Startups · Finance

What would you do? Clock's ticking…

Anonymous

July 24th, 2015

Here's your mission, if you choose to accept it:
  • You've borrowed money from friends and family to launch your business.
  • Between loans and personal savings and so on, you have $260,000 in.
  • You have no remaining savings or anything of much value to sell.
  • You haven't got much of a personal credit history, no credit cards, no nothing.
  • Your tax returns from the previous two years show (literally) negative adjusted gross income, because your spouse has a self-funded start-up, too.
  • Your business is bringing in revenue and has been since launching to customers four months ago, and you have a solidly upward trajectory.
  • Your spouse's business is bringing in some income, but not enough to cover all your living expenses and business shortfall.
  • You're, realistically, 2-4 months from your business being cash-flow positive/breakeven.
  • You have bills due at the end of next week, and not enough cash in the bank to pay them.
  • And no, the payees are not willing to be flexible with you. STEEP late fees on the two biggest ones.
  • You work about 80 hours a week in and on the business, and have for the last year and a half, because you have no paid staff and run as lean as you possibly can; which means there's not much time for a side hustle to bring in unrelated income either.
  • You have the possibility of a Line of Credit, but are not sure how long that process will take.
  • And the possibility of a *small* loan from a community lender, but also not sure how long that will take.
  • You have a potential investor willing to give you $20,000.
  • But he wants 30% equity in the business. Non-voting, but 30%.
  • 30% of your LLC distributions, in perpetuity.
  • Note: that $20K is still only enough capital to get you through 1-2 more months -- not quite to cash flow positive unless a rabbit jumps out of a hat or you suddenly have a major surge in revenue growth... which is always possible... but can't be counted on.
  • You've poked around looking for other possible investors, but don't have any other deals on offer.
  • And those bills are due next week.
On the plus side, giving the equity keeps you from taking on additional debt load, which is nice, because you already have a bunch of that. And he doesn't want voting rights or any other control of the business, or to be active in the business in any way.

But on the other hand, that seems like a ridiculously good deal for him and a bit unfair to you.
  • A 30% share would, by conservative revenue projections, result in his initial investment being "paid back" by year 4, and in year five, once your initial loans are paid off, he would get somewhere in the neighborhood of $60K a year from then on, so, you know, triple his money back every year. As long as you have the business.
So:
Do you take the deal?
And if not, what WOULD you do?

--------------------
Just discovered I could edit anonymously, too, to answer some of the questions that have been raised.

Thank you all for your input. Very much appreciated! This has turned out to be a really interesting look at different perspectives.

A couple of additional bits:
• It's a brick-and-mortar business. 
• The bulk of the startup costs were the buildout of the space
• I *had* enough in the initial funds to provide for buildout + a solid six months of operating capital, until some last minute construction curveballs wiped out more than half of the operating capital budget. 
• The landlord provided almost no tenant improvement money because it is a new business and I am a new entrepreneur. We got a REALLY good rent deal - so we more than recoup the initial buildout cost over the five year lease  - they just weren't willing to risk *their* capital upfront. Which I get. 
• The fixed monthly operating costs and bills with fairly-steep late fees are things like rent, utilities, etc. 
• The initial loans from family/friends will be paid off in 4.5 more years, at which point, our cash flow picture changes quite a bit. 
• Not presently taking a salary or any money from the business at all; about $20K from the initial money has gone toward living expenses over the past year.
• The working hours are rather essential; we *have* to be open, and since it's a new business and my baby, I feel it's important for me to be the one doing the hands-on interactions with customers; at least most of the time - plus, as a new business owner, while I have help (bartered for) with accounting and bookkeeping and marketing and some staffing and so on, I'm still learning and growing and shaping policies and procedures and All of the Things.
• But I am working on additional revenue-generating activities within the business that will help; and hopefully soon! 

• And the potential investor rejected offers like a convertible loan, or step-down in percentage after a certain amount of return, etc. - he believes it's going to be a big company and he wants that share of it when it is. While I appreciate the vote of confidence… still feeling a bit not-great about it. If I'm giving equity, I really would prefer it be to someone who brings more than cash to the table. 

But I also didn't realize that the LLC could vote to not distribute funds! Extra thanks to you Paul Bostwick. Neither my lawyer nor my accountant mentioned that. Because THAT helps a bit. I thought it was a given, and as a result, I was worried about my ability to reinvest in the business or to expand. 

Anyway: thank you all. 
Really educational to read all of your input. 


A great idea is 1% of the work. Execution is the other 99%. In this course, we’ll teach you how to conduct market analysis, create an MVP and pivot (if needed), launch your business, survey customers, iterate your product/service based on feedback, and gain traction quickly.

