5 easy ways startups can manage debts from day one5 June 2018 Category :
Starting your own business often means getting into debt.
You might have a little equity of your own for the setup. But chances are you’ll also be using a loan, a credit card, or even a few investors. And as startups generally don’t see profit for three to five years, this means you’ll be in debt to some degree until business takes off.
So here are five easy ways to keep on top of it – along with a few warnings to keep in mind.
1. Stay calm and accept it: A lot of articles focus on managing debt once you’re already in it. But there’s no better way to avoid problems than by preparing for what to expect in advance.
Setting realistic expectations about being in debt can take off some of the pressure. New business owners have enough to worry about in terms of setting up shop, finding new clients, pleasing investors, and doing the work. Worrying unnecessarily about debt is only going to detract from focus on growing the business and create an obstacle to success.
Research experts CB Insights found, in a recent study of 101 startups, that the top two reasons for failure were running out of money (29%) and a lack of market need (42%). These reasons are inexorably interlinked – not only with each other, but more importantly with a lack of forward thinking. It demonstrates the importance of making sure you’re spending your money strategically, while also keeping business focus on filling a market need. As a startup, this is where your focus needs to be, not on fretting about debt.
Research experts CB Insights found, in a recent study of 101 startups, that the top two reasons for failure were running out of money (29%) and a lack of market need (42%).
As entrepreneur and author Tim Ferris wrote in the 4-Hour Work Week, ‘It is far more lucrative and fun to leverage your strengths instead of attempting to fix all the chinks in your armor. Focus on better use of your best weapons instead of constant repair’. Accept you will be in debt at some stage and concentrate on those tasks which are going to bring profit.
2. Assign a budget (and analyse it): A 2016 study in the UK showed that some 9% of startups had no set budget, which means these businesses are setting themselves up for trouble. Why? Because assigning a startup budget doesn’t just mean planning on how to spend your money, but also how to control your costs.
Setting a startup budget means identifying both setting up and ongoing business costs from day one. These will be a mixture of variable and fixed expenses, such as office space, staff wages, utilities, equipment, and marketing. But don’t just guess at these numbers. Do your research to make sure you haven’t underestimated anything.
Remember that in the UAE it is not always easy for startups to get access to credit in the first place: according to the OECD, loan applications are rejected between 50 and 70% of the time. This can be a good thing in the sense that it is more difficult to get into debt – but one thing you should not do is take out loans from less reputable sources to help with your setup costs.
Setting a startup budget helps identify those costs essential to getting your business running, as well as giving you a spending plan that allows you to grow while paying off your debts. By creating this kind of budget, and analysing it on an ongoing basis to allow for movement in the market and the economy, you’re giving your business the best chance of success.
3. Consolidate what you can: Many startups get their start through funding from multiple sources. Research based on Inc magazine’s data of the fastest growing companies in America showed that over half had financed through a bank loan, while other main sources included credit cards and angel investors. And with each debt there are ongoing requirements, repayments to the creditors, and the threat of penalties for missed payments.
Managing just one source of funding is tough enough, let alone dealing with multiple streams. Burdening your startup with unnecessary stress and time-consuming accounting, when its focus needs to be on earning money, is a good way to find yourself with spiralling money problems.
Pulling all of your debts into one consolidation loan is a great way of managing them. It means turning several repayments (all at different times of the month) into a single payment, which makes it easier to keep track of your financial situation and set your budget accordingly. Depending on which consolidation loan you opt for – secured or unsecured – the interest rate may be lower too (although given the risks involved in taking on a secured loan against assets such as your house, car, etc, it would be wise to talk to a professional debt consolidation service provider to discuss your options).
It’s easy to let multiple debts (and repayments) get out of control. Consolidating them into a single loan is a great way of managing your total debt and will allow you to better stick to your budget. Which also relates to an important warning: avoid taking on unnecessary loans when your startup is in its fledgling phase if you’re not confident you’ll be able to pay them back in time. Take time to think very carefully about which expenses are vital to the running of your business, and which can wait.
4. Triage your payments: Remember that in business, everything is relative. Shikhar Ghosh from Harvard Business School has illustrated this by pointing out that not all company ‘failures’ are equal. If failure means literally liquidating all assets, then the rate is around 30-40%. However, if it is defined as simply falling short of a projection, the rate is up in the 90-95% region.
This applies to debt, too – not all of them are equal. Some are essential to the survival of your business, while others are a little more flexible. So manage them better by prioritising which are the most important and which can wait a little longer.
Priority debts are the ones that will cause you serious problems if they remain unpaid. These could include things like utility bills, rents, mortgages and taxes, or in more extreme cases possibly even court fines and bailiff action. They might not be the largest debts, but they are the ones that you absolutely must take care of first, otherwise you could be facing penalties of anything from loss of power and heating to bankruptcy or even losing your home.
Any non-urgent debts can wait until you’ve taken care of the important ones. These non-priorities might include things like bank loans, credit cards, or overdrafts, where you might be able to pay the minimum amount required until you can afford to pay more. The consequences of non-payment with these will also be less serious than your priorities, with small fines the most likely, so this will again help take the pressure off (although repeated non-payments will still lead to serious consequences, so consider this only a very short-term fix to get you out of trouble).
Write a list of all your debts and highlight those where the consequences of non-payment will be catastrophic for your business. Also include those debts with the highest interest rates. Make these your priority repayments and clear them as soon as possible. Meanwhile, pay as little as you can on the non-urgent payments until such time as you can spare the money to clear them too.
5. Cut back on all unnecessary expenses: It’s easy to get into debt by chasing a vision. And you wouldn’t be alone: according to the Institute of International Finance, global debt hit a record high of USD 233tn in the third quarter of 2017 – and the largest chunk of this, USD 68tn, belongs to non-financial companies.
But if debts are beginning to stack up to an unmanageable level, you need to think about where you can scale back operations. This not only means identifying priority debts (as above), but looking at every expense and figuring out what is essential and what can go or be reduced. For example, having the latest technology might not be essential for most startups, in which case you could look at moving to second-hand equipment, or even explore leasing, which could allow for more updated technology with a lower upfront cost.
But if debts are beginning to stack up to an unmanageable level, you need to think about where you can pare back operations.
There are always expenses you can cut back on. Second-hand or leased equipment is usually an option, and you can also investigate cheaper utility alternatives, more flexible working arrangements (staff working remotely equals lower office overheads), and reducing your service offering to a more manageable level until you can invest more as the business grows. And don’t get yourself into worse debt by putting extra expenses – such as advertising costs – onto your credit card.
Keep it simple
As stated in the Small Business Survival Book, ‘Just about every business faces difficult financial periods at some time. Despite the best of business plans, tough times can result from things beyond your control’.
So debt is an often unavoidable part of being a startup. But developing a smart, cost-effective business mindset will keep you out of trouble – putting you in a great position to manage your debt and keep your startup fighting fit.
Virtuzone Mainland is dedicated to helping clients open a company on the UAE mainland, providing advice and assistance with every aspect of the company formation. To set up a consultation, please call us on +971 4 457 8200, or click here.