Is Debt Ever Necessary? (Or, How to Anger All Your Friends)

Warning: This post has only been mildly proofread. It’s my “gut reaction” to a few conversations on debt over the last two days. It’s not nearly as polished as many of my others. Don’t say you haven’t been warned.

This post has been rolling around in my head for a while. I didn’t plan on writing it yet – partially because it’s a sensitive topic and partially because it’s difficult to be thorough and brief. Not impossible, just difficult.

On Thursday, I was talking with my oldest friend when the topic of debt came up. I told him that I believe any business could be started and operated without debt. He disagreed and it started a fun and challenging dialogue about “responsible borrowing.”

That same evening, I was talking with my wife Lisa at dinner recounting the conversation when I said, “Debt is a tool of the impatient person.” We talked about that for a while and I stand by my statement. (She agreed with me, in case you’re wondering.)

Today, I tweeted that statement out and heard about “responsible debt” again from a business perspective along with it being an “effective” tool when used responsibly.

Finally, my friend Amber asked what Dave Ramsey would say about – the micro-lending site that allows ordinary people in wealthier nations to help those in third-world countries by loaning them small amounts to start businesses. I told her I didn’t know (which I don’t) – nor am I really concerned about it.

My stance on debt and finances, while certainly informed by Dave Ramsey, is my own. It’s been molded from my own experiences and background and it has evolved a lot over the years. I met him once for 30 seconds. Kiva never came up.

So let me try to tackle these points.

Is Debt Needed to Start a Business?

The short answer: no.

The long answer: no.

“But what about…” Look, I’ve heard a lot of these questions. One of the more common ones I get is about restaurants. Opening a restaurant takes a lot of money. The average is about $125,000. Most are likely financed. I have no statistics on this – it’s a conjecture, but I’d bet I’m right. Anywhere from 60-90% depending on your source will close in the first 5 years.

Here’s the deal: if you take out a loan to start a business, you will have to personally guarantee the loan. Which means, you will be borrowing against your family’s well-being and putting it at risk for a business. If your business goes under, creditors have rights to your personal assets. This is bad. Just ask anyone who’s gone through bankruptcy after borrowing to start their business.

Would You Borrow Money to Invest in the Stock Market?

If I came to you and asked if I would be wise to take a home equity line on my house at a rate of 7% to invest it in the stock market which historically returns 10% or more in the long-term, what would you say?

I hope you would tell me I’m an idiot.

Investing in the stock market is investing in businesses. When you buy shares of a company, you are investing in that business. So it is when you’re starting a business. You must invest capital to start a business. So, should you borrow money and leverage your personal assets to start a business?

I’d argue the answers are the same.

Debt is a Tool of the Impatient

There. I said it again. I still stand by it.

Let’s go back to our restaurant example. The argument makes a faulty assumption that the only way to open a restaurant is to open a restaurant in one step. To go from “I don’t own a business” to “I now own a fully operational restaurant” in 6 months. If you take that view, then you will need $125,000 over the next 6 months (if not more). There are only three ways to get $125,000 (legally):

  1. Borrow the funds
  2. Get investors
  3. Save up the money

While I used to be, I’m no longer a fan of legal partnerships. I’d prefer to maintain 100% control. But how do you save up a $125,000? You bootstrap it.

Here’s an example of bootstrapping a restaurant:

  1. Save up $10,000 while keeping your day job. At night, start building up a killer short menu. Test out your recipes on friends and family who will give honest feedback.
  2. When you have some money saved up, offer to cater a friend’s wedding who’s looking to save money. Use your previously created menu as the starting point. Use your $10,000 (or whatever the actual number would be) to hire a few servers for the day – or recruit family.
  3. If it’s well-received, start connecting with local party planners, party supply rental companies, etc. Tell them about your services and create joint ventures with them to refer business.
  4. Save and invest back into the growth of the business but only grow as fast as you can manage without debt.
  5. Live on less than you make. (Shocking, I know.) I’ve tried it the other way, it doesn’t work for long.
  6. When you have some money saved up (let’s say $75,000-$100,000), try to find a failing restaurant in a good location. Structure a great buyout deal.
  7. Invest as little of your money as you can to refurbish the restaurant and get it running. Invite EVERYONE you’ve ever catered for opening night.
  8. Rinse and repeat.

Now, I’m not in the restaurant business. I’ve been a waiter before – and a pretty bad one at that. Obviously, there are steps missing in my sample plan. That’s not the point. The point is that is can be done. It just takes patience.

“But I don’t want to open a catering company.” That’s fine. You’re not patient. I get it. Go get a loan. Just don’t tell me it can’t be done.

So, how patient are you?

Bootstrapping is More for “Lifestyle Businesses”

Tell that to Cisco. The company is valued at $131 Billion (with a “B”). And, according to USA Today, the company has never had any debt since the inception of the company. Building a business debt-free is possible – regardless of the type of business.

My Thoughts on

Crap. This is going to tick some people off. Or a lot of people.

If you live your life by a set of principles, then you have to ask if those principles are black-and-white or if they’re guidelines. Things rarely fit neatly into a black-and-white world. After all, the world we live in is broken. But that’s a post for another day.

If you don’t know what Kiva is, it’s a micro-lending company where those in third-world companies are loaned money to get a small business started. The average is about USD $380. Not a lot to us, but a lot to them. You can pitch in as little as $25 toward their fundraising goal and the site a has a repayment rate of nearly 99% – an astounding figure.

Let me start by saying that my thoughts on Kiva are directed by this principle:

“The rich rules over the poor, and the borrower is slave to the lender.” Proverbs 22:7

Our faiths guide our worldview. So, if I look at this statement, what am I to believe? If I loan someone money, am I putting myself in the position of slave master? I’ve answered this for myself in the affirmative. Why? Because I’ve been on the other side and I was a slave to creditors and it nearly ruined me.

Separating the Mission of Kiva from the Method

I love what Kiva is trying to do. I’m a big supporter of their mission to end poverty. However, I have to ask myself if the method of putting people into debt is the right way or the best way to do this.

An interesting statistic that I’ve not been able to find on Kiva’s website is the success rate of businesses that have received money from Kiva loans. There is a difference between repaying a loan and running a successful business. They readily reveal the lending stats, but I’m not sure those are great measurement for success of any business other than their own (and the people loaning money).

The problems of poverty are huge and won’t be solved by this post. There are a lot of great organizations trying to fight it on different fronts. Many people have given money to Kiva. They are not bad people. The people running Kiva are not bad people. The people borrowing money from Kiva are not bad people. I’m merely calling into question the method.

I love the idea of helping people start small businesses in third-world countries. After all, I’m an unapologetic capitalist. But is the problem their lack of funding or is it a lack of education in basic financial principles?

Does the ability to repay a loan makes someone suddenly capable of making sound financial decisions?

Your Turn

Now that I’ve managed to anger a large segment of people, I’m going to stop and turn the blog over to you. The comment section is below. Have at it (or me). I will respond to everyone.

By the way, if you want to win 30 minutes on the phone with me to talk about goal setting or to yell at me for these viewpoints, read my post on How To Set Better Goals. You still have a little bit of time left. 🙂

Image credit: iandavid