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5 Tips for Managing Debt
Business profiles abound about wildly successful ventures launched on nothing more than dreams and a pocketful of credit cards. Be inspired by these anecdotes, but before going lock-limit on your Visa and MasterCard, consider this reality: Business startups have less than a 50-50 chance of survival, and in most premature business deaths, debt is the chief executioner.
1. Start on the right track
"In the early stages of a business, debt puts you at a tremendous disadvantage," says Jerry Osteryoung, director of the Jim Moran Institute for Global Entrepreneurship at Florida State University. "Your revenues, especially in the first few months, may fluctuate wildly from your business plan, but your debt obligations are completely predictable. They must be paid, regardless. That puts a tremendous strain on cash flow."
A good rule of thumb for startups is to raise at least $50,000 in equity, Osteryoung advises. "Businesses with at least $50,000 in startup equity have double the chance of surviving."
Osteryoung also advises young businesses to think of debt as more than a loan you get from a bank or a balance run up on a credit card. "A lease is effectively a form of debt," he says, "so the shorter the term the better. The last thing you want, if things don't work out, is to have four or more years worth of rent to pay after you close the doors."
2. Know your odds
Maximize your chances for success -- and greatly increase your chances of getting a loan -- by testing your capitalization plan against the historical experience of businesses similar to the one you want to start. For that, Osteryoung recommends Financial Studies of Small Businesses, by Financial Research Associates. The book lists key financial ratios, including debt-to-total assets, for up to 67 types of small businesses capitalized at under $1 million.
Say you want to launch a clothing store, and the place you are thinking of renting is asking for a one-year lease at $1,200 monthly. Effectively, signing that lease has put you $14,400 in debt. Financial Studies' ratio of rent to sales for apparel businesses tells you that you're going to need to generate monthly sales of about $22,000 to operate profitably. Assuming your other expenses are in line with the apparel store averages, you should be able to pay yourself about $1,800 a month and generate an additional $700 a month in cash flow before taxes. That's assuming you're carrying the apparel store average of only $20,000 in total debt.
3. Talk to the experts - for free
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Small Business Development Centers blanket the state, offering inexpensive training and free counseling. When cosmetologist Liza Basil wanted to buy a salon, she turned to Marty Zients at Florida Atlantic University's SBDC. Zients helped with her loan application and steered Basil away from the first salon she considered. "Marty sees the truth behind the numbers," Basil says. She eventually found a salon in Lake Worth with better cash flow and applied for a $50,000 SBA loan, putting up her home as collateral. "Are you sure you want to do this?" she recalls her husband saying.
Though Basil had only $28,000 in equity, she knew her cash flow from her large personal client base was her ace in the hole. Since then, Basil has also doubled the size of her shop and taken out a second SBA loan -- also repaid -- to open a barbershop in West Palm Beach. The two Sanctuary Barber and Spas now have 18 employees. Recently she took out a third SBA loan for $100,000. "On the last loan, I didn't have to put up my house as collateral," Basil says. "That was a nice feeling."
-- Jerry Osteryoung |
4. Plastic can be fantastic
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All Weather Tree and Landscaping Service is not your father's tree-trimming business. The Tampa-based company is equally at home in corporate headquarters and residential back yards. It invoices digitally, does web-based marketing and sends out e-mail reminders to generate repeat business. For big clients like ABC Liquors, it launches state-spanning tree-trimming forays with military precision.
Given its business savvy and its need for expensive equipment, you would expect the company to be an ideal candidate for SBA or conventional bank financing. And it might have been, except for one thing: an exploding revenue stream that made nimbleness and speed higher priorities than the cost and terms of borrowing.
Julio and Denise Collazo founded the business with $35,000 Julio had saved working as a contractor in Qatar, Uzbekistan and Afghanistan. They bought a bucket truck with a "cherry-picker" and a landscape trailer. The business grew dramatically. "When we started, we were hoping for revenues of $500 a week," Denise recalls. "In no time, we were doing huge multiples of that."
Then they landed their first corporate account, with ABC Liquors. "We had built our business on professionalism and responsiveness," Denise Collazo says. "The last thing we needed was to be hung up waiting for a loan approval when the first orders from a major new client came in."
They immediately spent $13,000 for miscellaneous equipment, making the purchases with their credit cards.
"We have excellent credit, so the card rate was almost the same as the loan rate would have been," Denise says. "It was the right decision. We were able to handle our growth while maintaining our high standards for customer service. Our second-half revenues doubled our first-half revenues last year, and we expect the same will happen this year. By that time credit card balance will be completely paid off."
5. When good debt goes bad - be proactive
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Just a few years ago, Tallahassee-based LearnSomething Inc. was drowning in debt. Though it had survived the dot-com implosion and developed an impressive client base providing training to Fortune 500 companies and national nonprofits, LearnSomething had amassed five dollars in debt for every dollar of equity on the balance sheet. Total debt had mushroomed into the millions.
"In a way, that balance sheet was our greatest asset in debt negotiation," says CEO Steve Roden, a former Arthur Andersen partner who merged his Atlanta-based training company into LearnSomething in 2003. "It was so terrible it spoke for itself."
Roden contacted each creditor and made them an offer LearnSomething's dire financial condition made it difficult to refuse: They could settle for a portion of the money owed them by LearnSomething, or they could convert the debt at full value into an equity position. Through these negotiations, LearnSomething shed about half its debt through settlements and converted the other half into equity positions.
The happy companies now are the ones that chose to convert to equity positions. Freed of its unworkable balance-sheet burden, LearnSomething was able to attract new investors, narrow its focus and expand its presence in its most profitable lines. LearnSomething has been profitable for eight straight quarters on revenue growth of 60% and has grown to 45 employees.
"Falling behind on your bills releases a tremendous amount of negative energy that sucks the life out of the entire company," Roden says. "When bad times hit, you have to remember your creditors and suppliers are your partners, with a vested interest in your survival. But if you run and hide, they are not going to work with you. You have to confront the problem early and head-on."
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