the word ‘undercapitalized.’ Views expressed in the examples do not represent the opinion of Merriam-Webster or its editors. Being undercapitalized from the get-go makes long-term success difficult. There are unexplored opportunities in the U.S.—specifically the undercapitalized Latino market–and now is the moment to maximize the potential.

In 1952, an interstate highway was built to bypass the town of Corbin, Kentucky. A small motel owner saw this as potentially the end to his business so sold off his entire operation to pay outstanding debt. Penniless, he took his first social security check of $105 and decided to use it to start a new business. With no other income, no savings to draw on, this small check represented his only capitalization. He developed a product and traveled through the area looking for restaurant owners that would sell it, giving him just five cents for each one sold. Twenty years later the business would be sold again, this time for $840 million, with the stipulation this entrepreneur would remain the spokesperson.


Shares of companies with large amounts of cash are often perceived as more valuable. This is because a company with a larger amount of cash has more flexibility to make investments and acquisitions that could create value for shareholders. Undercapitalized companies earn profit at considerably higher rates compared to similar companies in the same industry. The rate of dividends and the value of shares are higher than the rate of dividends and the value of shares in similar companies.

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It entered into a 10-year lease with the Baldwins for surface rights for a water pipeline, agreeing to pay the Baldwins $8,000.00 per month. After a multi-year contested case proceeding, Atlantis’ water permit application was finally denied, and the project was abandoned. Atlantis never had its own employees, bank account, or operating funds.

What is an example of undercapitalization?

Let us assume a company is running its full operations and earning a profit of $50,000 by employing a capital worth $10,000. The scenario is such that the actual capital required to earn this amount of profit is $20,000, but the company is making money on the same capital worth $10,000.

This is the most commonly used and effective method of correcting under-capitalisation. This study examines external equity acquisition by banks with declining capitalization. This study examines the impact of the Federal Deposit Insurance Corporation Improvement Act of 1991 on bank stock returns and risk. We find that FDICIA had a generally positive effect on bank stock returns and resulted in a significant reduction in bank risk.

The effects of declining capitalization on equity acquisition by commercial banks

While often more expensive than a typical bank loan, they do provide immediate help to any short-term business problem. Undercapitalized banks contribute to systemic risk in all countries they operate in. Most businesses die from undercapitalization, and we had access to a lot of cash. These types of investments are a form of reinsurance, a very established market that has existed since the early 14th century but remains largely undercapitalized. The management of the company may build up secret reserves and pay lower taxes to the Government. Because of higher profitability, the market value of company’s shares would go up.

However, in the cities, industry had become undercapitalized, and prices were rising. Unencumbered AssetsUnencumbered assets are assets that are free and clear of any liens, mortgages, or other financial encumbrances. In other words, they are assets that are not pledged as collateral for a loan or other financial obligation. But unlike mainstream lenders, Black banks are chronically and acutely undercapitalized.

Under-Capitalized – Top Reason Small Businesses Fail

When a company is not maintaining the proper amount of cash flow to operate their business and loss the ability to access credit they increase their chances of bankruptcy. Funding such as invoice factoring can be a cash flow solution for undercapitalized companies. In order to avoid future problems with undercapitalization, entrepreneurs need to perform a realistic assessment of their expenses and financial needs.


In the electricity sector in Argentina, the government introduced controls on energy prices in 2002, reducing profitability and thus discouraging capital investment. This was compounded by high inflation, which caused declines in real revenue, while devaluation of the peso increased the cost of servicing high levels of debt in foreign currency. The result was severe undercapitalization, which led to inability to keep up with increasing demand, contributing to the 2004 Argentine energy crisis. Fresh share capital can be raised via the primary capital market to curb undercapitalization. If under-capitalisation is due to inadequacy of capital, then it can be corrected by the issue of fresh shares, the company may also redeem its long-term debt by the issue of fresh share capital. We demonstrate that the simple and intuitive NPACR outperforms the complex Basel regulatory capital ratios in forecasting bank failures in the U.S.

Samantha Silberstein is a Certified Financial Planner, FINRA Series 7 and 63 licensed holder, State of California life, accident, and health insurance licensed agent, and CFA. She spends her days working with hundreds of employees from non-profit and higher education organizations on their personal financial plans. On this page, you’ll find the legal definition and meaning of Undercapitalization, written in plain English, along with examples of how it is used.

This paper shows that after excluding low-priced stocks and/or January returns from the sample, the stocks trading near their historical high prices, in fact, exhibit significant outperformance. The performance of 52-week high momentum strategy also improves significantly upon exclusion of low-priced stocks and/or January returns. These findings have important implications for the anchoring-based behavioral explanations of these return patterns.

What are the causes of undercapitalization?

  • Financing growth with short-term capital, rather than permanent capital.
  • Failing to secure an adequate bank loan at a critical time.
  • Failing to obtain insurance against predictable business risks.
  • Adverse macroeconomic conditions.

