When should you borrow money? JULY 8, 2015 : USIERE UKO Leave a Comment debt or borrow Author and personal finance coach, Usiere Uko, writes on when to leverage on other people’s money Debt can be an asset or a liability depending on whether it is good debt or bad debt. Good debt pays for itself while repayment for bad debt comes from your pocket. It is the cash flow pattern that determines good debt or bad debt, not what you spent it on. Many people make this mistake. They assume that since they are spending on their business or an ‘asset’ then it is good debt. That is not always the case. You can borrow for your business and still end up repaying by yourself. If the item ends up not paying back the loan, then you have bad debt in your hands no matter your original intention. Like someone said, ‘the road to hell is paved with good intentions’. You can assume the item will pay for itself but it turns out otherwise. You went to war without facts. Many have borrowed to start a business and it did not work out, so they end up with a pile of debt and items to dispose of. The question remains – how do you know if you will end up with good or bad debt? The reality is that at the human level, you cannot be 100 per cent certain. However, you can improve the odds in your favour. Start small with your own funds and test your assumptions What most people do is to start big, and borrow from day one. They are essentially pumping in money into an idea that has not been tested. Rather than experiment with other people’s money, why not start small with your own funds and test your assumptions? Every business idea is an assumption no matter how robust. It has no actual data. The best way to find out if your idea will work is to actually do it. Until you actually do it, what you have are assumptions no matter how valid. Every business is successful on paper, but the reality is different. It is when you actually do it that you hit the road and the men are separated from the boys. What you do is to scale down your start up to the level where you can start with available resources (rather than keep waiting). That is why most of the current success stories today did not start from the high street, but from dorm rooms, garages, someone’s parlour, gate house, boys quarters, you name it. Usually the founder is the CEO, accountant, receptionist, janitor, operations manager and so on. It usually starts as a one-man operation. You try to avoid overheads until the business can sustain itself profitably. The focus is to get to the market with a prototype or beta version and start gathering real life data and feedback. That is where you get to realise that some of your assumptions were completely off mark. There are cases where what you thought was a mistake is what your clients like about your product. You can design a product for men only to find out that women love it more. The marketplace gives you a reality check and live feedback. If you are smart, you return to the drawing board, incorporate the feedback and release the next version. You don’t wait till the product is perfect before you take it to the market. As a matter of fact, field testing is part of product development process, which is why the work is never done. There will always be newer versions of Windows, iPhones etc. It is work in progress. It is when you test your prototype and it is well received, and the demand is so much that you cannot cope, that you look for help. That is when you borrow money to expand. There is hardly any bank that will turn you down at this point (if you bank with them and they see the growing turnover). At this point, you have a tested idea. You have a winner. You have actual data. You can see the actual cash flow. You can calculate actual profit margins. You can reasonably project future income if you scale up production by injecting fresh funds. You have enough cash flow to service the loan facility. This is where you borrow money. At this point, your chance of ending up with good debt is high. If your account officer is smart, he will offer you an overdraft facility before you ask for one. Having money to spend can be a disadvantage When you are starting a business, especially if you are new to the world of business, one of the worst things that can happen to you is having ‘enough’ money. You end up buying things that are not necessary, tying down your capital. Many start-ups in Nigeria start big and crash with a loud bang. They rent high street offices, hire many employees, buy a fleet of cars and cover the town with giant billboards and bombard the airwaves with their adverts. Many fizzle out as fast as they came. They had too much cash, which made them feel invincible, so they threw cash at everything. Herein lies the danger of borrowing from yourself. No due diligence is required before the funds are released. You are the applicant, approver and disburser of the funds. No process check or questions asked. You just look at available funds and decide what to buy – end of story. If you are building to rent for instance, you keep pumping in money until the project is completed. Very few can tell the actual cost at project completion. Very few hire a quantity surveyor, validate rental rates, vacancy rates and determine return on investment before making a final investment decision (FID). We just jump in based on assumptions. You cannot get away with such a stunt with a bank. Many wipe out their financial security plan (liquidating their money market investments) and some go as far as selling off their stocks in a bid to raise money to build. This is all in a bid to escape the scrutiny that comes from borrowing from a bank, hiding under the excuse of high interest rates charged by banks. You cannot play in the big league in business, real estate etc if you do not learn how to borrow from a bank. If you want to buy a N500m investment property, how long can you save to raise such an amount? How many shares can you sell? Are you going to sell your wife and children also? Borrowing from yourself is a poor man’s mentality. If you keep that mentality, you will always play small. You will not be able to use the leverage of other people’s money (OPM). The earlier you learn how to borrow (good debts), the better for you. Stop hiding behind lack of capital. Figure out a way to start small with what you have, test your assumptions, give the market what it actually wants, and when the demand is about to go out of control, call in reinforcements by borrowing to expand (and increase your profits). This type of borrowing makes you richer and takes you to the next level. For questions, comments or enquiries about the next seminar, you can contact me at usiere@gmail.com, www.financialfreedominspiration.com. Follow me on twitter @usiere, 08106788187 text only, BBM 514F9CA6