The Entrepreneur's Office
Why this chapter
To move to the other side of the table and learn to choose money for your own business, rather than simply agreeing to what is offered.
An analogy
Imagine you need a car for three months. You can rent one from a neighbor on an IOU, you can take one from a rental company for money, or you can call a friend in as a partner and drive together. All three are honest, and none of them is wrong. But in the first you risk a relationship, in the second money, in the third half the trip. The eleventh chapter is built the same way: problems no longer have a single correct solution. There is a fork, and every branch has its own price — sometimes in percentages, sometimes in a stake, sometimes in sleepless nights.
How it works
Here everything is the other way round. For ten chapters you were the banker, looking at the entrepreneur across the desk. Now you are the entrepreneur, and the tasks no longer have one correct entry: there is a choice, and every choice has its price. Any path can be walked without a single mistake — and still leave you with a problem you picked yourself.
The price of money = the risk of the one who gives it. A bank with collateral risks the least — so it is the cheapest of all. A factor without collateral is dearer. A partner who carries the risk alongside you is the most expensive if you succeed and the cheapest if you fail. Debt is cheap when the cash flow is predictable; with no cash flow, the only honest money is equity.
The entrepreneur's three questions before taking any money (the mirror of the virtuoso's three): 1) Out of which cash flow will I repay this? 2) What am I giving in return — interest, a stake, control, my sleep? 3) What happens to me in the bad scenario? Walk through all five forks and you will answer without stopping to think.
The words of this chapter
The price of money
Not the rate in the agreement but the sum of everything you give up: interest, a stake, control, collateral, limits on your decisions, and your own sleep.
The concept is needed because comparing offers by the rate alone is like choosing an apartment by the price per square meter without looking at the floor or the neighborhood.
Collateral
Property that passes to the lender if you have not paid. It lowers their risk and therefore lowers your rate.
It was invented to lend to someone who is not trusted on their word, without going bust over it.
The rate against the asset's return
A rule of comparison: the interest on a loan has to be compared not with zero but with the return of what is bought with it.
It was invented as protection against two opposite mistakes: fear of any debt at all, and love of debt for its own sake.
A stake instead of debt
Financing in which the investor gets a part of the business rather than a promise of repayment. They earn only if you earn.
It was invented for ventures with no predictable cash flow: there is nothing to pay interest with, but the future can be shared.
The structure of a deal
A way of breaking the price into parts: how much in money now, how much in installments, how much depending on future results, how much in a stake.
It was invented as a machine for aligning interests: however a person gets paid is how they behave.
The entrepreneur's three questions
Out of what cash flow will I repay this; what am I giving up in exchange — interest, a stake, control, sleep; and what happens to me in the bad scenario.
They were invented as a mirror of the financier's three questions from the previous chapter. That one asks about the deal; you ask about yourself.
What happens to the balance sheet
Look at one and the same need for money from three sides. A secured loan: you get money and an obligation, the bank gets a claim and collateral; this is cheap, but it ties up your property. Selling receivables: you get money, and the claim on your buyer leaves; more expensive, but the risk of non-payment leaves with it. A stake: you get money and a co-owner; there is nothing to pay, but future profit is shared forever. Note an important detail: in the first two cases the money was born for you by a bank's entry, and in the third it simply changed owner.
Where the money comes from here
Whoever supplies the money earns exactly as much as the risk they take on and your haste are worth. A bank with collateral risks least and is therefore cheapest of all. Whoever buys your receivables with no right to hand them back to you charges more, because they are taking on your buyer's ability to pay. A partner coming in for a stake is the most expensive in success and the cheapest in failure. You lose in two cases: when you borrowed expensively against an asset that does not earn, and when you came for money at the moment you desperately needed it. Here is why this matters to you: desperation is always visible in the price, so you have to agree the money before you need it.
What people usually get wrong
The common belief. Debt is bad; you should grow on your own money.
What is actually true. Debt is an amplifier. A loan at 18% per annum on equipment that returns 34% grows your money. The same loan against an asset that does not work grows your hole.
The common belief. The cheapest money is the best money.
What is actually true. It is cheap where whoever supplies it risks less: there is collateral, a history, a proven cash flow. Cheapness is paid for with tied-up property and with limits on your decisions.
The common belief. The structure of a deal is a formality for the lawyers.
What is actually true. The structure is a machine for aligning interests and at the same time an X-ray of your counterparty. A seller's willingness to take part of the price on results says more about their belief in the business than any presentation.
After this chapter you will be able to
- judge the price of somebody else's money by the risk that travels with it to whoever supplies it
- compare the cost of financing with the return of the asset it buys, rather than with zero
- predict who will be left with no money if a project fails, from the financing scheme alone
- tell financing instruments apart by what they do in the bad scenario, not by their price in the good one
- assemble the price of a deal out of three currencies — money, a stake and a promise — to fit the risk sharing you want
Check yourself
You are offered a loan at 18% per annum for equipment that will bring in 34% per annum. Is that expensive?
No.
A rate has to be compared not with zero but with the return of what is bought with it. Here the difference works for you. The same offer against an asset that brings in nothing would be very expensive at any rate.
Two investors offer the same amount: one as a secured loan, the other for a stake. Which is cheaper?
It depends on the scenario.
In the good scenario the debt is cheaper: you will pay the interest and stay the only owner. In the bad one the stake is cheaper: there is nothing to pay, and the partner loses along with you. Choosing an instrument is a bet on a scenario.
The seller of a business agrees to take a third of the price two years later, based on results. What does that tell you?
That they believe in their business.
A willingness to stake part of your own price on the future is the most honest evidence you can get. The reverse holds too: a demand for the whole sum in money at once is worth treating as a signal of its own and checking more carefully.
In short
When your business needs money, there are no wrong paths — there are different prices. The cheapest money is given against collateral and against revenue you can understand; the most expensive against a promise. Compare the interest on a loan not with zero but with how much what you buy with it will bring in. If the flow of income cannot be predicted, it is more honest to take a partner for a stake than to take on debt. And agree it all in advance: when money is needed urgently, that is always visible in the price.
Reading is half the job. In the academy this chapter is worked through by posting entries: you run the operations yourself and see whether the balance sheet still balances.