You Can’t Build a Profitable Startup Without Debt
Money is one of the most important things to think about when building a startup. For many entrepreneurs, it is an emotional topic. As soon as we bring up the concept of money, people get uncomfortable.
One of the reasons why people focus so much on vanity metrics in startups like reach, followers, page views, brand value, marketshare and so on is because they are not comfortable talking about money. Money takes you on a date with reality and people resist it.
To be brutally honest, the only metric that matters for a startup is its finances.
Revenue, profits, investment and debt is all the language that is required to define how well a startup is doing. And it is amazing how people do not think about it often enough, let alone talk about it.
If money is an emotional topic, debt is even worse. Almost every entrepreneur has some experience with debt. More often than not, it is a negative experience.
If you go into debt in the wrong place and time, it can kill your startup and your career. And you probably know people in your friends and family circle who destroyed their lives and careers because of mismanaged debt.
If you have made it up to this point in the article, chances are that you already have some emotions surface around money.
If reading about money makes you uncomfortable, think about me. I am writing about it.
It took a long time for me to get comfortable with the topic of money and debt so that I can write a chapter on it. This is a result of lot of learning, experience and introspection.
So let’s talk about money and debt without shying away from it.
What is “Value”?
Before we dive deep into understanding the importance of money and debt, we need to zoom out one step and talk about “value”.
Every transaction that happens in this world at any point in time is an exchange of value.
As I am writing this article right now, and as you are reading it at this very moment in time, 1000s of transactions are happening across the world. All the transactions are exchange of value created by human beings using division of labour.
What is division of labour? Let’s do a thought experiment.
Think about one man in an island. (If you can seen the movie Cast Away by Tom Hanks, you can visualize it very well.)
If this one man has to take care of himself and survive, he has to do everything by himself. He wouldn’t be great at anything. He has to build his own house, grow or hunt his own food and take care of himself if he is sick.
He cannot build a great house, because he doesn’t have the luxury of time to invest years into learning how to build a house. At best he can build a hut.
He has to do everything himself, and he will not be great at anything. His quality of life wouldn’t be good.
Division of Labour Builds Productivity
Now imagine ten people in the same island. They can agree to develop specific skills and divide the labour among themselves. One person can focus on one thing and really get good at it.
One person can focus on building houses for everyone. One person can focus on fishing. Another one can focus on growing vegetables and grains.
Since every person has only one job to do, he/she becomes better at that specific skill over time and therefore becomes more productive.
Someone who is just going to focus on catching fishes is going to catch more fish for all the 10 people than what people would have caught fishing by themselves. The fisherman’s skill compounds because he is focusing on one thing. He can become more productive.
The productivity that comes from focus creates wealth for all the islanders.
We have more than 7 billion people on this planet. Everyone can afford to become a super super specialist in one thing. And exchanging value among 7 billion people has now become highly efficient, thanks to technology.
As a planet and human civilization, we are growing in our overall wealth because of the insane scale of division of labour. (This also proves the point that more population creates more wealth for everyone, a topic for another day).
Division of labour allows a person like me to focus on one topic and become an expert, in my case, Digital Marketing. Someone can be an astronaut. And someone else can be a neurosurgeon.
The more number of people there are in this planet, the deeper one person can go in one subject and build a unique skill. But to build that skill, you need to invest time, energy and money. That means you need to go into debt.
Your Debt as an Individual
If someone is dedicating 10 years of their life to learn a specific skill, and you have only 5 years experience, they will always beat you.
The more time, energy and money you invest in a specific skill, the better you will become. The better you become, the more you will earn, because you will be the best. People would want to pay you for a skill than someone else with lesser experience.
If you think about yourself, you’ve gone into a debt of almost 20 years to become a mentally healthy and functioning member of the society.
You have invested the time and your parents invested money to make you “profitable”.
If you did not have school and college education, you cannot make money. You wouldn’t have any skills that other people are ready to pay for.
Even as a professional, we go into debt.
If your parents are great, you might not need to necessarily repay them for their investment of time and money in raising you. But it is a debt. A debt that is waived off by your parents. If you get an educational loan, you have to repay, with interest.
A Startup’s Debt
A startup is not too different from a working professional.
A startup needs an incubation period where it is nurtured. Time, money and energy has to be invested upfront.
