Mission #2-10 Financing Your Venture

Objectives:

• To make sure that living expenses and emergency funds are line items in your business plan.
• To appreciate that many new businesses fail because of undercapitalization.
• To succeed it is more important to change yourself than to change your job.
• To accept that when you start a new job that you prove yourself before you are welcomed with open arms.

Background:

In starting your own business, you're going to need money. It could be a few hundred dollars to rent a garage to sell used furniture to a few million dollars opening a motel franchise. As you develop and refine your business plans, you will begin to focus on the amount of money your business will require.

Aristotle Onassis, the billionaire shipping tycoon, advised only half in jest, "To be successful, keep looking tanned, live in an elegant building (even if you're in the cellar), be seen in smart restaurants (even if you nurse one drink) and if you borrow, borrow big."

If you are starting your business part-time, you will have living funds from your full-time job. But, if you are starting your business full-time, you must incorporate monies for day-to-day living into your business plan. At the very least, you will need money for food, clothing, shelter and transportation.

It can be argued that one of the advantages of embracing the entrepreneurial spirit is resiliency. While a less goal-oriented person might be more set in his or her lifestyle and unwilling to change or sacrifice, an entrepreneurial oriented person might be more amenable to sustaining the Spartan lifestyle of delayed gratification often needed to keep profits in a business during its infancy.

The Spartan lifestyle is being strong. This is following the Action Principles® - doing what others can't or won't.

Remember your warrior edge; you are a practical serious person with a strong foundation in research. This research should provide you with the numbers you need to know to make informed decisions.

Cindy's Bake Shop

Cindy wants to start Cindy's Bakery. Cindy does her research, and calculates that she'll need $80,000 to rent a space, make improvements, buy ovens, advertise, etc. She goes to the bank hoping to borrow the $80,000.

Sorry, Cindy, no way. In fact, the bank may not be willing to lend her a dime.

Does Cindy have any experience in this business?

Does Cindy have demographic data to support a new bakery in her area?

Does Cindy have comparable data to show that her income and expense figures are supportable?

Does Cindy have a signed lease and guarantees from suppliers and vendors?

Does Cindy have contractor estimates?

All of these questions may be for naught, because a bank is going to look at the worst-case scenario, and you can't blame them.

Let's look at Cindy's business from the bank's perspective. Cindy starts her business. No one likes her "natural ingredient" baking formulas. The business fails. Cindy walks. The bank forecloses on the business and has to sell the baking equipment for ten cents on the dollar. Actually, the bank will be lucky if the cost of disposing of Cindy's assets matches the funds generated by the foreclosure auction. As a result, the bank loses all its investment in Cindy's Bakery. If Cindy signed a personal guarantee on the note, the bank may have recourse against her personal assets. If Cindy's Bakery is a corporation, the bank will get nothing.

The business of banks is to lend money. Banks have to lend money to stay in business. Therefore, banks always want to lend money. You should not be shy about asking a banker for money. But, listen to the guidance that the banker gives you. The banker wants you to succeed for one good reason - so that you can repay the money you borrowed with interest. Then, you will have positioned yourself to borrow more money and pay more interest. Don't be naive. Banks are not liberal social agencies with an obligation to see you succeed. The mandate of the bank is to see that the bank succeeds and that the people who own the bank make money.

Banks want to see business plans with one bottom line - an assured ability to repay the monies borrowed with interest. Period.

Many beginning businesses don't have a credit history or asset base to warrant bank financing.

What can poor Cindy do?

Poor Cindy can whimper and whine about the economy and the Federal Reserve's control on banks and interest rates. She can cry about how she can't raise enough money to start her gleaming new modern bakery.

Or, Cindy can be realistic.

She can take on partners and/or investors with experience and with other assets that they are willing to put at risk. She can work until she saves enough money and/or has other assets to pledge.

She can buy an existing bakery with owner financing.

