As my day job I manage an SBA Microloan Program where we help provide loans up to $50,000 to small businesses. A major mistake that I see happen over and over again is an entrepreneur will fail to create financial projections before jumping in and investing in a new business, they will invest their life savings to get the business started, spend every last penny and then still come up short and in need of a business loan.
A recent example was a hopeful restaurant owner put $70,000 into purchasing and rehabbing a building for his new restaurant, but after spending everything he had, he ended up $30,000 short. At this point no one could help him. If he would have come to the bank first and asked for a loan for $100k and said that he had $70k in savings that he was willing to pledge as cash collateral for the loan, the bank would have almost undoubtedly said yes. They would have taken the whole building as collateral, plus his $70k in cash and slapped an SBA Guarantee on the loan to cover 85% of the loan if it went bad. In this situation the bank could hardly lose.
Instead, the business owner asked the bank for $30,000 which is a small loan for a traditional bank, they wouldn’t make any interest income on the loan anyway, plus the owner had no savings, and his building was basically worthless at this point because it was all torn up and only halfway complete.
This poor guy had what he needed to start a successful restaurant, but he spent his life savings first. I urge any potential business owner to spend time creating financial projections before you invest your life savings into a business, this would have saved this particular entrepreneur $70,000. He would have realized that 70k was not enough to open and would have sought a loan from a bank first before jumping into the business.
The moral of the story is to preserve your cash because it gives your more options. It is better to keep 70k in cash and borrow $100k than to spend the 70k in cash and try to borrow 30k. Cash gives you options, so guard it closely!
About the Author: Adam Hoeksema is the Co-Founder of ProjectionHub which is a web application that helps entrepreneurs create financial projections without Excel.