Many people who want to start a small business will read some books, visit the local small business center, and check out sites online. These venues will be very quick to tell you about all the ways you can reduce your risk.
First they will tell you about LLCs and how they will protect your assets. What they won't tell you is that any and every bank you go to, plus every vendor you do business with, will make you sign a personal guarantee so that you can't hide behind your LLC. Most people going into business for the first time don't realize this, and I wonder why everyone continues to discuss the asset-protecting advantages of the LLC.
Secondly, and worst of all, they will tell you that SBA is there to help you out. Yeah right. SBA is a program that supposedly encourages entrepreneurship by having the government guarantee 80% of the loan so that the bank be more aggressive in lending money to small business. But the banks still want you to put down the 20% that isn't covered, which is difficult for some startups. Plus, if you do have any assets, SBA will expect you to put them up as collateral. So, it only benefits people who have at least 20%, but not much more.
This has caused my partner and I to undertake a very, um… interesting financial maneuver. I didn't have the money to start a business, and didn't have the 20% the banks wanted either, so I took on a partner. Now, since we overshot our startup costs by about 100K, he has assets that are being used to guarantee the loan that he had planned to use to start another business. We need working capital and are almost tapped out, so I am going to apply for an SBA loan to buy him out. That will be the most difficult step in the process. If I can get it, he will turn around and (now that his assets are free) loan 100K back to the company. No payments will be paid for 3 years, and at that time it will be convertible into equity if he chooses (which he probably will). I'm sure we will run into some legal and tax challenges for this, but ultimately we just want to free up some money.
Here is what I don't understand. In one of my finance classes in college, we learned the four Cs of credit (although some people teach 5 Cs). The professor said that the most important of them was character. He said that more than any other variable, character determined whether someone would pay back a loan. Now, I am the kind of person who believes so strongly in capitalism that I think stealing money is one of the worst crimes someone can commit. I refuse to play the lottery because when I am very wealthy someday I don't want people to qualify it by saying "well, he did have all that money from the lottery (or parents or whatever)." So what I don't understand is – why can't I get a business loan that says if my business fails and I can't pay back the loan it will be docked from my pay for the rest of my life? I'll take that. Because if I borrow money and squander it, I would feel so guilty about that I would pay back every cent if it took me 20 years. Why can't I take a character test and get a loan? Why do they basically just look at my assets? But enough ranting. If SBA really wants to help encourage small business startups, they should seriously change their policy. And so should all the other books and websites that propel these myths about how easy it is to get funding and legal protection. I have to agree with a startup CEO who spoke at an event I attended a few years ago. He said there is only one way to get money for a new business if you don't already have some – beg. And keep at it.