Picking Dave Ramsey’s Brain on Entrepreneurship – Part 3

If you haven’t already, I recommend you read Part 1 and Part 2 of this series for the first two pieces of advice given to me by Dave Ramsey during a town hall meeting.

In this third and final article in the series, we’re going to break from the marketing angle of the first two posts and focus on something that is especially pertinent in these economic times.

“Be Prepared… the meaning of the motto is that a scout must prepare himself by previous thinking out and practicing how to act on any accident or emergency so that he is never taken by surprise.” – Sir Robert Baden-Powell, British Army Officer & Founder of The Boy Scouts

Principle #3 – Create a “Sharon” Fund

In case of emergency break glass

Image by noaz. via Flickr

This principle is classic Dave Ramsey, but incredibly valuable none-the-less. The “Sharon” Fund is basically an emergency fund of retained earnings for the business named for his fiscally conservative wife, Sharon.

The principle is a simple – set aside a percentage of your profit in an account that can be used in emergency situations to cover planned or unplanned expenses such as payroll or rent.  Ideally, this fund will be enough to get the company through a number of months (I’d say closer to a year) should things turn dramatically against your business. The best part of having an emergency fund? You don’t owe anybody anything when you use it. There are no monthly interest charges, no collection calls, and you’re debt-free when your industry turns around.

Working in the technology industry, I see this principle violated on a daily basis where companies are built on debt. They live and die by the almighty “burn rate” (the rate at which they burn through cash either invested in, or loaned to, the company).  I can’t tell you how many industry blogs and articles I’ve read lately warning technology start-ups of the coming credit and investment crunch.

Why?  Because insiders know many of these companies have tiny revenue (if any), large payrolls and a business model built on a buyout.  Investors are realizing that, in this market, those companies will need to survive longer than originally estimated, yet don’t have the inherent model to do so.

Admittedly, this can be difficult to do when things are going well. The tendency is to spend every dollar that comes in. It’s hard to imagine the slow times during periods of high growth. However, it just takes a little bit of foresight and planning to prevent heartache and ulcers when things inevitably turn against you. (Did anyone really think we’d never have another downturn?)

Lisa and I have done this personally and we’re going to apply it to our business. I can tell you from personal experience that our emergency fund has kept us from charging up a credit card for things like auto repairs, medical bills, etc. When we use our emergency fund, it’s the first account to get paid back until it’s restored to the amount we agreed on – no questions asked.

Do you have an emergency fund in your personal or business finances? What has been your experience with them? If you don’t have one setup, is there are particular reason? Does something work better for you? Leave a comment below and tell me about your experiences with emergency funds.

For anyone that’s interested, here is a link to Dave Ramsey’s latest book. I highly recommend it.

The Total Money Makeover: A Proven Plan for Financial Fitness

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  • Drew Rodgers

    Ahh, Travis…I do have a personal emergency fund and believe in them almost as passionately as you do. But I am somewhat conflicted by your post. As a banker, I would like to have philosophical sparring session with you to discuss the merits of leverage and lowering your overall cost of capital.

  • Drew Rodgers

    Ahh, Travis…I do have a personal emergency fund and believe in them almost as passionately as you do. But I am somewhat conflicted by your post. As a banker, I would like to have philosophical sparring session with you to discuss the merits of leverage and lowering your overall cost of capital.

  • Hey Drew! I thought you might have something to say about this! I do believe there are legitimate reasons to incur debt. Companies in certain industries would have a hard time expanding and growing without loans. I also believe that if you have some sort of debt load already, reducing the cost of it is incredibly smart.

    Examples would be those companies that require large expenditures for constructing new buildings, purchasing machinery or retooling of factories. There can also be huge tax benefits for "smart" debt in how it can be used to lessen tax liabilities in a particular year.

    All too often though, debt is used incorrectly to cover mistakes in management or to grow the overhead of the business with little or no guarantee that the growth will lead to increased revenue. For years, companies have tried to grow themselves to larger revenues – rather than letting profits (not revenues) dictate growth.

    Take the auto industry for example. They are in front of a congressional panel today seeking another $25 Billion in "loans" in an effort to avoid bankruptcy. Mitt Romney has an excellent article in the NY Times today (http://bit.ly/10N7E) in which he discusses the real reasons behind the request. A bankruptcy would cause the heads of those companies to lose their jobs. There has been an utter failure in management and we've all seen it happening for years. They were hemorrhaging money even when capital was easy and cheap, but they were able to keep the status quo solely because of debt.

    My point is that debt is rarely the answer. The more a company (or individual for that matter) relies on debt to sustain growth, the more likely it will be to struggle when the cost of that debt increases or the revenue to offset that debt decreases.

    Thoughts?

  • Hey Drew! I thought you might have something to say about this! I do believe there are legitimate reasons to incur debt. Companies in certain industries would have a hard time expanding and growing without loans. I also believe that if you have some sort of debt load already, reducing the cost of it is incredibly smart.

    Examples would be those companies that require large expenditures for constructing new buildings, purchasing machinery or retooling of factories. There can also be huge tax benefits for "smart" debt in how it can be used to lessen tax liabilities in a particular year.

    All too often though, debt is used incorrectly to cover mistakes in management or to grow the overhead of the business with little or no guarantee that the growth will lead to increased revenue. For years, companies have tried to grow themselves to larger revenues – rather than letting profits (not revenues) dictate growth.

    Take the auto industry for example. They are in front of a congressional panel today seeking another $25 Billion in "loans" in an effort to avoid bankruptcy. Mitt Romney has an excellent article in the NY Times today (http://bit.ly/10N7E) in which he discusses the real reasons behind the request. A bankruptcy would cause the heads of those companies to lose their jobs. There has been an utter failure in management and we've all seen it happening for years. They were hemorrhaging money even when capital was easy and cheap, but they were able to keep the status quo solely because of debt.

