Is this “good” debt?

It’s time to help another PDITF reader out. Jane sent me an email. It says…

You’re all about debt reduction and I can get on board with that, but we (hubby and I) are contemplating getting into business for ourselves.  Would this be acceptable debt (in your eyes)??  We’re looking at possibly $50k with the potential to recoup in the first year (or two if we actually want a salary in that first year, which is what I’m leaning towards).  We DO have some savings, but that would leave us with NO emergency fund (and me, VERY uncomfortable).

So do I think taking on debt to start a business is a good move? Not knowing all of the details (interest rate on loan, type of business, success of similar companies, amount in savings, annual income, etc) it’s hard to give Jane a completely detailed response, but I’m gonna do my best….

Jane, DON’T FREAKIN DO IT! In fact, I’d rather squirt lemon juice in my eyes than start a business with credit.  Why you ask?

Well according to the U.S. Small Business Administration, three out of ten new businesses fail within two years, and only half survive five years. If you could cash flow the business, I’d say go for it. But financing a business that is just as likely to fail as succeed, is no bueno in my opinion.

Honestly, I think Jane answered her question with the information she provided in her last sentence. By starting a new business she would deplete what little savings she has, she would have NO cash in the event of an emergency, and she would be the proud new owner of a crapload of debt. There is no way I can, in good conscience, recommend she put herself in such a stressful situation.

Obviously I don’t know what type of business she is looking to start. If it’s going to be the next Microsoft or Facebook, then she should probably ignore my advice and take on the debt. But let’s be real, the chances of that happening are the same chances that Ricky Martin was ever straight.

Here’s my advice Jane: Keep working hard. Save up as much money as you can. Build your business slowly. And pay cash as you go. If you do this, you’ll have a lot less stress and a ton more freedom when it comes time to open your business. And if said business does in fact fail, you at least can walk away with no financial obligations. I couldn’t imagine a worse feeling than being $50K in debt, 3 years out of the workforce, and have NOTHING to show for it.

So PDITFers what’s your recommendation to Jane? Would you ever take on debt to finance a business? Is it too risky? Anyone out there think she should go for it? Help a sista out!

20 thoughts on “Is this “good” debt?

  1. While I do agree that taking on this debt and eliminating their emergency fund is a bad idea, i dont think its realistic to say you can start your own business without some form of a loan, whether it be family or through a bank. I recommend to put off this business idea for the foreseeable future but plan on launching it in a few years. This planning should include saving up as much as possible so the loan you take out is as small as possible. This time will also allow you to really figure out the details of the business, expenses, loan rates, a business plan, competition etc. Good luck!

  2. I agree to build slowly, while they both have their day jobs. They should get out of debt first. Then, use the money they were paying towards debt to slowly fund the business. If the business takes off, then they can leave their day jobs. If the business tanks, they can keep their day jobs and not have any debt from the business.

  3. I'd be cautious about starting a small business without a financial backbone. Small businesses have high failure rates, especially as we hobble out of the recession. The cost rack up faster than most people imagine. Additionally, it helps to have extra money saved because in small business, it's go hard or go home. You'll want to put every penny into that business to make it succeed. If you don't, you'll wonder what if. If you do and don't have extra money lying around afterward, you'll be saddled with debt.
    I believe small business can go anywhere from 6 months to a 3 years before a profit can reasonably be expected. I believe I read that somewhere.

  4. Jane here, okay, so it's a tough crowd. At the risk of sounding like I'm trying to convince you all, I'm providing a little more information.

    So the business is an at-home business (so virtually no overhead), partners with an existing set up (so we're provided training, support, ect), it's NOT a franchise or a pyramid thing, no inventory (we order what the customer wants).

    It would require that DH quit his job to do (because of a non-compete issue), but I would keep working. (Currently my salary overs nearly all our household expenses.) DH has a background in sales/marketing, so that part is covered.

    We have excellent credit, and thinking of taking a loan so that we can use the savings to 'float' the business for a year. The expectation is that the company WILL make enough to pay the loan in the first year (but of course that is not a guarantee), so the backup plan would be that we coud use the savings could pay for the loan (worst-case).

  5. Hi Jane!

    My parents owned their own business and while they struggled financially at time I know that they would NEVER have given up the sense of pride and freedom that comes from working for themselves.

