He's talking about bank loans, and a relatively small class of innovative small businesses that are trying to achieve something new and go big with it. For those businesses, a loan debt is a cash drain that makes it harder for the business to succeed and is typically secured by a personal guarantee and collateral on the part of the entrepreneur who takes the loan, which greatly increases the risk. Small business administration loans, for example, are very conservative, they do require personal guarantees, and they usually want to cross-collateralize the loan against every other business and real estate the borrower owns, which means they are risking personal financial collapse for themselves and their family, and it will hurt their ability to obtain cash from any other source.
In other contexts, debt is the cheapest financing you can get. If a going concern can get a loan based on inventory or receivables, that is money at 6-8 percent annual interest that stands out for a month or two when needed, as opposed to an equity investor who is hoping for 100% return year after year.
If you are doing a more conventional business such as real estate development, or building out a supermarket, you are a lot better with debt financing than equity financing. Instead of giving away 50% of the business for half a million dollars, you can borrow a million dollars and pay back $1.1 million in a couple years. If the company fails, you are the same either way, $0. If the company succeeds, you now have 100% of a $3.9 million business, say ($5M minus the $1.1m to pay back) instead of 50% of a $5 million business.
One of the biggest causes of business failure is being undercapitalized, it is hard to know how he can say otherwise. When you run out of cash you run out of cash, no matter how profitable your business, how well you are running it, or how much potential it has.
Cuban is right that people greatly underestimate the commitment, hard work, time, and cost of getting into business. If a loan is easy money it can facilitate bad decisions, and you have to pay back sooner or later. That's true with equity financing or bootstrapping too, but in those cases you don't have a bank after you.
Obtaining a loan to start an unproven business is indeed a bad idea. Obtaining a loan to start a franchise location usually is a good idea.
However ... there is also a marketing problem banks have. I can get business credit with no paperwork. A business loan will often have worse terms and require lots of paperwork.
Functionally, a business credit card is a form of a loan. Small business loan origination process is in dire need of an overhaul.
I agree with Mark. For software business, what you need is a clickable prototype that is compelling enough to generate sales before software is ready.
For brick and mortar small businesses, well, you need startup capital. The prospective entrepreneur could consider launching multiple businesses.
For example, here is my plan, which is subject to change.
- Launch Sendlinks at starting price of $0.25/transaction--pure SaaS, near zero cost
- Launch Vostimonial at starting price of $10/transaction--requires humans, can't afford them in the beginning. This limitation forced me to figure out what else I can build to get that capital.
- Launch my Flatrate Helpdesk business--requires expensive staff to be effective, can't really do anything at the scale I envision with less than $500,000 in capital.
- Launch my ebikes business--requires lots of capital because you have to buy containers full of bikes, have repair shop staff, invest in engineering, build facilities, and so on.
- Get my private school system operational--and by this point we are talking about serious money.
Like many entrepreneurs, I want to change the world. Hence you see my last 3 initiatives that are more of a public service (eliminate the stress related to using computers, reduce automobile traffic, lead by example how education can be done (too radical for now to be implementable in public schools)). However, getting to that point will require lots of money and they are not something that a VC would ordinarily get excited about.
Many entrepreneurs try start at step 2 and really more like step 3, which requires significant capital, but what they need is to figure out the initial business they can start that does not require capital investment.
Let's take the typical example of a restaurant. It requires staff, real estate, and location. The better location, the more rent you will pay. If you made $0 today, you will still have to pay your fixed costs in salaries and rent.
On the other hand, we have catering companies. A catering company could be based anywhere within the driving distance, can pay for the use of a shared commercial kitchen by the hour, and doesn't have fixed costs except for employees who can be part-time or contractors.
If the entrepreneur is skilled at marketing, she can build a wildly successful catering company from scratch with zero investment and a much greater profit margin than a restaurant. If they require a deposit for a catered wedding, they can pay their staff and the commercial kitchen from that deposit and enjoy significant profits.
Many prospective restaurateurs don't understand that there are other ways to be in the food business and so they get stuck on the "I need a loan" part.
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