    My point is that debt is rarely the answer. The more a company (or individual for that matter) relies on debt to sustain growth, the more likely it will be to struggle when the cost of that debt increases or the revenue to offset that debt decreases.

    Thoughts?

  • Hey Drew! I thought you might have something to say about this! I do believe there are legitimate reasons to incur debt. Companies in certain industries would have a hard time expanding and growing without loans. I also believe that if you have some sort of debt load already, reducing the cost of it is incredibly smart.

    Examples would be those companies that require large expenditures for constructing new buildings, purchasing machinery or retooling of factories. There can also be huge tax benefits for "smart" debt in how it can be used to lessen tax liabilities in a particular year.

    All too often though, debt is used incorrectly to cover mistakes in management or to grow the overhead of the business with little or no guarantee that the growth will lead to increased revenue. For years, companies have tried to grow themselves to larger revenues – rather than letting profits (not revenues) dictate growth.

    Take the auto industry for example. They are in front of a congressional panel today seeking another $25 Billion in "loans" in an effort to avoid bankruptcy. Mitt Romney has an excellent article in the NY Times today (<a href="http://bit.ly/10N7E) ” target=”_blank”>http://bit.ly/10N7E) in which he discusses the real reasons behind the request. A bankruptcy would cause the heads of those companies to lose their jobs. There has been an utter failure in management and we've all seen it happening for years. They were hemorrhaging money even when capital was easy and cheap, but they were able to keep the status quo solely because of debt.

    My point is that debt is rarely the answer. The more a company (or individual for that matter) relies on debt to sustain growth, the more likely it will be to struggle when the cost of that debt increases or the revenue to offset that debt decreases.

    Thoughts?

  • Hey Drew! I thought you might have something to say about this! I do believe there are legitimate reasons to incur debt. Companies in certain industries would have a hard time expanding and growing without loans. I also believe that if you have some sort of debt load already, reducing the cost of it is incredibly smart.

    Examples would be those companies that require large expenditures for constructing new buildings, purchasing machinery or retooling of factories. There can also be huge tax benefits for "smart" debt in how it can be used to lessen tax liabilities in a particular year.

    All too often though, debt is used incorrectly to cover mistakes in management or to grow the overhead of the business with little or no guarantee that the growth will lead to increased revenue. For years, companies have tried to grow themselves to larger revenues – rather than letting profits (not revenues) dictate growth.

    Take the auto industry for example. They are in front of a congressional panel today seeking another $25 Billion in "loans" in an effort to avoid bankruptcy. Mitt Romney has an excellent article in the NY Times today (

    I figured we weren't far off! I couldn't agree w/ you more about WACC, leveraging and valuation. I know we were discussing this the other night, but look what's happening w/ the bank bailout money. Banks are realizing they can impact the value of their stock more by acquiring other banks than lending it out at small profit margins.

    The cost of that capital is too high to lend in this market, but low enough to fund mergers and acquisitions. The law of unintended consequences, right? Now, if only our elected officials understood this. 🙂

  • I figured we weren't far off! I couldn't agree w/ you more about WACC, leveraging and valuation. I know we were discussing this the other night, but look what's happening w/ the bank bailout money. Banks are realizing they can impact the value of their stock more by acquiring other banks than lending it out at small profit margins.

    The cost of that capital is too high to lend in this market, but low enough to fund mergers and acquisitions. The law of unintended consequences, right? Now, if only our elected officials understood this. 🙂

  • Drew Rodgers

    Travis, I agree with you that leverage has been overused and underappreciated. I am currently working through the ramifications of the credit environment of the last 15 years and it is a treat.

  • Drew Rodgers

    I would respond that as it relates to corporate valuations, the use of debt continues to drive valuations higher on account of a reduced weighted average cost of capital (WACC) and that is why you will continue to see Private Equity Groups, Institutional Investors, etc. using debt to fund acquisitions. Or in another scenario, deploying equity to make a particular acquisition and then leveraging the company in an effort to reduce the hurdle/WACC and increase enterprise value. As long as the demand for debt remains high, the lending community will rise to meet that level of demand and creditworthiness and sound lending practices have a tendency to fall by the wayside. Our hope is to bank the ones that fall in line with your thinking, we want the companies that use debt as a necessity, but generate the cash flow after paying bills to service that debt. Obviously, in the case of the auto industry, there was a time when the big automakers were able to service that debt, but the amount of leverage was in fact, overused and underappreciated. A lack of perspective towards market forces have caused a gross mismanagement of these companies and a "culling of the herd" should begin shortly. Great post today!

  • Drew Rodgers

    Travis, I agree with you that leverage has been overused and underappreciated. I am currently working through the ramifications of the credit environment of the last 15 years and it is a treat.

  • Drew Rodgers

    I would respond that as it relates to corporate valuations, the use of debt continues to drive valuations higher on account of a reduced weighted average cost of capital (WACC) and that is why you will continue to see Private Equity Groups, Institutional Investors, etc. using debt to fund acquisitions. Or in another scenario, deploying equity to make a particular acquisition and then leveraging the company in an effort to reduce the hurdle/WACC and increase enterprise value. As long as the demand for debt remains high, the lending community will rise to meet that level of demand and creditworthiness and sound lending practices have a tendency to fall by the wayside. Our hope is to bank the ones that fall in line with your thinking, we want the companies that use debt as a necessity, but generate the cash flow after paying bills to service that debt. Obviously, in the case of the auto industry, there was a time when the big automakers were able to service that debt, but the amount of leverage was in fact, overused and underappreciated. A lack of perspective towards market forces have caused a gross mismanagement of these companies and a "culling of the herd" should begin shortly. Great post today!

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