The Most Frequent Source of Funding

By Frank Demmler

This past week I ran into Rich Ekstrom, CEO of Demegen, Inc., at the BioBlast gathering, and he brought up this series of articles in our conversation.  My chest puffed up and I prepared to graciously accept his compliments. Instead, he lodged a complaint. He said, “You’ve overlooked the source of capital that I have used to fund each of my start ups, as has virtually every other entrepreneur I know - credit cards!” He added, “At one time I had 120 active credit cards!”

You know, he was right! I have mentioned in passing things like sweat equity, savings, foregone wages, and the like as being the entrepreneur’s contribution to launching his business, but I haven’t probably put sufficient emphasis on the role of personal debt, particularly credit cards.

Some Background

According to estimates of the Small Business Administration, in 2003 almost 573,000 firms with employees were started; almost 555,000 ceased operations; and a little more than 35,000 went bankrupt.  Census data from the same period shows that there were 5.7 million businesses with employees.  A Federal Reserve Board study in 1998 showed that 82.5% of small firms used debt, with 34.1% using business credit cards, and 46.9% reporting the use of personal credit cards.

In the overall scheme of things, venture capital serves only a very small niche of the small business activity. 2,779 companies received venture capital investment in 2003 (Source: MoneyTree Survey by PricewaterhouseCoopers, Thomson Venture Economics and National Venture Capital Association), of which about half were first-time investments.

Bottom line: If you attract venture capital, you are in very elite company.  Conversely, if you are going to start your business, it is extremely unlikely that you will receive venture capital, but it is very likely you are going to go deeply in personal debt to pursue your dream.

Your Creditworthiness

You are going to have to supply the initial funding to your company, by whatever means possible, and that almost always requires some degree of personal debt.  If nothing else, it means that you’ve got to plan for that eventuality.

Let me share a story with you.  I had a friend with a good job, a house, a family and entrepreneurial aspirations.  One day he showed up at my office almost beside himself with anger.  Once I got him settled down, I inquired as to the problem.

He replied, “I went to see my banker, and after all that I’ve done for him, he wouldn’t lend me $50,000 to start my business.”

I interjected, “Whoa! Wait a minute here. You’ve always talked about starting a business, but I didn’t realize you had decided to do it.  Take me back to the beginning.”

“Well, I just had my 35th birthday party and I realized I wasn’t getting any younger. You know that I’ve read books on small business, and every one of them says the older you get, the less likely you are to start a business,” he explained. “So, I got up the next morning, went in to work and quit. Then I went to the bank to get funding for my business. And the SOB said, ‘no.’”

“In fact, to add insult to injury, when he learned that I was starting a business, he converted my home equity line of credit into a term loan,” he continued.


Let’s look at this from the banker’s perspective.

Š      A sold upstanding citizen with a job, good W-2 income, a house and family is a good credit risk.

Š      A person without a job and trying to start a business appears to be unemployed and a bad credit risk.

The former can borrow money within limits. The latter cannot.

It Gets Worse

Not only do conventional sources of debt financing become unavailable to you, but also you will have to provide personal guarantees for any debt financing you are able to secure for your business. Pretty soon after you start your business, between actual debt and other guarantees, you will “owe your soul to the company store.” (Tennessee Ernie Ford, “Sixteen Tons”)

Advice to the Entrepreneur

Caveat: I am not an attorney. Don’t do the following without legal advice.

Š      If you’ve got a job, keep it as long as you can and secure access to as much debt as possible. 

o      If you own a house, establish a home equity line of credit. 

o      Sign up for any credit card that doesn’t have an annual fee.

Š      When you quit your job, try to do all you can to make at least the minimum payments on any outstanding debt. You want to avoid bringing attention to yourself and have your lenders realize you are “unemployed” from their perspective. Some of your loans may have a requirement to report any change in employment status, thus the legal caveat at the beginning of this section.

Š      You cannot let the fear of bankruptcy influence your decisions.

Š      From a mental approach to your business, you’ve got two choices, depending upon your personality:

o      Refuse to accept bankruptcy (and any form of failure) as an option, or

o      Assume that bankruptcy is inevitable, so that every day that you’re not, is a good day.

Š      Have fun!

Frank Demmler is Associate Teaching Professor of Entrepreneurship at the Donald H. Jones Center for Entrepreneurship at the Tepper School of Business at Carnegie Mellon University. Previously he was president & CEO of the Future Fund, general partner of the Pittsburgh Seed Fund, co-founder & investment advisor to the Western Pennsylvania Adventure Capital Fund, as well as vice president, venture development, for The Enterprise Corporation of Pittsburgh.