Should I bet the house?
First of all let’s make a distinction between gambling the equity in your house unwittingly vs. agreeing with a bank that your house is security on a loan.
In the case of the former I’ve seen examples of entrepreneurs using either their credit cards to fund the business or telling themselves that they are making an investment in the business when they write cheques against their mortgage to cover costs of a loss making enterprise. Many do the first example and recover; the latter is more dangerous as you are increasing your debt but have a reducing capacity to pay it back.
But what about knowingly using your house? I’d like to look at how you evaluate the decision as to whether to use your house as security against a bank loan…
Under what circumstances would you be asked to use your house as security?
Well if you want a loan rather than an overdraft from a bank it is not uncommon for them to want security against the monies lent. The most common form of security is a ‘personal guarantee’ which essentially means that any assets you have could be seized by the bank to pay back the debt should you default on the loan.
If you are seeking venture capital investment then investors like to see you have some ’skin in the game’ ie investing some monies into the development of the business at the same time as they are providing the main funds (your previous investments don’t count at this stage as these are essentially sunk costs that have already been accounted for in the growth to date and the valuation of the company). However these sums are likely to be less than 5% of the total funds raised and VC’s know they are asking for a ‘gesture’ rather than a significant investment. It is much less common for VC’s to ask for a personal guarantee.
Is your business worth the risk?
Well at the end of the day we can’t answer this for you but here are a few things to consider….
- if you have a clear budget as to how much income you need to payback the loan and you’ve already accounted for the ‘what if’ scenarios of increased cost but reduced income and you can still see how it will be paid then these are indications that the business is likely to be able to pay back the loan.
- if you are in need of working capital to develop the business to a point whereby the income will start to be able to payback the loan but at the moment you can’t see what the revenue stream or scale of income would be that would have this capacity then you are considering taking on a debt without a route to payback and this is more risky.
- if you have other sources of income and or savings and investments that you could use to payback the loan if the business was not able to then whilst you are still incurring the risk of losing the monies you put into the business but you do at least have a backup plan.
You might also look at the stage of development of the company/product. One key question when considering any investment into the business is whether or not it is sufficient funds to get you to market (and thus achieve income to pay off the investment). Typically entrepreneurs invest at the very earliest stages when the ability to achieve revenues from products and services sold are at their lowest ie when the risks are greatest; furthermore it is all too easy to under-estimate the cost and time involved in getting to market so inevitably there are stressful patches when you need to progress faster than funds will allow.
It is at these points that you need to take a bit of care … as you are likely to feel that ‘if only we had x,y,z’ then everything would be ok … you risk making non-rational decisions based instead on your emotional involvement. To help avoid this scenario again the answer is a budget looking 12 to 36 months ahead where you can see where the pinch points will come and therefore can make plans ahead of time as to how to resolve this … asking for credit from suppliers or for early payments from clients are both ways to avoid seeking loans or equity investment when you are at your most vulnerable!
If you have a partner or other source of income into the household then again whilst you are risking the money you may be able to avoid not losing the roof over your head!
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