It’s estimated that 95% of businesses fail in the first five years (source). Not exactly phenomenal odds since they’re stacked against any entrepreneur who opens his or her small business doors. Considering the high rate of failure and the number of years it takes to build a substantial business, should entrepreneurs focus more on debt elimination before starting their business or go all in by taking the plunge while in debt?
Starting a Business While in Debt
The problem with starting a business while still in debt, whether it’s student loans, credit card, or even a mortgage would be the lack of capital access to get the business up and running. Limiting the amount of capital one could invest into the business limits opportunity for growth when opportunities are presented. An entrepreneur could start a small business, but not have the capital to properly market it and thus cause it to die a slow painful death where they wait for more customers to make more money, yet don’t have the money to get more customers. Much like the chicken or the egg dilemma.
The other problem is that the small business doesn’t have a cushion to allow it to weather storms influenced from the aggregate market or from like competitors. If a competitor enters into a price war with the business an entrepreneur without any cushion is going to have to fold. One could see from this that the businesses that make sense for entrepreneurs in debt may be ones that have minimal competition, low capital costs, and significant upside to make the risk worthwhile. Sounds like a dream business to me!
A few Possible Solutions
Reduce living expenses to the minimum – Live like a pauper and put your business first if you don’t have much money. Most likely time will be your great asset so leverage that into productive hours working on your business. Instead of marketing, prospect. Instead of hiring an employee to do the grunt work, do it yourself.
Keep working on the side – Pick up part time work on the side to pay your minimal expenses. This is currently my strategy. The downside is that you may hurt your career path, but as an entrepreneur minded individual you’d rather be poor than a cubicle drone anyways, so it might not be that big of a risk to you.
Start a business that doesn’t require much capital, such as a online business – Online businesses are so ridiculously cheap that I’m surprised more people don’t take advantage of this. I listened to an interview with John Chow in which he asked what the internet marketplace would be like if online businesses cost $100k to start. There would be a lot more motivated people online and a lot less junk, that’s for sure. Just because it has low barriers to entry via cost, doesn’t mean it doesn’t have a huge upside potential if you treat it like a regular business. It’s a bit of a blessing and a curse at the same time. Any service business also has the potential to be started with low capital since your abilities are the product.
The Best Case
The plan works out and five years down the road your business is supporting itself and you’re doing as well if not better than if you’d not gone into business. You’re able to completely pay off the debt and make substantially more due to your success. However, that’s only if you’re in the 5% of businesses that don’t fail. Five years is a long time to stick it out and there will be a constant barrage of reasons why you could quit or why your business could fail.
The Worst Case
You could go deeper into debt and have a failed business which then removes the possibility of starting future businesses until your finances are back in order. You could lose a few years of income potential and aren’t able to contribute to any retirement portfolios thus losing out on some of the benefits of the time value of money. However, you will have the invaluable experience of starting a business from scratch, which can then be leveraged into a job or business down the road. If you play it completely safe you won’t have to worry about bankruptcy since you’ve decided to live significantly below your means.
If the entrepreneur is willing to fit a mix of living below their means, possibly working part time, and starting a low capital business starting a business while in debt, it might be a feasible option to start a business before eliminating debt. However, if they can’t keep up with the bills when the doors open, want to continue to go on trips to the Bahamas every three months, and engage in high capital businesses it might be best to clear the debts first.
What do you think? Should a wannabe entrepreneur kill their debt before taking the plunge?
Have you ever started a business while in debt? If so, how’d it turn out?
Image from Peter Kaminski