She can start on a shoestring. She can start in her home or in a small commercial kitchen where she would bake for other bakeries or restaurants or hotels or caterers. She can gradually build up a commercial baking business before she starts a retail operation. She can gradually build a credit-worthy business.

In one, three or five years of operation, the banks may be bending over backwards to lend Cindy money. Remember, the banks must lend money. They just want a surety of being paid back with interest.

The federal government also may offer your business financial assistance through the Small Business Administration (SBA). The SBA makes a limited number of direct loans. However, the SBA guarantees many more loans through cooperating lending institutions. Since interest rates may be lower or borrowing terms more liberal, you should investigate if your venture would qualify for direct or guaranteed SBA funding.

Few outsiders will be interested in investing with you if your own money is not at risk. The higher your personal stake in the venture, the more secure your investors should feel. With the exception of your cash reserve, you will probably be putting all your other monies on the line.

Your business can have several types of investors.

One type of investor is actually investing in your business and becomes a part owner. This investor may lend you $10,000 with the hope of eventually receiving $20,000 or $50,000 back. Totally depending on your individual negotiations, this investor may or may not receive partial dividends as the business grows and before the business is sold. Or, you may have a buy-back agreement with this type of investor. With a buy-back agreement, within a specific period of time and at a specific amount, you would have the option to buy-back this investor's interest in the business.

Other lenders, such as banks, may simply serve as creditors. Creditors will lend you a specific amount of money for a specific term at a specific interest rate. You repay creditors what you promised.

When you are a success, the investors share in your success. The creditors, however, only receive what is promised.

For some types of incorporated small businesses, it may be possible to sell stock to investors interested in becoming shareholders of your business. However, the filing and accounting requirements for selling stock make this a prohibitively expensive option for most beginning businesses.

If you are in a technology field, you may attract the interest of a venture capitalist. However, this can be a long and involved process with extremely limited chances for success. Remember; go back to your early missions. Most businesses can be started small or part-time. Businesses with the fewest employees are the easiest to manage. You can become a multi-millionaire being a landscaper or a taxi driver, making a good salary, saving and investing. So don't be too concerned about raising millions to float a major enterprise. Start small. Make your fortune. And, then, go forward if you wish.

Story:

Andrew Martin, Investor

Andrew Martin is twenty-five years old and has an associate's degree in business. He served six years in the Navy. In the two years since his discharge, he has drifted through four different jobs.

For his few months, he worked as a life insurance salesman. He sold policies to everyone in his family and every known acquaintance. Then, he found himself out of names, luck and enthusiasm.

His next stop was retail computer sales. He liked the job but after a year, the company folded. He tried another job selling computer software but the programs this company offered weren't the programs everyone wanted or were buying. After a hard fought effort with very few sales, Andy gave up trying to convince buyers that his software was "just as good." Even Andy believed they weren't. The wrong business.

After two years of treading in the business waters, Andrew had a pent-up desire to succeed. He considered going back to insurance sales where, at least, he had learned the secret.

Here's the secret: make a hundred cold calls. Cold calls are non-referral calls. Cold calls are unsolicited calls. Needless to say, cold calls have a low positive response rate. Get ten people to listen to you. Arrange five at-home appointments. Sell two policies. Start again. Make a hundred calls. Get ten people to listen to you.

For over a hundred years, some insurance sales people have gotten rich and some insurance sales people still get rich with just this formula and patience and persistence. But, nothing is tougher than cold call sales, so before Andy voluntarily went back to 50 "No, thank yous," and 40 slammed receivers for every 10 folks who'd listen, Andy wanted to explore another commission business. Well, how about real estate?

Real estate looked like an interesting and promising field.

You're selling people something they already want to buy: a house. Homeownership is the American Dream. You really don't even have to sell. You just drive your customers around. The houses sell themselves. The people find the home they want. You fill out the papers.

And, the money looks good. If the commission is, say 6%, the selling office gets 3% and the listing office gets 3%. Then, the selling office splits the 3% with the selling agent who gets 1.5%. So, for selling an average $200,000 house, the agent gets $3,000. Not bad pay for driving around town for the day.

