In an interview on Bloomberg Television’s Street Smart (video is below), Dallas Mavericks owner and billionaire entrepreneur Mark Cuban said something startling. He opined that if you start a business by taking out a small business loan, you are a moron. He’s wrong, because he overlooks the popular loan options for small businesses available today.
In the interview, Cuban said, “The one certainty is paying back the loan. The bank does not care about your business. 99% of small business you can start with next to no capital. It’s more about effort. Small businesses don’t fail from a lack of capital, they fail for a lack of brains, a lack of effort.”
While a lack of savvy and insufficient effort doom many businesses, Cuban’s theory is simply incorrect.
Not everyone has personal savings or wealthy relatives to call upon for startup funding. That leaves two other sources: debt financing (loans) or equity financing (angel or VC investors).
Cuban advocates equity financing. He is in favor of raising money by selling shares of common stock to individual or institutional investors. In return for the money they invest, shareholders receive ownership interest.
However, if an investor provides enough capital, he or she may take a controlling interest in the company. In this way, the entrepreneur may be hindered in his vision. At some point, the entrepreneur could even be removed from her own firm. This has happened many times!
And in fact, equity investment is rare. Only about one percent of startup companies are funded by venture capitalists (VCs).
The more common way of raising money is through debt financing. In other words, the entrepreneur takes out loans to start or expand the business.
Popular Loan Options for Small Businesses
In the past few years, the big banks ceded their dominance of the small business lending space. When they closed the door, others stepped in to fill the void — including community banks, smaller regional banks, credit unions, microlenders, and cash advance companies.
Now that bank lenders have reentered the marketplace, the competition has become more intense.
Competition among lenders is good for business owners. It leads to more financing choices, attractive interest rates and better terms.
Here are some of the more popular loan options for small businesses (including non-traditional debt financing):
- Cash advance companies and accounts receivable financiers used to charge rates at near loan shark levels. They have come down quite a bit in recent years. American Express, which offers merchant cash advance services to its customers, was a leader in helping reduce rates.
- Microlenders are willing to give entrepreneurs — even those with spotty credit histories — smaller amounts of startup cash to launch their firms.
- Small banks and credit unions are good sources of capital. They know the local economy and can make informed decisions.
- Big banks use their size, brand equity, and their ability to lend at attractive interest rates to their advantage.
Small Business Loan vs. Equity Investment
The intense competition occurring right now between different types of lenders is good for entrepreneurs.
Taking advantage of one of the popular loan options above is smart for a small business. It can be smarter than seeking equity investment. Here’s why:
First, loans (unlike equity investment) allow entrepreneurs to maintain control. Founders have the ability to run their companies as they see fit and make any decision. Banks generally do not want to be involved in the running of companies. They leave that in the hands of the entrepreneurs who are investing the skill set and sweat equity in their companies.
Second, loans enable the small business owner to preserve full and complete ownership. If the business becomes successful, the entrepreneur does not have to share the riches with investors. He or she can reap the profits while paying back the agreed upon amount of money to the bank each month.
Third, there’s a tax benefit. The interest paid on the small business loan is tax-deductible.
Finally, paying interest on a small business loan in the long run is not as costly as giving up a slice of your company to equity investors. Interest rates are very attractive compared to historical levels. In recent years, Small Business Administration (SBA) backed loans have become vital to the growth of small businesses. They generally offer more favorable interest rates than traditional bank loans.
In short, loans have helped countless successful small businesses get off the ground and grow.
Disadvantages of Small Business Loans
Yes, there are some disadvantages of small business loans and similar debt financing. For one thing, if you borrow too much money, the interest payments will be substantial. You must ensure you have the cash flow to make payments.
On the other hand, if you do not borrow enough, you have to go back to the bank and ask for more money. This is never good. The loan officer begins to wonder if you wasted the money, misappropriated funds or did not plan properly. None of these scenarios makes it likely that the bank would be willing to give more money.
Not asking for enough money is something many business owners fail to think about, but should.
Mark Cuban claims success boils down to smarts and effort. He says, “Most people aren’t willing to put in the time to work smart. They don’t recognize how much work is involved. If you start a business, you’d better know your industry and your company better than anyone in the whole wide world because you are competing.
Why Cuban is Wrong
If Cuban truly believes this, he has little faith in our capitalist system that supports the start and the growth of small businesses. Further, an entrepreneur will not receive money from lenders if he or she cannot articulate the startup’s competitive advantages in the local market place. This information should be in the business plan. Or at the very least, you must be able to explain it when applying for a loan.
I disagree with his assertion that companies “fail from lack of brains and a lack of effort, but not for a lack of capital.”
I know first-hand how challenging it can be to secure a small business loan because I speak with numerous entrepreneurs and potential funders every week. They are dedicated and hard working. Many times the reason why they cannot get off the ground or grow is because they do not know how to go about applying for a small business loan.
Fortunately, nowadays, there are services that match potential business borrowers with small business lenders.
Watch the video interview of Mark Cuban claiming that small business owners do not need a loan. See what you think.