Friday, March 24, 2017

Borrowing Money to Run Your Business

A few days ago I put a note on Facebook about a new financing opportunity from PayPal. If you have a lot of income via PayPal, you can get a loan and pay it back by dedicating X% of your sales to payments.

There's a onetime up-front fee that varies with the amount you borrow. For example, when I checked, a $20,000 loan would have a $1460 fee - that's 7.3%. Not the cheapest money in the world, but way better than putting things on a credit card. The percentage rate varies depending on the amount borrowed.

Next, you choose the percentage of each sale that will be used to make loan payments. So, instead of having one big monthly payment, you make payments every time money arrives via PayPal. You also get to choose this percentage - within limits. Your interest rate above is also affected by the payent percentage you choose.

For example, you might choose to have 20% of every sale go to your payments. Thus, a $1,500 managed service payment would automatically make a $300 loan payment. It might be a little painful BUT if you manage the money you borrowed properly, you should always have the cash flow necessary so that payment doesn't hurt too much.

If you do your credit card processing through PayPal, your payments will flow out on a regular basis.

ANYWAY - I'm not necessarily advocating this program, but I think it's a very clever way to finance something if you need it.

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Danger Will Robinson!

As soon as I posted the one-sentence note about this on Facebook, my friend Andrew posted a comment that you shouldn't be borrowing money for your business. Andrew helps figure out the value of businesses as a part of his job as a business broker. So I take his advice seriously.

But I believe there are lots of legitimate reasons to borrow money for your business. You just need to have a mini business plan that includes a specific way to pay it back.

There's one big reason NOT to borrow money. But, first, here are some very good reasons you might borrow money.

1. Buying hardware and software for resale. When you buy something from Ingram, Synnex, D&H, etc. you are borrowing money. You order a server and pay for it within 30 days on your company credit. Personally, I get paid in advance for all hardware and software orders. But if a supplier will let me pay 30 days later, I usually do that. After all, it just means I get to use that money for an extra 30 days.

2. Marketing. This is a little more dangerous. If you borrow money to do marketing, you better be darn sure it will work. You know the old saying, "Fifty percent of my marketing doesn't work. I just don't know which fifty percent." But if you've got something you know will work, then borrowing money here should result in a positive result.

3. Expanding your business. Again, also potentially dangerous. If you need to add a staff member to fulfill a contract, or you want to open a second office in another city, it may make sense to borrow money to get that done. But once again, you should have a mini business plan to make sure you really understand the cost of expansion.

Many businesses go out of business exactly at the moment of expansion. This is because they borrow a lot of money, start the expansion, and something happens. It might be that they underestimated the expense, or the economy went down, or that there were delays or problems of some kind. So, instead of staying comfortably small, they borrow to grow and the whole thing collapses.

4. Special Projects. This might include buying hardware for a HaaS (hardware as a service) offering, or prepaying for certain materials in order to get a better deal. There are lots of opportunities that require a little more cash up front than you happen to have. But have a budget for the project. Know how you'll pay it back. If you can't point to the dollars that will repay the loan, don't take it out in the first place.

Five minute video on this topic.

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The Big Danger

When should you NOT borrow money. In my opinion there is one very bad time to borrow money: To fund the daily operations of your business. In other words, if you need to borrow money one or two or three times per month just to keep things going, that's a danger sign.

Full disclosure: I've done this. It hurt. I paid the price. Some lessons are learned by paying the tuition in full.

If you have to borrow money on a regular basis just to make payroll or pay the rent, you have a cashflow problem. That is a real danger sign. It means three really important things are going on. First, and most importantly, it means that you either need to increase revenue or decrease cost.

You might say, "Duh." But 99% of the people with cash flow problems are in total denial. It will be okay, they think. We'll get another sale, they say. After all, you're a positive attitude kind of person. So you know the money will flow. But if you're in this situation again and again, you need to wake up to the dangers of cash flow.

The second thing that happens is that you borrow a little money here and a little money there. And because you have a cash flow problem, you don't always pay it back within thirty days. Because you can't. Because you have a cash flow problem. The result is that you go deeper and deeper into debt.

First it's a few dollars here and a few dollars there. But it keeps adding up. Soon it's a thousand here and a thousand there. And then you realize you owe tens of thousands of dollars and you have no way to pay it back - because you have a cash flow problem.

The third thing that happens is that you have no way to save for retirement. Why? Because you have to borrow money just to get through the month. There's nothing left over to invest in the future.

Borrowing to run the daily operations of your business is the canary in your coal mine. That's because it's hard to reverse, the longer you do it. And eventually, when you want to get out, your books will show that you have an unsustainable business. It may have a very low valuation simply because you have bad cashflow.

So the bottom line is . . . It's okay to borrow money. But be extremely clear about why you're borrowing and how you will pay it back. One of the things I like about the PayPal program is that the "paying it back" part is built into the loan agreement itself.

Take care. Go slow. Use money wisely.


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