By Ed McLaughlin and Wyn Lydecker
The key economic factors impacting the potential value of any business include Capital, Cost & Control. Understanding the meaning and purpose behind each of these words will have a direct impact on your vision fulfillment, value realization, and personal satisfaction. It is imperative to slow down and take the time to understand the implication and interaction of each of these concepts. Sometimes entrepreneurs can get ahead of themselves in the pursuit of startup capital and unnecessarily give away too much control.
Weigh the Cost of Giving Up Control
It is important to remember that one of the many reasons that you decided to start your own business was to work for yourself. You want to have decision-making authority. You want to be responsible for the plan. You want to fulfill your vision, and you want to realize the value. Since startup capital is the primary negotiating lever for control, you need to make absolutely sure that you need to raise outside capital in order to realize your business vision. The cost of startup capital from an equity investor is degree of control. How much control you give up is a permanent decision.
Fuel Your Business Engine
Startup capital is the precious fuel that enables every business engine to start, while cash flow is the continuous feed of new fuel that keeps every business running. A smoothly running business creates more fuel than it consumes, resulting in the generation of positive cash flow. A highly efficient business engine can produce substantial and consistent profits. Sustainable profits drive equity value for the owners. Equity value is a marketable asset that can be sold for multiples of profit. It makes sense to think through these concepts long and hard before selling your equity. What follows is how I sized up the real cost of startup capital for my own venture.
Lucky Decision #1
When I started my business, USI, in 1991, I was convinced that I needed startup capital. I was naïve but lucky. I had saved up a sizeable nest-egg but I was advised that OPM was the way to go. OPM is the acronym for Other People’s Money. On the surface, OPM seemed to make sense. I put together a shortlist of wealthy friends and family to consider as equity investors. However, the more I thought about it, the more I did not like the idea. I had strong feelings about risking their hard-earned savings. I was also concerned about getting friends & family involved in my business. I started to think more about bootstrapping or borrowing rather than selling equity. That was my Lucky Decision #1.
Lucky Decision #2
Next, I stopped at my personal savings bank and inquired about a loan. I had good credit and had always fulfilled all of my obligations. Much to my surprise, I was greeted with a stop sign. Given the recent real estate lending crisis in 1990, my bank was not really interested in lending money to a new real estate services business. Even still, I was asked to fill out a boatload of paperwork and to submit a business plan. Even though the bank held a good amount of my personal savings, they would only lend an amount equal to the value of my savings. Said another way, my personal savings bank wanted a fully-collateralized loan (dollar for dollar). My bank would not extend one cent of risk for me. More and more, I started to think about bootstrapping my business without 3rd Party involvement – but I had one more base to cover. That was Lucky Decision #2.
Lucky Decision #3
I decided to pursue a Small Business Administration (SBA) loan. I felt certain an SBA Lender would provide me with a loan. When I met with the SBA Loan Officer, he was not excited about lending to a new real estate services business. However, he did agree to review my loan request but needed three boatloads of paperwork, a comprehensive business plan, and a cash flow analysis indicating the breakeven and profitability point. The business plan, breakeven and profitability analysis seemed reasonable, but the boatloads of paperwork seemed onerous. The deal-breaker for me was the need to hurry-up and wait. The SBA Lender said that it would take more than three months to secure a directional decision – not a final decision. I could not wait that long to get going. That was my Lucky Decision #3. NOTE: The SBA has come a long-way since I considered applying for my loan.
Why did I consider these outcomes lucky? Because I was forced to bootstrap my business myself. I invested $100,000 of startup equity in USI and never looked back. Our startup management team secured pre-orders that converted into cash-flow-producing contracts. We made a profit in the fourth month of operation, and used those profits to fund growth.
More importantly, we maintained 100% control of the business and learned how to run and build the business without ever borrowing any money. There were no outside owners, just owner-operators. We never had any debt – other than a flexible Line of Credit (LOC) for a rainy day. As we grew, we built a sizeable after-tax surplus that became a strategic weapon for growth.
This strategy of self-funded growth worked for USI throughout the life of the business. Self-funded growth is not necessarily the best way to go for all early-stage businesses. But I do believe that self-funding is the best way to go for all businesses during the startup phase.
Who Will Be in Control?
In summary, Capital is the fuel for the business engine. Cost is the throttle on the business engine that consumes the fuel. Control is the owner of the business engine that realizes value creation. I was lucky. You need to be smart. Be sure to think through the ramifications of selling equity at the expense of losing control.
Have You Begun Your Entrepreneurial Journey?
If you are determined to build, lead, and grow a profitable business, The Startup Roadmap is designed for you. For a limited time, you can get a complimentary eCopy of The Startup Roadmap: 21 Steps to Profitability by clicking this link. If you prefer the print edition, you can purchase it directly from Amazon for $9.99.
Once you have read The Startup Roadmap, please let us know what you think by emailing us at: ed@ThePurposeIsProfit.com.
Ed McLaughlin is currently co-writing the book, The Purpose Is Profit: The Truth about Starting and Building Your Own Business with Wyn Lydecker and Paul McLaughlin.
Copyright © 2015 by Ed McLaughlin All rights reserved.