    I'll be the stand out and say, go for it (maybe). Sure, maybe it's the smart thing to wait it out a bit, save up some money, etc. but timing (and a bit of luck) is EXTREMELY important in a small business and the opportunity for success just might not be there a few years from now. However, here are some things to consider:

    1) It will consume A LOT more of your time that just 40 hours a week. I don't know if you have kids or not but I wouldn't expect an increase in any quality time with your kids.
    2) You have to really believe in your business and really sell it. If the idea of knocking on a stranger's door, or cold calling someone, or walking up to a stranger, to say, "Hey, I offer this service, would you be interested?" freaks you out than it's a problem.
    3) For some, the freedom is exhilarating, for someone like me, it's really scary. Everything falls on YOU. Everything is YOUR fault and everything is YOUR responsibility. No one is going to bail you out. There's no boss to ask for advice, no coworkers to bounce off ideas, (possibly) no employees to delegate tasks to. No one's going to pat you on the back for a job well done and no one's going to catch your mistake. It's just you.
    4) There's no off time. If you want to succeed, every waking moment has to be an opportunity to increase your business. You have to look at every person you meet as a potential client, every idea you see you have to ask, "Could I incorporate this into my business?".
    5) If your husband is taking care of the small business while you work a "real" job, then you enter into this weird faux-boss kind of role where you offer finance and support but he does the actual job. So, if the business isn't as successful as you'd like, would you start to resent him? Would he resent t he extra pressure?

    While getting your financial ducks in order is important, I think it's far more important to ask if you and your husband are mentally ready to be small business owners. You really have to know yourself well, know what motivates you, in order to succeed. For example, you husband might have been a very successful sales person in a firm but that doesn't mean he'll do well in sales by himself. Maybe what drove him to be successful was his competitive nature and if he can't go, "Ha! I just landed a huge sale! Beat that!" to anyone then his motivation is gone.

    If you do decide to pursue your small business I wish you the best of luck!

  6. Ninja said it best. The end. If you are going to start your own business, then you need something to fall back on, and that's exactly what the E-fund is. Bill Gates/Mark Zuckerberg were NOT starving when they started Microsoft/Facebook, respectively. They also were from VERY well-to-do families, so their E-fund may have been Momz. Yes, I said, Momz. The point is, because of the high-rate of failure of small businesses, by wiping yourself out completely to start it, you aren't hedging your risk, which can leave you completely exposed to horrible, horrible things. In the end, I would say, don't give up on your dream. Maybe start the business with extremely low operating expenses,(word-of-mouth advertising, moonlighting – working while at work, having small booths at fairs, etc). Once you see that there is a real chance of the business taking off AND that your inability to dedicate adequate time to this business is preventing you from maximizing your profits, then AND ONLY THEN, will I say, go the full nine for it!

  7. We took on a crapload of debt to get my husband out of the rat race. Now he has mad cash flow and people working for him, so I guess Ricky Martin is gay.

    Some people are risk takers, some people aren't. If you're not a risk-taker, you have no business being an entrepreneur. Small business is always risk, and sometimes you just can't cash flow it.

    My answer would depend on what she does. If she had a comfortable job, like I did when my husband went out on a limb, then do it. If she doesn't work and they don't have any kind of safety net, that is they need that business to survive, that's beyond even my risk tolerance.

  8. We did build a small business with credit and debt. Ugh, how we wish we hadn't. I guess in some ways it helped us get going faster, but now we have a crapload of debt we're working our butts off trying to get rid of. Thankfully we're still in business nine years later, but I have to work another full-time job in order to earn enough money to pay off the debt, while my husband runs the business and I work for him part-time. There might be a good reason to go into debt to start a business, but I sure can't think of what it might be.

  9. Hmm, just saw Jane's comment. This sounds very fishy. I don't know how on earth it could possible take 50K to do a home-based business with no overhead and no inventory.

    Where is the 50K going? Classes? Some kind of entry fee? Sounds like a pyramid scheme to me. I sure wouldn't spend 50K unless it was on equipment that could be sold (like our crapload of debt went to) or to inventory that you have to have to operate.

    • 50k is about double what the equipment and training package is. The remainer is for misc. expenses and back-up $$. I high-ended the expected expenses because I think that most people underestimate. Not sure if that's a good idea or not…

  10. I actually work in a field that encourages entrepreneurship… that being said, don't wipe out an emergency fund to start a business. That's not a good idea.