Patty DeDominic Chief Catalyst, Managing Partner at DeDominic & Associates (Also Chief Catalyst for Maui Mastermind and Exec Coach)

July 24th, 2015

20k is way too little for 30% of your business maybe 5%??? You can go to kabbage.com or the local community bank and you could finance your accounts receivable. Thank You, Patty De Cell 805-453-7490

Steve Owens

July 26th, 2015

Are the "STEEP" late fees more than the 20% equity?  If not, then take the STEEP late fees.

Even the worse factoring deal would be cheaper than equity.

Late fees on living expenses should be less than the 20% equity.  

The equity sounds like the most expensive option based on what you have shared.

Call your vendors and tell them your situation - including your personal ones.

Call all your customers and ask them to accelerate their payments.

Go back to the equity guy and tell him 5% for $30K.

Good luck!

Clynton Caines SharePoint Developer at Discover Technologies

July 24th, 2015

It sounds like you already know that $20K is really small for the 30%. The thing that gets me is the 'perpetuity'! Beware of shark.

I would prioritize bills and recognize that though they might be due next week, unless the payees are real loan sharks, tacking on some fees might actually be worth it. Have you considered the break even point if you fail to pay for a few months and the fees multiply? Will it then take you 8 months to break even after paying the outstanding bills + fees? If so, that might be a sound strategy - but only you can decide...

A few things to consider: sites like gofundme/kickstarter/prosper.com, credit cards - though they've really tightened up their lending, other potential investors (you might have a story to tell now that you've got an actual term sheet from one). And as others have said, double-down on the the sales side - maybe even bring on a commissions-based salesperson.

In any case, the best advice might be to take a breather before making your next big move. At 80 hours/wk, you likely need some real downtime - a day of ice cream maybe? dinner and a movie? Netflix? No matter what you do, I'm pretty sure the world will continue to spin - and it will do so well past next week....

Good luck

Michael Feder Founder and CEO at PrayerSpark; Finalist: Global Business & Interfaith Peace Award

July 24th, 2015

Seriously? Have they repossessed your car? Have you been locked out of your home? Has collections come and grabbed your computers? No? You have plenty of time. Focus on the goal, just 2 or 3 months away, as you say. Because if that is true, you have plenty of time. Ignore the static-  plenty of businesses have survived much worse than you are in-  you won't be laying anyone off, or losing key staff-  just damaging your credit while the business ramps up in just 2 months. Right?

Chris Sorensen Startup Executive / Mentor, Expert in Innovation and Product-Market Fit, MBA, MS

July 24th, 2015

I like Clynton Caines' perspective and insights.

At the moment, it sounds like you trying to make critical decisions under high stress - which is always very difficult because we tend to go with our gut (which is often driven by fear) rather than our head or our hearts.

Clynton is right - take a breath and have some ice cream and think about your options "coolly" and dispassionately.

"..unless the payees are *real* loan sharks, tacking on some fees might actually be worth it."

Good point.
The fees are likely to be *much* cheaper than giving up 30% of your company and its income in perpetuity.

I would also ask - if you are "willing" (or forced) to give up 30% equity - how might you get more than $20K value for it - even if it is not in cash?

For example one company I know just hired a very experienced salesman who's last salary was way above the company's ability to pay. They sweetened the deal with substantial equity. Now the new VP sales and founders are clearly on the same side of the issues - because their interests are tightly aligned. This is not always the case with an investor.



Michael Barnathan

July 25th, 2015

You're probably not going to like this answer: Contract work out or pick up a part-time job and work on the business when you can - that would be less disruptive than establishing a $60k valuation on something you've paid almost $300k for and giving away 1/3 of the company at that valuation, which is a move you won't be able to undo. While entrepreneurs need to be optimistic, an objective assessment of the current state of things is also important. Realistically, you're in a situation where financial issues are presenting ultimata that could kill your company. Stabilize that and firm up your financial foundation while you continue to develop your business (albeit more slowly) and seek investment at better terms as soon as you can. Entrepreneurship is a marathon, not a sprint - pace yourself and keep yourself going for the long haul, even if it means slowing down in the short term.

Andrew Lockley

July 25th, 2015

Tell him the deal is dumb because it won't allow the business to take on any future investment. If you're credit report isn't affected, tell the creditors you won't be paying them yet and there's nothing they can do about it so they need to be patient. As long as you communicate and stand your ground nobody ever does anything.

