In the Beginning: Let There Be Money
Author: Wulf Rehder, Ph.D
February, 2008 Issue
Money begets money. Yes, money is fertile. But where’s that very first dollar coming from, that initial buck so eager to multiply? This is the monetary Catch-22 facing every business: Before you make money, you need to spend money—for advertising, inventory and a place to call home.
Luckily, this paradox has not just one but two solutions. You either own money you can use now or, if you don’t, you’ll owe money later. In other words, you either pull yourself out of the conundrum with your own money and money from people around you, or with money from a bank. The first solution can be labeled with four Fs; the second one with six Cs.
Friendly Financing: Four Fs
The four Fs of begetting money for your business are: Your own personal funds, financial support from your family, contributions from your friends and help from other fools.
First F: Personal funds. These are your own savings, but could come from your cash-based life insurance or even from a loan against your 401(k). When using your 401(k), beware of penalties and tax consequences.
Second F: Family assistance. There may be a trust fund you can tap into, or an anticipated inheritance your family will let you use. Or you receive a monetary gift from a rich aunt who always liked you. A relatively new idea is to formalize and administer lending between family members through person-to-person promissory notes. These loans are usually unsecured, based on family ties and obligations. The company Circle Lending, which started this mode of financing in 2000, passed $150 million in loan volume in 2007 and has, since this writing, been acquired by Virgin Money.
Third F: Friends. Before borrowing from a friend, decide which you need most. Few deals have been lost because friends didn’t jump in to help, but many friendships have been destroyed because debt created a strain they couldn’t survive.
Fourth F: Other fools. It does happen that coworkers or acquaintances, girlfriends or admirers, sometimes even current or future customers find your business idea so exciting that their foolish greed to gain from it defeats their common sense. Usually, cobbling together funds in this undisciplined way spells trouble.
Many new business owners have regretted they didn’t put aside enough money in anticipation of starting a business. Then, when they need it, they feel like Jackie Mason, who said he’d have enough money for the rest of his life unless he bought something. If that’s the case with you, you need to look at debt financing.
Debt Financing: Six Cs
Debt financing here means bank loans. A bank is selling you money at a price. The price is called interest. I’m not concerning myself here with venture capital, angel financing, or private investors. (An investor’s “interest” isn’t in monthly repayments but in “poop”: profit, ownership through shares, organizational influence by choosing executives, and power by having seats on the board.)
The six Cs are checkmarks for a bank’s debt financing. They are a bank’s list of requirements to qualify you for a loan.
First C: Credit. “Credit buying is much like being drunk,” says Joyce Brothers. “The hangover comes the day after.” Banks actually don’t mind if you get a bit tipsy on credit cards—it’s the American way. Just don’t be late with your payments. Long-term credit cards and short-term payoffs are excellent for your credit rating. And a good credit rating is as important for loan eligibility as is a clean driving record for your insurance premium.
Second C: Capability. You need to prove you can pay back the loan out of the income from the business you’re financing. The bank doesn’t want you to engage other fancy schemes, loans or gifts. Always remember Oscar Wilde: “It is better to have a regular income than to be fascinating.”
Third C: Collateral. The bank wants to make sure that—just in case you’re defaulting—there’s a valuable asset it can seize. This usually means your personal residence, where you have considerable equity. To get a loan, you must have had enough money to afford a house. Or in Bob Hope’s words, “A bank is a place that will lend you money if you can prove that you don’t need it.”
Fourth C: Capital. Not only must there be the background security of collateral, but you must show your commitment by chipping in a substantial percentage, at least 10 to 20 percent, of your own money. This must be real money (cash in savings accounts), not just “paper equity,” such as a home equity line of credit.
Fifth C: Character. You have to show you’re credible—that your background, education and experience qualify you for the business you seek to fund. Despite privacy concerns, banks and the SBA want to know about possible problems, even if they were in the past, and especially if they concern money. Problems Errol Flynn alluded to when he said, “My problem lies in reconciling my gross habits with my net income.”
Sixth C: Conditions of the market. A savvy banker will know what’s hot and what’s not. Construction loans were once sought after and granted more easily than they are now that the housing market has weakened. A super high-tech venture of quantum computing likely won’t be funded in an area where there are no top universities or qualified employees. On the other hand, when conditions are right, previously hidden or marginal industries get a bank’s attention, such as, currently, all types of “green technology,” from biofuel to green buildings (“eco-tecture”) to new farming and fertilizing methods.
As reasonable as the Cs sound, most beginning businesses fail them. For them, it’s usually better to resort to the Fs, especially the first one (personal funds), or launch the business on the wings of a home equity line of credit from your favorite bank. A bank, however, will only sell you money; it won’t give you business advice. Nor will it give you an umbrella, as in Robert Frost’s witty remark: “A bank is a place where they lend you an umbrella in fair weather and ask for it back when it begins to rain.”
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