During the incubation period the startup goes into a debt, and in the future when the startup has created a product or service of value, it can repay the debt, with interest.
A professional who has more time and money to invest in personal growth ends up becoming a renowned expert in one field.
A startup that gets better nurturing with time and money, ends up creating highly valuable products and services that people would be ready to pay for. Longer the nurture period, stronger the startup becomes.
The more time and money the startup gets from its founders and investors, the more valuable the startup becomes and gives a healthy return on investment.
If you have saved up money for a while, and if you invest that money into the growth of your startup, you are still going into debt with your startup.
You are “lending” money to your startup in the hope that your startup will pay back with interest in the future.
Can Your Startup Pay Back the Debt?
Many entrepreneurs would argue with me that they are not going into debt if they are just investing their time and not their money. I would like to disagree.
If you are working for no salary in your own startup, you have an opportunity cost. You are giving up making money somewhere else, and working on your startup for free.
Though you are not spending your money, you are spending (investing) your time. And you “invest” your time into the startup, because you know that you can create something of value and then get a higher returns on it later.
Your startup goes into debt, because it is taking up your time, but not giving you returns instantly. It is yet to throw up a profit and it takes time.
Until your startup becomes profitable, your startup is in debt, with you.
Consider this… If you work as an employee for 3 years and make $100,000, your 3 years of time is valued at $100,000.
If you later you quit your job and build your startup for another 3 years without paying yourself, you are technically “lending” $100,000 to your startup and your startup would theoretically be in debt of $100,000.
It has taken your time, and hasn’t paid you back.
In the long term, the startup starts making money for you. It is paying you back the principal – with interest.
If your startup does exceptionally well, your startup is “paying” you back with a very high interest rate. And it can afford to because it is making a lot of money. Your startup is the most generous borrower you will ever find, if you can make your startup work. It would pay back everything to you and the shareholders.
If you cannot make your startup work, it would be like your distant friend who borrowed money and never showed his face again. You wouldn’t get back anything for your investment of time (and may be money).
Debt at the Right Time
Once you understand the truth your startup can never be built without debt, you will get more comfortable going into debt.
Valuable products and services create a good return on investment. You need to go into debt (of time and money) to create valuable products and services.
As long as you make sure cost of debt is less than the value you are creating using the debt, you will end up building a profitable startup.
More often than not, many startups go into debt without knowing how it is going to translate into value.
If the money is not used well, then the startup wouldn’t do well, and the startup cannot afford to pay back the borrowed principal with the needed interest. The startup would fail.
A startup needs both time and money but if you have to prioritize, time investment comes first.
A startup flourishes when the founders of the startup spend quality time growing their startup. A startup is in need of founders time more than money at a very early stage, just like a sapling requires more care, and not resources, from a gardener.
Right now, my startup is not a funded startup. Nor we have borrowed a large amount of money from a bank or a financier. But I am investing my time into my startup, and my time is translating to value for my customers.
My startup right now depends on my time investment, more than money. There will come a time, when my startup needs money to scale more than my personal time. And that would be the right time to go into debt.
Types of Debt
There are different types of debt that your startup can leverage.
The simplest form of debt is the time investment by the founder and the founding team.
Beyond time, money is required to grow.
If I need money…
- I can invest my savings or
- I can go into a financial debt where I have to pay an interest on the borrowed money or
- I can go into equity debt by selling shares in my company.
If I am raising money (going into debt) by selling a part of my company to investors, I would pay back in the form of a higher valuation of a slice of my company that the investor owns.
The debt can be funded by private investors in the case of a private company.
If the company goes public, any buyer of stock is a lender of money, wanting better returns in the future in the form of dividends and increased stock value.
Having access to all the types of debt is very important for the growth of a startup.
The more debt (capital) a startup has access to, the higher the possibility of investing time, energy and money to build something of great value, that people would be ready to pay a premium for.
Final Words
Money is a topic that we all tend to shy away from. Don’t. Think deeply about debt, money, value exchange and division of labour. The more uncomfortable it makes you, the more you need to come to terms with it.
Do not stay away from debt because it looks dangerous.
Debt looks dangerous because it is very powerful. The better you learn how to use it, the faster you can grow. Debt is the biggest growth engine a startup could ever have.
The art of entrepreneurship is the art of leveraging debt.
So tell me, how does your understanding of debt and money from this post going to impact your decisions?
I would like to hear from you…