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Should you borrow or self-finance your start-up?

April 15, 2009

That depends on what your business risk profile is. The more risky, the more inadvisable it is for you to borrow, especially if you have no other income to act as insurance.

There’s the much hyped OPM/OPR principle – Other People’s Money or Other People’s Resources, which is basically a fancy term for a loan. Its promoters will tell you that if your venture fails, no problem. Its other people’s money you’ve lost and not your own.

Well, if you know anyone who’ll give you a million dollars and won’t come after you with their lawyers if your start-up goes kaboom, let me know cuz I want a piece of that action too. If only it was that simple. Even if you plan to hide your assets in the worst case, they’ll make it hard for you operate in town again. Never underestimate the resolve of lenders, especially if its the loan shark variety.

You can see for yourself how many OPM champions have gone into hiding in this recession due to their inability to service their OPM obligations. Yes its fun to talk about OPM/OPR in the coffee shop, not so easy to do in real life.

My approach to business is similar to my approach to life. I try not to live beyond my means. I hate chasing people for money as much as I hate being chased for money. If you think of it as idealistic and impossible, I think you’ll be surprised at how many businesses out there are 100% self-financed.

To be fair, this approach will limit the type of business you can operate. You can stop dreaming about a regional chain of stores, large inventories, aggressive imports and exports, property development, and outfits with dozens of employees, at the start-up phase anyway. I’ll assume you’re a normal person who is leaving the corporate world to strike out on your own, probably with your life savings, and you don’t have a rich dad who’ll come to the rescue everytime you hit a patch.

So if its your own hard-earned money you intend to put in, this is what I’d recommend: Go low risk moderate return. Its a good entry point for startups anyway. Then grow organically using whatever income you can generate. Ignore your gambler instinct to go after speculative high-risk ventures, especially those that involve entities outside your control, and ESPECIALLY those that claim many people before you have become wildly successful. If you make a mistake, you may not be able to recover.

This is not to say that its always foolish to take out a business loan. If the risks are truly small and you have the most conservative accountants agreeing with you, then by all means, knock yourself out. But if you are a first timer, I’d be very careful about jumping in with a million borrowed dollars. You have to remember that loans are a liability, not an asset, and that by starting out on borrowed money, you are starting out in the negative. Your lender will want his money back at some point, with interest or the pre-agreed chunk of profit, whether you are ready or not.

My other advice for recession startups: Never put all your eggs in one basket. Put aside some funds just in case – something for you to survive on for a few months while you wait for things to pick up.

Good luck.

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2 Comments leave one →
  1. April 15, 2009 1:31 pm

    Very useful advice here. 🙂 Definitely useful for someone like me. I’m planning to start something on my own – as part time, using my own savings. I won’t go full time yet since I’m still trying to learn up some stuff (can be useful in my work also).

    For me, I won’t go for OPM – be it relatives, friends, VCs, or banks. It’s just too risky. I’ll only start borrowing once everything is more stable because in the beginning, it’s all about trials and errors. You won’t know what works until you’ve tried it and by using other people’s money to try things, it’s just too risky.

    And without OPM, i can only aim for small startup, to climb from the ground up. Good to dream big, but realistically, it’s not going to work out with the personal fund I have. So, better be content with smaller size biz with steady and moderate income now. There’s no quick way to being successful.

    Some people said no pain no gain, or high risk high return….for me, running a small startup is different. The risk can be so high that you might have to close down everything once and for all. And the last thing you want is to close down your biz, still owe people tonnes of money, and forced to be declared bankrupt. At least, if it’s your own money, you can still avoid the bankruptcy issue.

    Sounds like you’re on the right track. Many ppl think big capital = big profit. Its not necessarily true. Sometimes big setups only mean big expenses and nothing more. If you operate small, hope for the best but prepare for the worst. Meaning that if you do get stuck and have to close down (shit happens), make sure you don’t owe anyone anything and you have enough left over to sustain yourself until you get something else going.

  2. April 15, 2009 10:51 pm

    Nice post , Damien 🙂

    I am a fan of starting from scratch ..without loans and all the other bullshit ..this post sort of reminded me of my past..

    back then i was a student , part time teaching guitar and selling guitar parts on the internet ..i think my capital was RM1200 or something..LOL

    soon it grew , from guitar parts to selling 1 guitar a month , then to 3 guitars a month..then to a shop..

    today (5 years later) , i am running a RM100,000 business without loans or any other bullshit ..my capital ? LOL , RM1200 , rolled on .

    i guess business is all about hard work , patience and time ..
    and the experience of starting small , and slowly watching your business grow ..

    …is priceless 🙂

    Clement
    gapnap.com

    Hi Clement, I think you have a great model there, congratulations! 😀 It looks we walked down a similar path, albeit mine being a consultancy. I started my business with about $50,000 of my own money. I recovered that in about 6 months and since then, I’ve been in positive territory. You’re right, its a lot of hard work and its certainly not impossible.

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