Financial Peace for the Entrepreneur

I was trying to think of a title for this post and my mind kept thinking of Dave Ramsey’s “Financial Peace University” course that he provides to help people control their finances and live debt free, and that’s what this post is really about–peace of mind for the entrepreneur when it comes to financial matters.

As any of you who have read through my “You might be an entrepreneur if…” list (yes, I’ve been through all that and much, much more), you know I’ve had some tough times with my business. Thankfully, things have been going pretty well for the past two years, although I’m still paying for my past sins and have a ways to go. Through it all I’ve been blessed to have worked with some great people who were extremely patient with me in my failings, and especially for my wife who has suffered more than anyone else. But although I’ve been through some pretty tough years I can’t say I regret it. Sure, I wish I had been smart enough to make better decisions, but given that I wasn’t that smart to begin with, I’m glad I had some wisdom knocked into me, if only through painful experience. In claiming to have any wisdom at all, I feel a bit like someone who has burned his hand on a red-hot stove. That is, you can’t say it was smarts that got me to where I am today, but I can claim to have learned some lessons very thoroughly. I’d like to share a bit of that now.

The one lesson I would share with any aspiring entrepreneur who wants to be successful in business and life and have the satisfaction of their labors is this–don’t go into debt.

It sounds simple enough, but not only are there strong temptations to go into debt when you’re an entrepreneur, but sometimes you can end up in debt without realizing you were getting into it.

Temptation. Entrepreneurs have more hope than anyone in the world. But hope leads to faith, and faith can get you in trouble if it’s placed in the wrong things. An entrepreneur’s hope works like this:

1. Entrepreneur has an idea and thinks “Hey, I would use this, I bet other people would use this, and I can make it and sell it and make a fortune!”

2. Entrepreneur researches idea, realizes it will require $100K to get off the ground.

3. Entrepreneur realizes he doesn’t have $100K, or even $5K.

4. Entrepeneur realizes he can get $20K from family and friends, $30K from credit cards, and $50K from an SBA loan. Then he can launch his business, make his fortune, and paying all the loans off will be easy.

The entrepreneur gets the loans, and starts his business. But then reality sets in.

5. Entrepreneur spends the $100K, but as the money is drying up, realizes he needs another $100K to get his product launched.

6. Entrepeneur talks family and friends into loaning him another $50K, and gets a $50K home equity loan, which actually results in him having a loan on his house that’s more than what it will actually sell for. But that’s ok because real estate is going up. Plus he’s going to be making millions a year from now, and all this debt will be a cinch to pay off, and then he might pay off his entire house, just for fun.

Whoops, I guess reality hasn’t really set in yet. This entrepreneur is still full of hope and faith that his idea is going to work out. But eventually reality will set in.

7. One year later, the entrepreneur has spent all the money. But he’s sooooo close to getting his product launched. He convinces his family and friends that things are soo soo close, and it really does look like things are that close, and they don’t want their previous investment to just disappear, and it seems like throwing more money in is the only way to make their initial investment pay off.

8. At this point the entrepreneur also has a few employees working for him. But he’s run out of money, so he convinces them to keep on working for him, and he’ll get them caught up on paychecks in just a few months once their ship comes in.

Still no reality check? This entrepreneur is undaunted, isn’t he? He’s chipper, he’s full of hope, and nothing can stop him. He glories in the challenge of it all, and has his eyes on the prize that will surely be his after all his hard work. After all, if there’s any justice in this world this idea just has to work out.

9. Six months later, the product still hasn’t been launched. The employees have all quit. Nobody is willing, or able, to give the entrepreneur any more funding. Worst of all, the entrepreneur just learned that a huge company has just launched a product virtually identical to his, only better. Plus it has a multi-million dollar marketing budget promoting it.

10. The entrepreneur is now saddled with $300,000 in debt, and nothing to show for it other than experience. The bank is calling on a weekly basis, threatening to take his house if he can’t keep up with loan payments and they keep zapping him with $120 in late fees whenever he misses a payment date. He’s paying $500 per month in late fees and interest on his credit cards. His family and friends are calling him telling him that they love him and all, but they desperately need the money back that they loaned to him to make their own house payments. And his wife wants to know when he’s going to bring home enough money that she can go to the grocery store to get milk for their baby.

Ten steps to misery. Sure, it could have all turned out differently. The entrepreneur’s plan could have worked out. He could have ended up a millionaire. And if every time I took a three-point shot it went in I’d be in the NBA. Just because you have hope and faith in something doesn’t mean it will happen just as you want it to, and when things do work out it’s the exception, not the rule. Statistically, most businesses fail.

But it doesn’t have to be like the sad story above. The entrepreneur in the story made mistakes he could have avoided. The major one was to go into debt. But there are some others, namely:

1. Don’t use credit cards. The interest is insane, as are the late payment penalties.

2. Don’t involve family and/or friends in your business pursuits–ever. No exceptions. Not unless you’re willing to lose your friends and make family reunions very awkward.

3. Whatever you think a business is going to cost to get off the ground, multiply it by at least 10.

But the major mistake is to go into debt. Not only does it stink to be in debt, but easy money allows people to make bad decisions and cover them up. In fact, easy money promotes making bad decisions.

For example, let’s say you need $100K to get your business off the ground. But if you had another $50K, you could get some nice furniture for your office, which might help your business grow even faster since you’ll be entertaining clients and partners at your office, and you want to put on a good show. If it’s easy for you to get $150K in debt financing, then you’ll probably buy that $50K of furniture. But two years later, when your business hasn’t taken off, you’ll have the furniture, but you’ll also have an extra $1,000 per month that you’re paying out to cover the extra debt. You might realize at this point that the furniture wasn’t really worth it and hasn’t helped you at all, but you can’t sell it for more than $10K at this point.