This paper investigates the relation between bank dividends and bank risk over the period 1984–2011, and assesses the existence of risk-taking and risk-shifting in the US commercial banking sector subject to regulatory regime changes. The introduction of PCA in 1992 and TARP in 2008 constitute significant regulatory regime changes, and provide the necessary framework to explore whether regime-dependent risk-shifting or risk-taking is present. We find strong evidence of risk-shifting and risk-taking over the post-PCA regime spanning the period 1992–2008. We interpret this evidence as indication of ineffectiveness of PCA in controlling risk-taking and risk-shifting.

Importantly, Acharya et al. and Onali emphasize the role of dividends as a risk-shifting mechanism that impinges on the capital structure of the firm, whilst Dahl and Spivey fail to confirm the role of dividends in bank recovery. In terms of the effects of bank capital adequacy regulation on risk, related literature comprises studies by Keeley , John et al. , Akhigbe and Whyte, , Aggarwal and Jacques , and Barrios and Blanco . If you have a brilliant business idea, you may be itching to get started as quickly as possible. By understanding how https://forexbitcoin.info/ may allow your creditors to pierce the LLC veil, you can better plan for both meeting customer demands and protecting your individual wealth.

What is overcapitalization and undercapitalization?

Over capitalization is a state where earnings are not sufficient to justify the fair return on the amount of share capital which has been issued by the company whereas under capitalization is a state where the capital which is owned by the business is much less than the borrowed capital.

Undercapitalization also acts to limit the growth of many small businesses, because without sufficient capital they cannot afford to make the investments necessary for expansion. In this way, undercapitalization can pose a problem even for profitable small businesses. «Without sufficient capitalization, companies do not have the staying power to withstand intense competition or downturns in the business cycle,» Richard Hamilton added in an article for Manitoba Business. Undercapitalization occurs when a business does not have the proper working capital to run their normal business operations and pay creditors.

EverTrader is helping traders successfully deal with under-capitalization — EIN News

EverTrader is helping traders successfully deal with under-capitalization.

Posted: Wed, 11 Jan 2023 08:00:00 GMT [source]

First, Robb and Coleman concluded that startup capital is a key indicator of business success. This research confirmed that women start their business with nearly half the amount of capital as men, and further that women entrepreneurs raise substantially less equity and debt throughout the business lifecycle. In a second study, conducted by PQC Consulting, Inc, we learned, that all else equal, undercapitalization negatively impacts business survival. Undercapitalized corporations can leave entrepreneurs personally liable for business matters. These entities are more likely to involve commingled assets, defrauded creditors, and inadequate records.

  • Undercapitalization may also lead to the company being unable to pay its creditors.
  • An under-capitalized business has a higher risk of declaring bankruptcy due to an inability to pay your businesses financial obligations.
  • But perhaps the most critical factor in determining whether there should be personal liability for corporate debts is whether the owners provided sufficient capitalization for the business.
  • Because of this, small business startups should create a monthly cash flow projection for their first year of operation and balance it with projected costs.
  • In terms of the effects of bank capital adequacy regulation on risk, related literature comprises studies by Keeley , John et al. , Akhigbe and Whyte, , Aggarwal and Jacques , and Barrios and Blanco .

This information should not be considered complete, up to date, and is not intended to be used in place of a visit, consultation, or advice of a legal, medical, or any other professional. Where under-capitalisation is due to insufficiency of capital, more shares and debentures forex basic vocabulary for beginners may be issued to the public. If a company is earning higher profits, the customers may feel that they are being over­charged by the company. Most cities and counties require business operators to obtain various licenses or permits to show compliance with local regulations.

It seemed appropriate because the inventor, a gentleman by the name ofColonel Harlan Sanders, had become one of the most recognized people in the world. The amount of capitalization needed by a small business depends upon a number of factors. Businesses that offer a service usually require less funds than those that manufacture a product. Similarly, businesses in which the owners perform most of the work tend to need less up-front capital than those that must hire employees. A company’s initial capitalization also depends on the entrepreneur’s ability to invest personal funds and institute a sound business plan.

The Baldwins argued that, under Montana law, Iofina’s failure to provide Atlantis with sufficient operating capital was evidence of bad faith and justification for piercing the veil. An under-capitalized business has a higher risk of declaring bankruptcy due to an inability to pay your businesses financial obligations. The condition of lacking sufficient capital to perform normal business operations. Some telephone and utility companies require deposits, while others do not. A deposit may not be required if you own real estate or have a previously established payment record with the company.

In the banking industry, undercapitalization refers to having insufficient capital to cover foreseeable risks. Under-capitalization is often a result of improper financial planning. However, a viable business may have difficulty raising sufficient capital during an economic downturn or in a country that imposes artificial constraints on capital investment. Companies seek equity financing from investors to finance short or long-term needs by selling an ownership stake in the form of shares. Startups and small businesses should prepare monthly cash flow projections & equity forecasts to avoid being undercapitalized. When Atlantis stopped making lease payments, the Baldwins sued Atlantis, as well as Iofina, seeking to pierce the LLC veil and hold Iofina liable under an alter ego theory.

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