    I would suggest Jane to do A LOT of research first. Read up on the competitors. Look at the market. Develop a business plan. Look for grant money and funding from organizations and government. But most of all, be realistic. Most small businesses fail within the first five years because they were not realistic with their cash flow. You need to be smart in your money and what you are going to use it on.

  11. What if they wait and their opportunity passes them by, while they are saving to start said business?

    Ninja you say that it won't take them very long to save up the $50K but on the flip side, it won't take them long to pay it off, either.

    Sometimes if you have a fabulous idea you need to run with it in order to cash in on it. Waiting till you have the cash may very well mean missing out.

    Jane says that her salary covers nearly all of their day to day expenses – and please correct me if I'm wrong, but it sounds as though they have a good sum of money in savings but don't want to use that, and would rather get a loan. I'd rather do the loan as well, and keep my savings as savings just in case this idea doesn't pan out.

  12. I think it is realistic in this case. $50K is not a preposterous sum, and with some dilligent savings efforts I think she could save the money quicker than she thinks. Now if she needed $200K that would be a different story

  13. NINJA, I received an American Express Card offer in the mail the other day. It was extremely enticing. If I spend $500 on it by June 30, 2010. I get two free plane tickets for domestic flights. The only area that I need to check in on is if I can cancel the Card after I spend the $500., because after the first year there is a annual fee of $175.

  14. I would wait until we had the start up cash.

    $50k would only take 2-3 years if it was really important to us and we only make $80k before taxes…it could be faster if y'all make more or spend less.

  15. Is the $50K to pay your own salary? If so I wouldn't finance that. I definitely wouldn't finance a variable costs.only fixed costs…because usually you can recoup some of the fixed costs by selling the stuff if the business fails or gets sold. And there are places that sell used office equipment, restaurant supplies, as well.

    The last thing I'll comment on is how much competition is out there? I had a friend who started selling promotional items (pens with company logos on them, etc). It sounded very similar to what she described..she's essentially a commissioned distributor of a bunch of products. My friend had lost his job, so he really didn't have much to lose. He did not take a loan out to do it and he only ended up doing it for a year or so. He did make some money, but not enough to continue. He really didn't have anything that differentiated him from the 1000 other people doing it. Alot of these things are based on how many contacts you already have or can make easily. He was already a salesperson so he had that going for him and it still wasn't worth the effort.

  16. My husband and I have talked about one day opening a business. I’ve told him I’m fine with it, so long as we can save up at least 50% of starting costs.

    In addition, I’d want to be sure that we had enough money to last at least 3 years because I’d want to operate on the assumption that we wouldn’t turn a real profit for at least that long.

    In other words, I would want to go to the bank with a plan saying, “This is how much we’ll need for 3-4 years’ rent, this is for inventory, this is for store help, this is for insurance,” and so on and then show that we had 50% of the total, plus I have bookkeeping skills. I think that would make us a safer bet for the bank and it would make our risk greatly diminished.

    I would never want to start a business and leave myself without an emergency fund, let alone a salary. I don’t think there are many situations where you have to start a business that quickly and can’t wait until you can save a bit more.

    For example, we discussed starting small and edging our way into business by buying some inventory and selling from home. Then we’d have a known presence and some clients when we opened the store. It would also be a good way to start the company without putting tens of thousands of dollars at risk.

    Then again, I’m overly cautious. I am also cynical that any small business could be so assured of making a profit in the second year unless it was incredibly streamlined/automated.

  17. Terrible advice from Ninja. We would need to know a lot more about your business to provide proper borrowing advice. Will you be operating a cash business (i.e. no receivables?) Will you have need for large amounts of initial capital – possibly to purchase equipment etc… If you want to start a business, you are required to take on more risk than I believe Ninja is capable of accepting. I would not use this blog to seek that advice.

    • Jeff,

      She asked for my opinion, so how dare you say my opinion is terrible. It may be different from your opinion, but that doesn’t make it bad. Be a little more tolerant, and less judgemental next time you contribute please.

      And if you read closely, before I even shared my opinion i said…

      “Not knowing all of the details (interest rate on loan, type of business, success of similar companies, amount in savings, annual income, etc) it’s hard to give Jane a completely detailed response”

      All I gave was how I would do things. If you would do things differently that’s fine, don’t bash me for feeling differently…especially when it’s on MY blog.

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