Last issue, an anonymous small-business owner wrote to ask PROFIT-Xtra readers:
“Should I put my house on the line to grow my business? I’m thinking of using my house as collateral for a loan, or taking out a second mortgage. It’s a scary prospect, and my wife is quite worried about it, but it seems the only way I’ll be able to finance growth. I want to take my business to the next level, and I’ve already used up my other obvious option—asking friends and family for money. Am I making a mistake?”
Kelly J. Ramsay:
Putting your house, and possibly your marriage, on the line would be too great a risk, and one I would not take—ever.
If your business is in fact ready to go to the next level, then I presume it has a solid track record and growing revenue. If that’s the case, you should be able to negotiate a line of credit from your bank to cover working capital needs. You could also look to outside sources, such as private investors or merchant banks, who may have an interest in investing in your business for a piece of the action.
If neither of these two options is viable, I would suggest you take a step back and ask yourself, “Is the business really ready to go to the next level? Or should I focus more effort on maximizing its potential at its current level?” At the very least, speak to a business advisor who will give you an unbiased opinion.
Alternatively, depending upon the size of your business, you could and should explore the Business Development Bank of Canada and other government-sponsored programs.
Judy Clark, Bortolotto & Associates:
It depends on how confident you are in your business. You also have to think about how confident your wife is. Too much stress, especially financial stress, is really tough on a relationship. Please make sure it is a “team” decision before you go ahead with putting your house on the line.
There may be ways other than asking friends and family. There could be private investors that may be interested. There are a lot of private funds out there waiting to invest. Advertise in business newspapers or local publications “looking for private investor for small business.” You may be surprised.
If you meet the criteria, you may be able to access funding through a government grant. There are many grants open to small business, some repayable, some forgivable.
Above all, if you have the vision for where you see you company growing, write it down! If you can visualize it, it will happen!
Whatever you do, do not put your home on the line for your business. A very good friend of mine did exactly that. He had a structural fabrication company that had enormous potential and quality contracts. Naturally, this type of business involves major overhead. He went to the bank with his contracts, etc., and the bank said they would back him, but not quite well enough to complete the contracts. So he put up a beautiful home for collateral. The time between the supply at the end of the contracts and the payments for the contracts were far enough apart that he could not meet his obligations with the bank. The bank gave him an extension, but it could not or would not extend it to the point he needed.
He lost everything: home, business and reputation in his field. I see him from time to time, and he’s surviving, but he is just a shell of the person he was. Personally, I would not do it myself. Your home is the last bastion for you and your family, and when that is lost you are in the middle of nowhere with nothing.
Jeremy Lichtman, MIT Consulting:
I remember talking to a number of friends in the early ’90s about the “mortgage the house” option for financing a business. Several of their parents wound up losing their shirts in the late ’80s by doing just that. The whole point of incorporating is to try and keep personal finances separate from business.
I would suggest one of the two following options instead:
1. Focus on financing growth internally. By developing the right mix of products and services, and by focussing on slow, steady growth, it is often possible to leverage the cost of growing entirely through internal cash flow.
2. Look for other sources of private equity. This could mean angel investors, or even the bank. If you can prove the value of your company to potential investors, they may bite. And conversely, if you can’t show the value of the investment—even on paper—perhaps you shouldn’t be putting more money into the venture anyhow.
I own an SME in Ontario and have for the last 28 years. Your house will be on the line more than once if you plan on surviving—and that is the kicker. Do your analysis, then take it home at night, look yourself in the mirror and say yes or no to actually doing it.
It starts with you and your wife believing in it, and then there are a hundred other reasons you won’t. But it all starts with you believing in the business model and your ability.
Del Chatterson, DirectTech Solutions:
In my experience, bankers use the house for collateral as a test of your confidence. It’s on their checklist. And I’ve never met a banker who thought it was very amusing to suggest that if he gets my house when the business fails then I should get his house if the business does well.
Only do it if you’re confident that you can manage to pay the loan out of the business, or if necessary from other assets or revenue sources.
Eric Carcoux, MPA Engineering Ltd.:
Like any other business decision, the numbers have to make sense. Considering that mortgage rates are so low, as are home-equity loan rates, the return that you would expect from your investment would likely far surpass the cost of the loan. And don’t forget the tax implications that could somewhat offset the cost of the loan.
If the math works, then I think the likelihood of success needs to be considered. If your business is already doing well, and the loan is for a well-planned expansion, then the risk is low. Go for it!
The final test, which I learned about from a business professor at the University of Alberta, is the “3 S” test. If you are still sleeping, sex is still good and you are still shitting (in cleaner terms, no body-function disruption), then it is a good decision. Go for it—you are not making a mistake.
My wife and I are investing in a consulting company, and we used money borrowed against our house. The 3 S’s are good, and we are prospering from our decision. Go for it!
Wayne Edgar, Trade Exchange Canada:
Before you go to the extent of using your own capital or assets, you should check out other options using OPM (Other People’s Money). Check with private equity firms, existing clients or banks, and see what options you have that don’t directly tie up your own resources.
In the end, if you truly believe in your company and its prospects, then you should use whatever money you have available to put into the business to grow it.
Bill Kennedy, Resources Global Professionals:
Every small business owner has faced that question—if he or she has a house, that is. The reality is that lenders want to see that you have skin in the game, that you are as committed to its success as you are asking them to be. After all, if you can’t convince your wife—or yourself, for that matter—that this is a wise investment, how are you going to convince a banker?
But wait a second; you may be making an assumption. Many people think the bank is their only source of working capital. Wrong! See if you can get friends and business colleagues to sign on as investors or lenders. Check government programs. If you are growing via acquisition, see if the vendor will take back a loan secured by the assets of the business he’s selling. Get creative!
If you must put your house on the line, make sure you have an exit strategy. Put a time limit on the security or build it into a calculation, e.g. when revenue reaches X million dollars, the assets of the business will be sufficient collateral.
For his answer, Bill Kennedy will receive a copy of Firms of Endearment: How World-Class Companies Profit from Passion and Purpose by Raj Sisodia.
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