Right now a lot of people are either unemployed, underemployed or working in a career or job where promotion opportunities are close to non-existent. In such times, thoughts often turn to cutting a new path by starting a new business. If you do, should you borrow money to start a business?
Many of today’s business models are based on the Wall Street principle of OPM — Other Peoples Money. Whether through the sale of stocks, bonds or by obtaining bank financing, large companies and well publicized start ups seek to open new ventures and expand through leverage.
But what works (sometimes at least) on Wall Street can often be business poison to the would-be small business owner.In my accounting career, it was apparent that the most successful and most enduring small businesses were the ones who had no debt. They started small, and grew by self-financing out of their cash flow. While it may seem to defy logic that a business could be started and grow absent an injection of fast cash to finance it, it’s equally true that paying a debt service reduces cash flow.
If you’re starting a business, why should you avoid borrowing for the start-up?
Personal liability. Very few would-be business owners can get financing for an upstart operation without pledging personal assets. Usually, this means taking a loan against your personal residence, borrowing against a 401k or even tapping credit cards. In each case a debt service is created even before the first dollar of income is earned.
Some believe that this type of no-turning-back plunge is necessary for success, but it also creates ongoing expenses and causes stress, both of which can threaten the success of an upstart business, not to mention paying for a venture long after it fails. We may not like to think about that last point but it shouldn’t be ignored.
Survivability. Starting a new business is usually a long term process that will take several years to accomplish. If there’s one thing you can count on it’s that the economy will turn sour sometime during that time frame. One of the major reasons some businesses survive downturns it that they have no debt. No debt means no debt service and no loans to be called in at the worst possible time.
Increased flexibility. If you have debt when you start your business, your primary objective will be to make at least enough money to make your payments. The problem with this approach is that it can limit your ability to move your business in directions you feel are necessary to make it thrive. If it’s one thing you need in a small business, especially a new one, it’s flexibility. You’ll be denied that ability if your cash flow is committed to loan payments.
Profitability. Businesses often leverage not to build profitability, but to increase sales and operations for future take over potential. But for a small business owner, profitability is more important than size. With enough profit, you can grow your business and move it in any direction you choose, creating even more profits that won’t be reduced by debt service.
Complete control. When you borrow money to start a business, you enter into an unofficial partnership with your lender. Product lines and business direction may be compromised in favor of debt service. By operating without debt, you eliminate your “partner” and can take the business in any direction you choose, and isn’t that the reason you would choose to go into business for yourself in the first place?
Stacking the deck in your favor
Talent and the ability to manage money on a shoestring will serve you better than having a big wad of cash from a loan. In fact no amount of money will cover a lack of these abilities. What can you do to start and run your business without taking a loan?
- Pick a business that you know and have contacts in. Often when a person is determined to start a new business, there’s a tendency to go for one that’s “hot”. Even if we don’t know anything about it, the lure of a “can’t miss” opportunity is strong. But any business venture you attempt will require a learning curve—the longer the curve, the lower the chance of success.Choose a business that you already have at least some knowledge of to speed the process—in business, time really is money and the less of it you spend getting out of the starting gate, the quicker you’ll hit profitability. If nothing else, try working in the business for a future competitor on a part time basis before venturing on your own, that way you’ll learn the business and develop needed contacts while you’re getting paid.
- Start the venture as a side business. Don’t quit your job to plunge into a new business venture or you may cut you off the steadiest cash flow available. Better to start your business gradually as a side venture, at least until you get a cash flow going, establish a book of business and have some hard numbers to make future projections.Lack of cash flow is the surest way to kill a new business, so it may be better to slow down some and keep the cash flowing from your regular job. Juggling two activities will be stressful and time consuming, but it reduces the risk enormously because it buys you time to get things moving.
- Master the art of free and nearly free marketing. As a start up, one of your biggest expenses—maybe even the biggest—will be marketing. Though there’s often a temptation to pour money into marketing in the hope of hitting the ground running, it’s important to realize that a good message consistently applied over a long period of time can be more effective than a heavily financed one. Find ways to do this that require little or no money.A web site is one way to do it; offering affiliate participation is another that will enlist sales support completely contingent on revenue generated. Learn all you can about networking and marketing via the social media—Twitter, Facebook, LinkedIn, etc—that you can use for free. Avoid more costly venues like newspapers or TV that can drain your budget in short order.
- Start the business early in an economic recovery. Time is a crucial element in the starting of a new business, and the more of it you have, particularly in a rising economy, the greater the likelihood of success. Early in a growth phase is the time when markets tend to be the most receptive to new business. This is in part because spending is increasing but also because many competitors were wiped out in the preceding recession. Time your start right, and you can have several years to build your business until it’s strong enough to weather the next down turn.
Have you ever lost a lot of money on a failed business venture? Can you think of other ways to get a business going without borrowing?