To Borrow or Not To Borrow?
Whenever someone starts a new business, one of the most important things to consider is finance, notably where its going to come from. As far as I’m concerned there are 2 ways to go about getting finance, the one way is quicker, and the other is generally thought to be safer. I disagree, and the 2 ways I’m talking about are borrowing it, or saving it up.
I’m definitely not an expert, but this is the way I see it. I believe that there are a number of reasons why borrowing the capital would be a wiser decision then saving it all up. Firstly, you can get started quicker (time is money), secondly you do not put your own hard earned cash at risk, and thirdly, you might find that you will save more in the long run by borrowing.
Let me try to illustrate this with a simple story. Mary and Emma were neighbors and they were both starting new businesses. Mary was a firm believer in not owing anything to anyone, so she was prepared to wait a while in order to save up enough capitol. Emma, on the other hand, was a bit more of a risk taker so she immediately applied for a small business loan at her local bank. They both needed 60,000 dollars to get started.
Mary immediately set her mind to the task of planning out how she was going to save the money she needed. Mary didn’t have to worry about the bills since her husband was also working, so she figured that if she worked overtime she could pull in about $5,000 a month, which meant that in only a year she would be able to start debt free.
Emma started out by drawing up a complete business plan. She figured that she might struggle for the first 6 months, so she would only be able to afford a premium of $7,000 per month. Of the $7,000 only $5,000 would be to pay back the loan. Emma calculates that she will break even after 3 months, and by six months she should be turning a profit of around $5,000 after all expenses (including premium payments) have been paid. At this point Emma decides that she will start putting all her extra cash into the loan, so instead of only putting $5,000 into the loan she is now putting $10,000 and she is paying a premium of 12,000 dollars. By the end of 9 months, Emma has paid off her loan and she has managed to save up about $10,000. Her company is now on a roll and is making about $20,000 per month after all expenses have been paid.
By the end of 1 year Mary is about to start her company and she is dreading the thought of risking all of her hard earned 60,000 dollars. Emma, on the other hand, has spent the year paying in total of $18,000 in interest payments to the bank, but she has managed to not spend a cent of her own money, she has been able to save up an additional $70,000, and her company is well on its way to success.
Somebody great once said that “successful people make their fortunes with their own sweat, blood, and money, but rich people use other people’s money”. If nobody has said that yet, I shall claim it as my own :)).
I feel that before I close I should add a disclaimer. The views expressed in this post are my opinion, and not the opinion of a financial expert, use them wisely. The figures presented are for illustrative purposes only, in real life they might differ dramatically.
Simon
P.S. If you have any wisdom to add, feel free to do so in a comment. I love to learn.
I started my business as a student with no collateral. The banks wouldn’t even consider giving me a loan.
So instead, I dipped into all of my savings and applied for a 12 Month 0% Interest credit card to jumpstart the business.
This was very risky to do, but fortunately the business is doing very well. We recovered our initial investment within the first 6 months. We just got lucky and worked hard.
I’m glad to hear that. There are so many different ways you can start a business, but in my opinion starting a new business is one of the most exciting, fulfilling, and fun things anyone can do.
And its encouraging to know that most successful business men lost 3 businesses before they became successful, so never give up.
Simon
I also think that money taken out on a loan can be put into investment. That way if the amount is high enough, your interest is actually paying back the premium that you owe each month.
That can work, but its very risky. If you do something like that you have to be sure to plan everything to the tiniest detail.
For example, if you borrow from the bank and then put some of that money into investments with the bank, your interest on your loan will always be more than the interest the bank gives you for your investment, so the only alternative is to invest elsewhere which can then become risky.
But its possible.
Simon