In a recent interview with Trish Regan on Bloomberg Television’s Street Smart (video is below), Dallas Mavericks owner and entrepreneur Mark Cuban said if you start a business by taking out a small business loan, you are a moron:
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 or equity financing. Cuban advocates equity financing (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 a shareholder provides enough capital, the investor can take a controlling interest in the company. In this way, the entrepreneur may be hindered in his vision and, at some point, could even be removed from his own firm. Only about one percent of startup companies are funded by venture capitalists (VCs).
The more common way of raising money is through debt financing, meaning that the entrepreneur takes loans out to start the business. Admittedly, capital is not flowing as it did during the halcyon days of the mid 2,000’s, when big banks approved about half of the small business funding requests they received. However, the so-called credit crunch — when many of the big banks hunkered down and reclined an overwhelming percentage of funding requests — is not as severe as it once was. In fact, according to the Biz2Credit Small Business Lending Index for May 2013, big banks are approving small business loan applications at the highest rates since the Great Recession of 2009-2011.
In the past few years, the big banks ceded their dominance of the small business lending space. When they closed the door others — including smaller, regional banks, credit unions, microlenders, and cash advance companies — filled the void. Now that they are reentering the marketplace, the competition has become more intense. Thus, interest rates are quite attractive at the moment.
Cash advance companies, accounts receivable financiers used to charge rates at near loan shark levels. They have come down quite a bit over the past year or two. American Express, which offers merchant cash advance services to its customers, helped drop the rates to as low as 6.5 percent. Microlenders are willing to give people — even those with spotty credit histories — smaller amounts of startup cash to launch their firms. Small banks and credit unions, both of which are local in nature, are good sources of capital because 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.
The intense competition occurring right now between different types of lenders is good for entrepreneurs.
Debt financing provides entrepreneurs with the ability to run their companies as they see fit and maintain control. 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. 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.
Another benefit of debt financing is that the interest paid on the loan is tax-deductible.
In the past few years, Small Business Administration backed loans have become vital to the growth of small businesses. They generally offer more favorable interest rates than traditional bank loans. Indeed, debt financing has help countless successful small businesses get off the ground.
Yes, there are some disadvantages of debt financing. If you borrow too much money, the interest payments will be substantial. 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.
Mark Cuban says that:
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.
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 funders if he or she cannot articulate the startup’s competitive advantages in the local market place. This information should be outlined in the business plan.
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 is because they do not know how to go about applying for a small business loan.
Fortunately, nowadays, there are services that match potential borrowers with small business lenders.