Almost a decade ago, I left the traditional office-based “9 to 5” workplace behind me, and went into business for myself. Even though I’ve gone through plenty of ups and downs, I have never regretted it for a second; there’s something special about “clocking in” and relying entirely on yourself for your happiness and success. After years of hard work, I was finally starting to feel like I was getting somewhere: I expanded my personal training business enough to open a physical gym location, offering customized nutrition and workout plans, with a personal, small-community feel. I knew it was going to be tough—but I never imagined what would happen when the pandemic began to spread around the world. It’s not a shock that our state has been one of the hardest hit (though it is a bit disappointing), but it is evidentiary of a state-wide problem: an inability to look at hard facts, and base behaviors off of those indicators. Nowhere is that more important than in my recovery plan, and I hope I can impart upon you the importance of complete objectivity as you assess your business honestly.
Starting Out: Sorting Out Priorities
For the first five years of offering my personal training services, I constantly reinvested in the business, and never had anything left over for myself; after working through bankruptcy from failed small business years before, I felt that I couldn’t risk not throwing every last dollar into my clients; however, I neglected my marketing, software, and data management needs. Eventually, working with the right marketing and financial companies gave me the tools to truly know if the business could afford improvements or extra employees. I looked at my life and company objectively, and decided that I had a viable business that could support me; once I changed how my spending priorities, I went from just getting by thriving. If your small business is suffering through this crisis, prioritize where your money is going.
Debt is a Business Killer
For my first business (a failed coffee shop) I took on a loan to get started. The problem with taking on debt—as opposed to selling equity—is that debt hits the cash flows pretty hard on a start-up. Most loans require monthly payments, which is negative cash flow. You are allowed to expense the interest portion of the payment, but not the portion that goes towards the principal.
With equity, you won’t see any changes to cash flow until there is a payment of dividends or equity buyback. This is true even if there are profits, or dividends owing. There’s also the fact that the more debt a company has, the more expensive it gets to borrow more money. Lenders tend to not care a whole lot about the division of equity, since debt always gets paid back before equity in a bankruptcy, but they care a lot about the debt acquired before they make a loan.
Many business decisions are made by weighing the risks vs rewards. Starting a company with debt can result in bigger rewards, but it is far riskier. This is because servicing debt with a new company can be enough to crash the cash flows. If you started your company by selling equity, then good news: you are already on your way to recovery; if needed, you can perhaps
take on the risk of a loan to stay afloat until the pandemic cedes its grip on our economy. However, if you’re already in debt and struggling, it might be time to consider a different financial option.
Why They Might Sell, Why You Should Buy, and Vice Versa
Investors with a large portfolio can make large risky bets that have positive Expected Value (EV) payout. But a lot of regular folks just want enough money to live on (and retire on), and have what we like to call a lower risk tolerance.
Let’s take this prospective scenario as an example:
- imagine someone in front of you with a pocketful of cash, proffering a coin in their outstretched hand. Here’s their offer: would you rather have a guaranteed $10 bill right now, or a 50% chance of getting $40 on a coin flip bet? Basic arithmetic says you should take the coin flip bet. The EV on the 50% bet on $40 is $20, which is a better value than just getting a free $10 bill.
- Now, let’s say I come to you and offer two options: a guaranteed $10 million right now, or a 50% chance at getting $40 million? If you’re working with an investor, it’s obvious that a 50% of getting $40 million is better than a 100% chance at $10 million, for the same reason that you’d take the $40 coin flip bet over the guaranteed $10. One has an EV of $20 million—the other has an EV of $10 million. The investor takes the higher EV.
- But if you’re the average small business owner, then values like $10 million, $20 million, and $40 million almost seem like similar sums of money: they all equate to “my kid gets to go to college” and “I get to retire.” So, that small business owner isn’t measuring a $10 million dollar EV vs a $20 million EV: instead, they’re weighing a 100% chance of retirement and college tuition against a 50% “chance” of retirement and college tuition. So, they take the guaranteed $10 million instead of taking a coin flip bet on $40 million.
The 100% chance of retirement looks way more appealing to the regular Joe, and the higher EV looks way more appealing to the investor, and so in the transaction where the investor buys the “risky” business for a higher EV—and business owner “Joe” sells the business for a guaranteed retirement—both parties get what they want.
Small Business Recovery: You Matter Most
In the above scenario, the investors and their partners come out ahead in the long run because they have a large portfolio—whereas the business owner’s in a much riskier position of owning and running only one business. If you’re in the camp where it looks like recovery might be a way off, but there might be a viable chance to sell, then contact a financial advisor and field some offers. With money in your pocket in the midst of the pandemic, you just might be able to pool your money with some professional investors and start something new.