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These days, a lot of people seem to be venturing into starting up their own business. Of course, one of their most worrying concerns is about financing. Should you look for an investor? Or should you finance your business by taking a personal loan from friends and family.
According to serial entrepreneur Mark Cuban, “Only morons start a business on a loan”.
Most businesses today run business models based on the Wall Street principle of “Other People’s Money” which involves using some kind of financing like stocks, bonds, or by obtaining bank financing. However, because it works for Wall Street and several large corporations does not mean such methods are effective for the small business owner.
It should be apparent that successful small businesses are the ones that started off with zero debts. They started as small as they could and financed their growth through the injection of more funds from their cash flow. While it may seem to defy logic that a business can start and grow without an injection of fast cash to finance it, it’s also equally true that paying debts reduces cash flow.
If you are starting a business here are a few reasons why you shouldn’t take a loan to finance it.
Very few prospective small business owners have access to financing for an upstart operation without pledging personal assets. For example, small business loans require personal guarantees, and they usually want to cross-collateralize the loan against every other business and real estate the borrower owns, which means they are risking personal financial collapse for themselves and their family, and it will hurt their ability to obtain cash from any other source.
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.
Starting a new business is usually a long-term process that might take a number of years to pay off. 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 is that they have no debt. No debt means no debt service and no loans to be called in at the worst possible time.
One of the biggest causes of business failure is being undercapitalized. When you run out of cash you run out of cash; no matter how profitable your business, how well you are running it, or how much potential it has.
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 necessary to make it thrive. If it’s one thing you need in a small business, especially a new one, its flexibility. You’ll be denied that ability if your cash flow is committed to loan payments.
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?
So should you start a business with a loan?
In this case, even if Mark Cuban words are a bit harsh, he is still right about the fact that people greatly underestimate the commitment, hard work, time, and cost of starting and growing a successful business. If a loan is easy money, it can facilitate bad decisions, and you have to pay it back sooner or later. While this may be equally true with other forms of financing, however you don't have a bank chasing after you.
MSBM - UK
The Professional Certificate in Information Systems in Business Organization aims to enable the learner to understand the fundamentals of information system
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MSBM - UK
The Professional Certificate in Information System Business Strategy Alignment Models and Analysis aims to provide the learner with the tools and models to align the organizational information strategy with the business strategy.
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