 When it comes to starting a business, there are many cases of financing gone wrong. For each entrepreneur who is able to succeed despite making poor financing choices, there are many businesses that fail within the first year. Let’s take one business “under the knife” and see how this cash-flow calamity could have been avoided.
Tall dreams
Amanda Jutland* grew up tall. She was tall as a 10-year-old, taller as a teenager and even taller still as a young woman. When she decided, at the age of 29, to venture into business for herself, she decided to design and sell clothing for tall women. Surely this would be a perfect fit.
She and her husband had some equity in their house and used that to take out a loan for her new venture. Inspired, she rented a space in a brand new plaza which bordered a highway and set about to open her business.
Here’s what happened
Many business owners start their businesses by taking loans against the equity they have in their homes. It’s a decision that places personal and business finances into the same pot. And that’s often the first step to true financial hardship.
Amanda received a $59,000 loan at 6.5% (a competitive rate at the time), and she started making monthly payments immediately on the principal and interest for the entire loan amount.
She spent the following:
Leasehold improvements $20,000
Carpet & flooring $2,000
First and last months’ rent $5,000
Display & counter cabinets $1,000
Computerized cash register
& software $10,000
Racking & hangers $5,000
Insurance $1,500
Signs $1,500
Phone $200
Business stationery $500
It all came to a total of $46,700.
Cash-flow crisis
When her inventory bill came in, the manufacturer demanded payment before delivery. Feeling confident as her new store would soon be full of beautiful merchandise, Amanda went back to the bank for more financing. She needed another $21,000 to pay for the inventory, which came to a total cost of $33,000.
The bank, although they had received her first monthly loan payment, declined her request. In fact, the bank became nervous about her need for additional funds so soon—and called her loan.
The result? Amanda was out of business before she opened and lost her house in the process.
As emotional as this story is, the numbers don’t lie. And you can’t fault the bank when it appeared that Amanda’s tall dreams were already in trouble.
Post-mortem report
Things could have turned out differently had Amanda diversified her finances. There are two tools Amanda could have used in addition to a much smaller loan of $20,000: a line of credit and equipment financing.
Use a line of credit
A line of credit for $40,000 would have had an interest rate of 9%. Amanda would pay interest only on the amount she used, which meant that she could borrow what she needed, take her time paying it back and only be charged interest on the amount used—not the credit line total. Another benefit of a line of credit is that it would not be recalled unless she fell behind on the interest-only payments.
She could have paid her insurance of $1,500, her first and last months’ rent of $5,000 and her business stationery costs of $500 with her line of credit. That would have left her with $33,000 available to purchase her inventory.
Opt for equipment leasing
Amanda’s second tool could have been equipment leasing. She could have used the value of the equipment as collateral for her lease. Even though the interest rate is higher than a loan (at 9-15%) her monthly payment would not be much higher. Equipment leasing is not recalled.
Don’t confuse this with vehicle financing—it’s not like vehicle financing at all.
Let’s say, like Amanda, you need a whole bunch of equipment like displays, registers and signage. If you take these products and put them on an equipment lease, then the equipment itself forms the collateral for the lease. You’ll make 36 or 48 lease payments and you’ll own the equipment at the end of the lease for a $10 buyout. And every single payment you make, including the GST, is a legitimate business expense.
This adds up to much more in savings for you at tax time. And one monthly payment frees up your cash flow for other purchases, like advertising and promotions, memberships in networking organizations, terrific business cards, a power suit and great shoes. Even in tall sizes!
Amanda could have had her lease structured over 36 payments and $17,000 would have covered the cost of her display and counters, her racking and hangers, her cash register and software, signs and phone system. The monthly payment for all of this would be a business expense; therefore there would be no depreciation on capital costs. And, she would have owned the equipment outright in 36 payments.
The much smaller bank loan could have been used for leasehold improvements.
Lower costs, more available credit
By using the tools of a line of credit and equipment leasing, Amanda’s monthly business costs would have been substantially lowered; there would be money to pay for her inventory and her payback could have been interest-only until she could afford to increase her payments.
Starting a business is risky, but borrowing for a business without obtaining some financial advice can be very dangerous. Don’t make the same mistake Amanda did and explore your options carefully—preferably with an expert—in order to ensure you always have a steady heartbeat. Oops, I mean cash flow.
Case closed.
*Not her real name.
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