Peter Kemball Member Issuers Committee at Equity Crowdfunding Alliance of Canada (ECFA)

July 25th, 2015

You have elicited a wide range of advice from which you should be able to put together an alternative. The following may help to flesh one out.

Start with the equity, fundamentally the return being sought in exchange for a total loss is in line. Why not counter with a royalty stream on sales with payments of the amount invested once your are above breakeven by the amount of the investment and payment that would be conditional on sales? if the investor is receptive, you might be able to have the investor up the ante to $40K and or sell of your accounts receivable on a short term basis to provide a capital infusion. This coupled with a collaborate delay in payments falling due could get you to where you need to go. 

Steve Everhard All Things Startup

July 29th, 2015

Hmmm. Number 1 rule of any business is "preserve your cash". Your burn rate seems extremely high for a B&M business that is barely off the starting blocks so the first thing you need to take a look at is where the cash is going. I'm amazed that you couldn't see scheduled payments coming to the point that you are a week away and broke. This shouldn't be happening at this stage of the business. 

You need to work with someone who can sort your finances, find better deals for services if necessary and track all of your outgoings. They can also help you negotiate with your creditors. Most folks owed money can be reasonable as long as they aren't lied to and they see a plan to pay them than passes muster. Efforts to reduce overheads will be rewarded with time to pay. Taking on extra obligations/debt is going to kill you given what you have said so far. Lines of credit disappear faster than water in a desert if the underlying plan is wrong.

I must say that both partners in separate startups at the same time is a pretty reckless thing to engage in. Opportunity  aside it would have made sense to get a least one of you on a trajectory before launching the second startup. But you are where you are. As Clinton said (to paraphrase) you need to get some perspective or you are going to run at high speed into a bankruptcy wall, so take a little time now and start to unravel some of the mess. Test your assumptions and evaluate your realistic goals to decouple them from hope. As many people here have said, your goal of break-even in 3 months sounds optimistic given that you can't make rent next week.

If you don't have one, make a plan and sanity check it with someone with business experience that you trust. If you do have a plan, have it sanity checked and update it because none of this looks right from an external viewpoint.

Glenn Donovan Vice President of Sales (fractional)

September 4th, 2015

Okay, so first things first. Get that you are panicking - don't fight me on this, just trust me. Realize that your brain is really bad at creative problem solving when it is full of anxiety and fear. For me, this is crucial when facing the existential cliff hangers running a small business entails. I've learned to keep cool, work on fundamentals and be pragmatically optimistic. 

A few specifics:

Like others have said, I don't see how you go from here to cash flow positive so quickly, if you are in trouble now, why not in 3 months? So, first things first, I'd have a heart to heart with myself if I was you. Is this business viable? Do your projections hold up in the real world? This has to be done in an unemotional, egoless way. One of the things I hate to tell founders, but most find out on their own eventually, is that sheer work is not enough. At a certain point you are pushing air, and getting no closer to break even. If you are not very sure you can get to profitability quickly, given your lack of capital/savings, you may be best off shutting down now. Maybe you can shutter the store (i assume it's a store since you chose brick and mortar) temporarily until you make some more savings. 

And oh yeah, this is a good strategy for the investor, btw. Tell him you'd rather go out of business than sell him 30%. That's negotiating - I'm sure you counter-offered with a better number and explained why and he didn't care. He's making a distressed purchase, that's clever of him. But you you now know is that he's interested in the business. He thinks he holds all the cards but he doesn't realize you could take it away from him completely. 

Sounds hard-ball? That's cuz it is. You aren't negotiating until you say no. He doesn't have to give cuz he thinks you've got no choice. And me? I'd never sell out for that price. 20k is very likely not the difference between you succeeding or failing, not to say the lack of it won't crash you sooner. In fact, what you need to do is open up a broader conversation with him about what you need via this line of dialog. I'll frame it out for you:

You: You don't want to put 20K in - that's not going to make the difference anyway. And I'm certainly not going to give you 30% - I'd rather let the place go under, and with only 20k it will anyway. Now if you want to have a serious conversation about how I get to profitability for a reasonable stake, great. Otherwise it's game over. 

Key to this gambit working is being ready to shut down the business for reals. And given what you laid out above, you should be seriously considering doing that. 

But stay calm. It's just business. You can pivot, you can juke and roll, try everything. I liked the ideas of sharing some equity with select creditors to buy time - not high probability, I realize. Can you get some consulting work of some sort? Is there some part time crap job you could take that would help with the expenses and shorten the store hours for an interim bit? 

Even if you shut it down, stay calm. Don't internalize the failure as about you, simply understand it, learn the lessons, minimize the damage and move on. Or not. I wish you luck.