But let’s change the scenario around. Suppose you had $50K in your pocket. It’s your money, free and clear–you can do whatever you want with it. Would you blow that $50K on furniture for your new office? I guarantee you’re going to think long and hard about whether that’s the best place to spend that $50K–a lot harder than you would think about it if the $50K were debt financing. Debt financing, which I classify as “easy money”, makes people make bad decisions.

For years I ran my business on debt. Loans, credit cards, paying employees late, paying taxes late, etc.. I was in debt to anyone I came in contact with. You could hardly have lunch with me without me ending up owing you money somehow. During that time, I could never get my business to turn a profit, even though our revenues grew every year. And when I say the business didn’t make a profit, I mean I didn’t get paid. I went four years without taking a paycheck. Nada. We lived off my wife’s meager salary as a state employee during all that time.

The best thing that ever happened to me was when all my sources of funding dried up. I couldn’t get any more credit cards, I couldn’t get any more loans, and suddenly I was faced with the prospect of…well, I didn’t know what at the time. All I knew was that I was spending more money than I was bringing in, and I wasn’t sure how I was going to pay employees, contractors, rent, utilities, debt payments, etc. But I didn’t know what to do. I felt hopeless. But luckily I had some experiences that made it clear to me what I needed to do to fix things. The decisions has always been obvious, but I had found ways to avoid them because they were decisions I didn’t want to make. But in the end, I did.

I closed our office. I let all my employees go. Suddenly it was no longer “MWI, the company with a nice office and big sign overlooking the freeway with 10 employees” it was “MWI, the company run from my home office with no employees.” That was hard for me to take. I worried about how it would affect my ability to get business. And worst of all it made me feel like I had failed. I knew I had made the right decisions, but I wasn’t all to happy about them.

But my unhappiness didn’t last long. Within two months things changed dramatically. I no longer had to figure out how to bring in $60K every month and then deal with only bringing in $40K. Now I only had to worry about bringing in $20K, but I was still bringing in $30K per month. Suddenly I was paying off debts instead of accruing them. During one four-month period I paid off $50K in business debt. And I started paying myself. My wife was able to quit her job. We moved out of a 400 square foot studio apartment into a larger place. We adopted a little girl. Flowers bloomed outside our windows–ok, maybe this is sounding a bit too rosy.

It wasn’t all flowers and sunshine. Chances are if you run a business the wrong way for seven years you’re not going to clean it all up in one or two years. I’m still paying off debt. But many of the largest and most stressful debts have already been paid off completely. My business still has its ups and downs. But now my business model accommodates ups and downs much better. Here’s how I’ve structured things:

1. Contractors instead of full-timers. The great thing about contractors is you only pay them when you use them. And the more I’ve been able to match their compensation to my own, the better things have gone. If a contractor gives me a bid of $2,000 for a project, I might charge the client $3,000. If they’re going to charge me $80 per hour, I might charge the client $125 per hour. Either way, I know I’m not going to spend more money than I bring in. If I am going to get paid $4,000 for a project but I’m paying my contractor hourly, then I risk getting into trouble, and into debt.

There are pros and cons to contractors. For one, I can’t turn to them and say “Hey, get this done right now.” I can send them an email and say “Hey, get this done as soon as you can, please.” but that might mean they don’t get to it until the weekend. But if I compare the overall results of contractors to when I had full-time employees, it’s actually better now than it was then.

2. No debt. Sure, I’m still in debt, but it’s getting paid off, and once it’s all paid off, that’s it. Never again. No credit cards. No loans. And here’s the tricky one–no spending money with the hopes of having the money to pay for it.

For example, let’s say I have a project I want to do, and a programmer says it’s going to cost me $5K. In the past, I would start the project, and hope to have the money by the time he finishes the project. But I’m done with that. The smart way to do it is to get a bid, save up the money, and then have the programmer start while you keep the money in reserve. When he finishes, you pay him from the reserve. If you can’t save up the reserve, you don’t do the project.

3. Cut expenses to the bone. What do you really need to run your business? I thought I needed a big, nice office and a sign on the building. That cost me $5-6K per month. Over a five year period I spent $360K in order to have a nice office and a sign. Did I make $360K in profit during those five years? No, I never made a profit at all. In other words, it was a complete waste of money. Granted, if I didn’t have the office I probably wouldn’t have had as much revenue (the office did in fact help us land some jobs we wouldn’t have otherwise), so it’s not as though I could have put $360K in my pocket if I hadn’t spent it on the office, but I certainly could have put $150-200K in my pocket. But hey, I wanted a nice office, and I had one. I just wish I could go back in time now and slap myself a bit and call myself a fool for not putting that money into buying a house instead…although with real estate prices falling as they are right now, I’m not sure that would have been the right decision either…

I also cut smaller expenses. Phones, internet, banking, other business services–I cut everything. I got excited about saving $10/month on a bill. I did everything I could to find ways to cut costs.

It’s been two years since I embarked on this experiment. Sometimes I still feel like a slow, lugubrious idiot for not starting things the right way from the beginning. That’s ok, I don’t care about having been stupid so much as I care about making sure I’m not still being stupid. Even though my business isn’t the picture of worldly success, I’m a much, much happier man than I was a few years ago. I’d still like my business to be something larger than it is someday. I’d like to have that successful harvest under my belt. But for me, that has meant starting over and restructuring everything from the ground up. I just hope that if you’re an aspiring entrepreneur you can do it the right way the first time. I’m already at peace because I know I’m on the right track, but if I can help others avoid the wrong track and achieve their own financial peace from the get-go, then that will only add to my satisfaction.