Consider strings attached
to funding options

Reports in the news media and even fictional dramas on television like “The Sopranos” inform us that the Mafia isn’t what it used to be. That is undoubtedly so, but other criminal organizations have sprung up to take its place. The net result is that if you can’t resist the lure of danger and want to finance your business startup with mob money, it can still be done.

Before you decide to do that, though, you might consider the broader implications of this type of financing.

Mob money provides an excellent example of why the old expression “money is money” is simply dead wrong. All money has a source, a history and some kind of explicit or implicit limitations — also known as “strings” — attached.

True, mob money loaned to a business works as well as money from any other source. But it is almost always accompanied by the implicit assumption that it establishes a relationship that can be terminated only by one party — and it isn’t you.

We often do not consider all aspects of how a business is financed. One of an entrepreneur’s most valuable skills is the ability to focus on what needs to be done. And when a business is starting up, one thing that absolutely needs to be done is to find enough money to get it rolling. Yet we pay a steep price if we focus so tightly on our immediate need that we don’t see what’s ahead.

For all but a tiny fraction of entrepreneurs, the idea of using mob money is never a consideration. Still, the reality of business in a modern world is that most of it involves a substantial portion of OPM — Other People’s Money. And the better we understand it, and the strings attached to it, the better we can manage our businesses.

OPM comes in two basic forms: debt and equity. And although they produce the same effect — money to finance the business — they are very different animals.

The distinctive characteristic of debt is the obligation to repay. Most money of this type supplied to a business comes with a contract that lays out the specifics of how and when the debt is to be paid back. It is important to make sure that the business can support the terms of payback through its profit and cash flow. It is equally important, though, to remember that the borrower can easily end the relationship by paying the debt.

It is also true of debt money that it usually comes with strings of some sort. They may be just heartstrings in some cases, where the entrepreneur knows how hard the relative or friend worked to save the money he is now entrusted with. With a bank loan, the strings are more visible. Many bank loans come with restrictions on your company’s expenses, profitability and cash flow that essentially determine the structure of the business.

That is not the case with equity. Money supplied to a business in the form of equity — that is, the person providing the money gets some share of ownership in the business — doesn’t usually come with a payback contract. The relationship lasts until the shareholder decides to end it.

Even though the equity form of OPM is the least burdensome for a business in terms of cash flow for payback, the permanent nature of equity financing can sometimes be difficult to deal with for a growing company. Buying out shareholders who don’t want to sell, for example, can be both tedious and expensive.

An entrepreneur starting a company should be especially aware of two things regarding any equity shareholders. The first is that if the business is succeeding, shareholders will usually have very little understanding of why the business might need more money in order to grow, or how that need for capital will change the structure of the company. The more you can plan ahead for that eventuality, the happier everyone will be.

The second is that the personal situations and needs of the shareholders will change. Over time, people get sick; couples have babies; and stuff happens. Big, publicly traded companies don’t have to worry about such things, but if these shareholders are your family and friends, you, the entrepreneur, will be expected to accommodate those changes and return all or part of the money invested. A good business plan for a startup will anticipate this kind of cash drain. It is one of the implicit assumptions, the invisible “strings” attached to the money received.

A little understanding of the strings attached to money from different sources will help avoid the kind of financing that provides a constant headache for your business. And, in business, one less headache is a real asset.

James McCusker, a Bothell economist, educator and small-business consultant, writes “Your Business” in The Herald each Sunday. He can be reached by sending e-mail to otisrep@aol.com.