At real estate license school, Andy also learned that the same commission split of 1.5% also goes to the listing agent. So, just for listing a house for sale which another agent sells, Andy would still get $3,000. Sounds good.

So, Andy gets his real estate license and a job with Taylor Realty. Taylor Realty was happy to have Andy on board with his contacts: Andy's family and Andy's acquaintances who might be buying or selling real estate now or at some time in the immediate future. Since Andy was on commission, Taylor didn't have to pay him anything unless he produced positive results.

For four months, Andy sat. Oh, he showed houses and even made a sale. And, he rented two apartments which paid $900 in commissions. A neighbor on Andy's street listed her house with Taylor Realty through Andy.

In four months, Andy had made just over $4,000. No one seemed to find this unusual. No one in the office bothered Andy. No one in the office pushed Andy. In fact, Mr. Taylor thought Andy was doing a good job for a beginner. In fact, Mr. Taylor felt that Andy shouldn't have any trouble making the average salary that the average real estate salesperson makes in a year. That's just under $36,000. $36,000? If Andy weren't living at home, he'd probably have qualified for public assistance.

Everybody at Taylor Realty seemed rather content. Mr. Edgers, a retired military man, came in every day and read five newspapers content to wait for the phone to ring. Mrs. Chambers did her knitting. Ann Brown did her crossword puzzles. Maybe Andy could find something to fill his free time at the office, like woodcarving or reading bird guides.

Instead of remaining idle, Andy decided to further his real estate education and he began reading books on selling real estate, books like, "You Can Get Ten Listings A Month - GUARANTEED." And guess what the book said to do? Open the phone book. Make a hundred cold calls. Get ten people to listen to you, etc., etc., etc.

Two people at Taylor Realty did not fit the Taylor Realty profile. One was Mr. Taylor himself. The other was Don Nardo.

Mr. Taylor, having been in the real estate business for close to forty years, owned the block of stores in which the Taylor Realty offices resided. He also owned three small apartment houses containing 18 units. And Mr. Taylor had at least one easy sale or listing a month from his many years of satisfied customers. At least half of the people who called or walked in to Taylor Realty with business asked for Mr. Taylor directly. Mr. Taylor also was friends with two of the largest builders in the area. All totaled, Mr. Taylor made about three or four times the annual income of his entire sales force combined. Except, of course, for Don Nardo.

Don Nardo wasn't that easy to figure out. Don's specialty was investment real estate, income property. And Don wasn't in the office that often. He'd rush in with cellular phone in hand and grab some papers or scratch down an appointment and he'd be out again.

Don Nardo was intriguing.

From the office scuttlebutt, Andy learned that Don Nardo sold about $6 million dollars worth of property a year, and that he sold most of his own listings and that he was on a 80/20 split and not a 50/50 split with Mr. Taylor.

Andy grabbed his calculator. $6,000,000 times 6% was $360,000 times 80% was $288,000. Very interesting. Don Nardo was obviously a man to watch.

Andy watched and listened. He learned about the Sullivans. Over the previous 25 years, Jack Sullivan had been buying and selling income properties in the Newton area. All the properties were sold to Jack by Don Nardo. At present, Jack Sullivan owned 14 apartment houses. As each of his children reached age 21, Jack would sell them a property at a very favorable price. Jack Sullivan wanted to give each of his children a good start in the real estate investment business.

Danny Sullivan was 23 years old, three years younger than Andy. Danny was in the office talking to Don Nardo about the pending sale of his three family house and barn for $245,000. Jack Sullivan had sold the house to Danny the year before for $180,000. Before selling to Danny, Jack had owned the property for ten years. Jack had paid $85,000.

From what Andy could piece together of the story, Joe Edgers, the newspaper reader in the office, had a buyer who wanted a house with a large garage to accommodate his lawn mover and power tool repair business. Joe had alerted everyone in the office to keep an eye out for such a property.

