Beware the Entrepreneur's Debt Trap

Last Updated Apr 27, 2011 9:04 PM EDT

Today, in virtually every corner of the country, well-meaning bureaucrats will hand out money to people who shouldn't have it. They claim they are offering a lifeline, but more often, it is a noose.

I'm talking about the network of community-lending programs and banks that hand out six-figure loans to new entrepreneurs who provide a business plan and pledge their house (and often that of a cosigner) in return for a start-up loan.

More often than not, those lenders end up saddling applicants with more debt than they need or can afford.

Capital is not the scarce resource that new entrepreneurs need.

The first of many tests of a true entrepreneur is the ability to make something out of virtually nothing. When Aaron and Michael Serruya decided they wanted to set up a frozen yogurt store, they calculated their start-up costs: They needed retail space in a tier-one shopping mall, signage, industrial refrigeration units and inventory, among other things. It all added up to more than $100,000.

Without the money to fund it themselves, they wrote a business plan and approached their father. The senior Serruya didn't hand over a check as most community-loan programs would have done (assuming the senior Serruya would have cosigned); instead, he suggested the boys rethink how they could start the business for less.

So rather than signing a five-year commitment to get a permanent storefront in a popular mall, the Serruyas decided to take a two-month lease on a summertime kiosk. They kept their kiosk simple and bought just the yogurt they could sell that day. The Serruyas quickly paid back the $3,000 they had borrowed from their father and started saving their profits. They tested flavors, customer service approaches and price points. By the time they had accumulated enough savings to open a real store, they had hundreds of valuable lessons under their belt. These would serve them very well when they opened their first real shop.

The Serruyas went on to start Yogen Fruz, which would become the largest frozen yogurt chain in the world.

Ironically, if the Serruyas had gone to a community-loan fund with their business plan, they would have probably qualified for the loan (perhaps with their father as a cosigner), saddling themselves with tens of thousands in debt and robbing themselves of the chance to learn on the cheap. In fact, they might still be paying off the loan to this day.

And this is where too many community-loan "clients" end up -- trapped under a mountain of debt and myopically focused on making the next month's payments instead of experimenting and learning how to succeed in business.

Lack of money is not the reason businesses fail to thrive. More than half of the Inc. 500 -- the fastest growing companies in the United States -- were started for less than $20,000. Facebook was created by investing time, not money, from a dorm room. The founders of Whole Foods started in a garage.

Handing a $100,000 check to a first-time entrepreneur is like giving a 17-year-old the keys to a Ferrari. It's too much, too fast -- should we really be surprised when it all blows up?

Stop polishing that business plan to present to the local community-loan fund and start brainstorming how to lop a zero off your start-up costs. Real entrepreneurs don't get tied into six-figure loans before they have customers. They figure out how to turn water into wine.

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John Warrillow is the author of Built To Sell: Creating a Business That Can Thrive Without You, which will be released by Portfolio/Penguin on April 28, 2011. Order a copy by April 30, and you'll get this $65 basket of goodies for free.
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  • John Warrillow

    John Warrillow is the author of Built to Sell: Turn Your Business into One You Can Sell. He has started and exited four companies. Most recently, he transformed Warrillow & Co. from a boutique consultancy into a recurring revenue model subscription business, which was acquired by The Corporate Executive Board. Watch this video to hear John's thoughts on starting and growing a business you can sell.

    John and his book "Built to Sell" have been featured in CNN, MSNBC, Time magazine and ABC News. John was recognized by BtoB Magazine's "Who's Who" list as one of America's most influential business-to-business marketers.

    John now divides his time between homes in Toronto, Canada, and Aix-en-Provence, France. He is a husband and father of two rambunctious boys.