Startup Lesson 6: Never EVER borrow money for a startup

When my wife and I got married in 1993, we both had entry level jobs with very low salaries.  I probably brought the salary curve for the GA State U MBA Class of 1993 way, way down.  We also owed several thousand dollars on my car, several thousand dollars on credit cards, and over $20k on my student loans. For those of you who are married, you know already that this was a recipe for disaster.  Debt sucks the life out of your earnings.  The same applies for the startup.

Many people will disagree with my absolute blanket title. In fact, it was this post from David Cummings that put this idea on my blog list.  That’s ok.  God made salt and pepper for a reason. You can choose to agree or disagree with me on this, but I’ll at least give you something to think about.

It took my wife and I over two years to pay off all that debt, and it was not easy, and took a huge toll on our first years of marriage.  But we learned our lesson the hard way.  Unfortunately, I did not apply that lesson – debt sucks the life out of earnings – to my startup, CWNP.  After our biggest year ever, $1.2M revenue, we decided that we would borrow $250k and “really grow the business.”  With our new revenue high and the fact that we were very profitable, getting that line of credit was not difficult at all, especially in the summer of 2008, you know, right before everything came crashing down? Yeah, then.

But we didn’t see that coming, so we put the pedal to the metal, hired 6 people, and began growing the business and dipping into that $250k line of credit. Then the bottom fell out. We lost of biggest client (Motorola laid off 15,000 people and began splitting the company), and our wonderful regular revenue stream dried up. In 2009, our revenues were less than half what they were in 2008. Three of the four principals of the business left.

But here’s the thing about a small business getting a loan or line of credit: depending on the size of that small business, the bank will make the principals personally sign and guarantee the loan. Ruh roh. That’s right, so three principals left, but their names were still on the loan. Don’t you know that was a fun time?!?  I had to mortgage my home. But that debt was still there, requiring that fat payment every month. Thousands of dollars that could have been spent on marketing or payroll or product development had to be paid to the bank.

For some reason that’s something people forget: you have to pay it back with interest!  Here’s a good example of the ultimate extreme of interest or “servicing the debt.”  The USA now has over $17 TRILLION in debt. Some people say that doesn’t matter…that you don’t run a nation the way you run your household or a small business. But consider this: we spend $500,000,000 (FIVE HUNDRED BILLION DOLLARS) every year on interest on our nation’s debt.  In B-school, this is what they call “opportunity cost.”  What could be done with $500B each year if it did not have to be spent servicing the debt.  Personally, if I were king for a day, we’d have a balanced budget amendment and zero debt, but I digress.

The same principal of opportunity costs applies to your startup! While David Cummings and I disagree on the borrowing issue, we agree that sales revenue covers many mistakes and problems. Think about what a few hundred or a few thousand dollars each month could do for your startup, and consider that when you think about taking out a loan or line of credit.  Building sales and scaling organically is a far better option.

Oh, and many people consider borrowing money from friends or family. DON’T. There is no quicker way to lose a friend or alienate a family member than to owe them money. Getting friends and family to invest is one thing. Borrowing money from friends and family is completely a different issue.

If my blathering here is not enough to convince you, maybe Dave Ramsey can. He was a multi-millionaire at 26, then went bankrupt because of debt. He now makes millions every year – debt free – by teaching individuals and small businesses how to live, grow, thrive, and build wealth without ever borrowing money.

What do you think?