Don Nardo had the property. It was Danny Sullivan's three-family with barn. From snippets of telephone conversations, Andy pieced together from Don Nardo's and Danny's conversations that although from a rental income standpoint Danny's three family was only worth about $210,000, the fact that the barn would make a perfect repair shop might be an opportunity for Danny to sell his property at a premium price.

Don and Danny decided to have Joe Edgers ask his buyer if he'd pay $250,000. The buyer saw the property. It was just what he wanted. He offered $240,000. The deal was made at $245,000.

Joe Edgers had a sale. Don Nardo had a listing sold. After taxes, Danny Sullivan would have about $100,000 to reinvest. Don Nardo had Danny Sullivan primed to buy about $500,000 worth of investment real estate with the $100,000.

Danny was already looking at a single-family house to buy for himself and a four unit apartment building. And, to Andy's surprise, he heard Don Nardo telling Danny about a possible buyer for the four-family, and Danny didn't even own the property yet.

Danny Sullivan looked like a young man with a very bright financial future. Andrew Martin didn't. Andrew Martin had a choice. Be wild with envy or start doing something constructive himself. Andy chose the latter course. Andrew Martin was about to get serious about his financial future.

The Background

To put it mildly, Don Nardo did not immediately warm to Andy. Don was busy and Andy was supposed to be in residential sales, selling houses, not investment sales, selling multiple dwellings. Don made it very apparent that he didn't want to be bothered.

Andy decided to feel out Mr. Taylor first. "Mr. Taylor, I'm very impressed with Don Nardo's side of the business, investment property sales. I was wondering if you'd allow me to sell investment property?"

Mr. Taylor shook his head half-listening, "Andy, you're here to sell real estate. Whether it's single family houses or apartment houses, that's up to you."

Andy was relieved. "You'd have no objections, then?"

Again, half-listening, Mr. Taylor replied, "No, I can't think of any. If you feel you'd do better selling investment property, then, give it a try."

Andy wanted to cover his bases. "Do you think Don would object?"

When you are accepted into a new unit, you may have a new patch or new headgear but you are still the newbie, the probie, the rookie. You should not expect everyone to run up to you with hugs. You still have to prove yourself in the field. No whining or complaining or saying that no one likes you or that life isn't fair. First, let's see what you've got. You are a warrior. You know this.

Now, Mr. Taylor was listening, and spoke, "Let's be frank. I don't think Don would be too intimidated by your interest. Don has mostly his own clientele of thirty or so investors. If you go after new business, there shouldn't be a conflict or problem. However, if you disturb any of Don's deals or interfere with any of Don's clients, you'll be shown the door fast. You'll be fired. No second chance, understood?

Mr. Taylor continued, "You can cross over my tracks but not Don's. Any dispute between you and Don and, be assured, right now, that I will side with Don. I won't even care to hear your side of the story. Understood? Don and I go back a long way and although he may seem gruff, the man's a good friend and he's had a hard life. I owe a great deal of my business success to Don Nardo. Understood?"

Mr. Taylor was very well understood by Andy. "Yes, Sir, I understand."

Mr. Taylor offered his deal, "And, Andy, between you and I, our commission split arrangement remains as it is, 50/50. Is that understood?"

Andy nodded, "Yes, understood. That's all fine. Well, Mr. Taylor, any advice for me on how to get started?"

Mr. Taylor made his point, "Well, Andy, your first challenge is the fact that you don't know anything about investment real estate. I don't want to laugh but that's quite a handicap, Andy. So, I guess, I'd say that that's where you should start, learning something. As a start, why don't you make an investment property log of every piece of investment real estate in Newton? Catalog each building, recording as much property and ownership data as you find."

This sounded to Andy like an almost impossible task. "Mr. Taylor, are you kidding? There must be hundreds of properties. That would be an enormous undertaking. It would take me a year. I wouldn't have time for anything else."

