One of the first places that entrepreneurs go to fund their business is their house. They take out a second mortgage, they pledge the house as collateral, or they sell the house altogether in order to start a business. For many people a house is their largest asset, and sometime their only asset. If you are going to risk your house for your business, please make sure that your business is in a position to succeed. So many people pledge their house as collateral for a loan, or take out a second mortgage before the business has a proven business model. Here are 3 signs that you should NOT pledge your home as collateral for a business loan:
1. No Sales Yet – Look if you have not made your first sale yet, you are crazy to risk your house. I know that “crazy” is the definition of an entrepreneur, but I really encourage you not to risk your home until you have generated some sales. What if you risk the house and then find out that no one really wants your product or service? Or not enough people want your product or service? Or what if it takes you a few months longer than expected for your sales to ramp up? You learn a lot when you make your first sale, I encourage you to do that before you risk anything.
2. No Proven, Profitable Business Model – Even if you make a few sales, that does not mean that those were profitable or repeatable sales. Did you just get lucky with the sale? Was it even profitable? So many businesses are so hungry for sales that they decrease their price to the point that they are no longer profitable. If you can’t compete, and generate sales without lowering your prices to an unprofitable level, then you might as well quit. The last thing you should do is risk your house too.
3. No Idea How Much Cash You Need – If you don’t know how much cash it will take to breakeven, then don’t do risk anything until you figure out that question. You need to understand your business model, and your cost structure to the point that you can determine how much in sales it will take to breakeven, then you can work backwards and try to determine how much time it will take you to generate those sales. If you know it will take you 3 months, and you know your monthly fixed expenses, then you can figure out exactly how much investment you need to make it to breakeven.
If any of these three scenarios describe you, then please don’t risk your home for your business yet. You may need to inch along step by step for a few more months or even years before you are ready to make this level of commitment. Once you have found a profitable and repeatable business model, and you know exactly how much cash you need to breakeven, then it is time to put the pedal to the metal and grow the business. Until then, be careful…