As an SF soldier will tell you, "If we did everything like everyone else, we wouldn't be very special." If you look around and everyone is doing what you are doing, you aren't special. You are average. And SF soldiers are volunteers; so if you don't want to do it, don't say another word leave immediately.

In Master Small Business III, you will follow Andy as he grows from new broker to new multi-millionaire. It's the Action Principles^®. It's the mastery mindset. What Andy does, you can chose to do.

Operational Limitations:

• If you are negative, until you change your style and attitude, the business doesn't matter. You are unlikely to be successful at any of them.
• Everyone can't do it. Everyone doesn't want to do it. If you want to do it, hunker down and get it done.
• Until you prove yourself, you may not be welcomed into the club.

Seeds for thought:

• What is the rule-of-thumb for money set aside for emergencies?
• What should happen to your cash reserve funds as your financial responsibilities increase?
• What are some sources of funding for your business?
• What does it mean for an owner to "take back paper?"
• Why are banks in business?
• What do banks look for in a small business?
• What are Cindy's options if she can't qualify for a bank loan?
• How might the SBA be able to assist a small businessperson with financing?
• What is the difference between a creditor and an investor?
• What does Andy say is the secret to insurance sales?
• What is a cold call?
• How did Mr. Taylor advise Andy to get started in the investment real estate business?
• What do you think Andy will have to do to become a success in real estate?

Jargon:

Cash reserve - Money put aside for a rainy day.

Cold calls - Calling people at random.

Contact - a person who can act as an introduction to someone else.

Credit union - a non-profit financial institution, usually formed by employees of a company.

Foreclosure - the end to all rights of a borrower in a property covered by a mortgage.

Incorporate - to organize as a corporation.

Listing office - in real estate, the agency hired to represent a seller.

Rainy day - Trouble brewing.

Rule-of-thumb - a useful principle with wide application, not intended to be strictly accurate.

Selling office - the company finding a buyer and closing a sales transaction for an owner.

Stake - to provide working capital or to finance a business.

Surety - a sum of money held as a guarantee or evidence of good faith.

What's wrong with this picture? - Looks or sounds too good to be true.

Question and Answers

How does a limited partnership work?

In a limited partnership, there are general partners and limited partners. The limited partners are categorized as such because their investment risk is limited to their cash outlay. The full financial risk of the venture is assumed by the general partners. However, the limited partners are also limited in their control over the business, since all decisions regarding the business must be made only by the general partners.

As you research other businesses in your industry, you should note the type of business organization selected, and ask other owners why they reached the decision they did.

When would you recommend setting up your business as a general partnership?

In a general partnership, the two or more partners can agree in writing to just about anything. All responsibilities can be equally divided, or there can be a managing partner who runs the business and a silent partner who puts up money and yet has nothing to do with the operation of the business. However, be careful. In a general partnership, all partners are individually fully responsible for all debts incurred by the other partner. That means that if a two-person general partnership borrows $50,000 and one partner takes off, the remaining partner is fully responsible to pay back the entire amount. Always choose your partners carefully. Be sure that all contracts, including partnership agreements, are written and reviewed by competent legal counsel.

The principle advantage of forming your business as a corporation is liability protection. A corporation is viewed as a separate entity under the law. If a corporation borrows $50,000 and doesn't pay the money back, the lender's recourse is only to the corporation and not personally to the owners of the corporation. The disadvantage to the corporation is double taxation. Your profits are first taxed as a corporation and then again when monies flow through to the employees and shareholders. If you run a small business, you can have the best of both worlds, both liability protection and single taxation, if you incorporate as an S-corporation. But, there are specific requirements for S-corporations that you will have to discuss with your lawyer and accountant. The same is true for an LLC, Limited Liability Corporation.

Action Plan:

• Make a list of ten types of businesses that employ commissioned salespersons.
• Look in the Yellow Pages for the names of two firms in each of the ten types of businesses

Support:

• For business success in the new economy
• For the business of technology
• For corporate responsibility
• For better business management
• For women who mean business

Inspirational Insights: