Shark Series: Are You Over Leveraged?

Every entrepreneurial endeavor requires some degree of investment to get off the ground. When a startup founder is just starting to build their company they often look for early-stage investors, sometimes called “angel investors.” These investors specialize in “pre-revenue” businesses. They invest based on the merits of the idea, and perhaps certain qualities in the founder, rather than on the value of their equity as determined by sales and profit margins.

Alternatively, some founders will bootstrap their businesses without the help of an angel, or perhaps seek “friends and family” investments. When founders go on Shark Tank you’ll often hear the Sharks ask about how much money they’ve already raised. If they’ve managed to bootstrap without taking investment, they’ll ask how much of their own money they’ve put into the business, followed up by asking if they spent their own money or whether they’ve leveraged themselves with debt.

What is “Leverage”

The term “leverage” refers to the level of indebtedness a person or company takes on to fund their business’s growth. Leverage can come from consumer debt, second mortgages, or through leverage equity by selling too much off, too early, such that later rounds of pitching are undermined because there’s not enough equity left to sell.

Startup founders must take care of how they leverage themselves. Taking on debt, to one degree or another, is sometimes necessary. Of course, that risk is taken in light of the hoped-for big payday. But if they leverage the company too much, too soon, they end up tying an anchor around the business, so that even if their idea is great—and their product is amazing—the fiscal condition of their company can make it completely uninvestable. Just watch what happened in the “Wisp” pitch in season 10 episode 5.

Creative Entrepreneurs Must Avoid Leverage

When creative entrepreneurs bootstrap their businesses, we must guard against the dangers of leverage—even more than a startup founder. In part, as we highlighted in the last article, there are no big paydays for creative entrepreneurs. There are no angel investors for creatives, and likewise, it would be a terrible idea to ask family and friends for an investment. That means all the investment must come from you, and you alone.

How Much Capital Do You Need to Build a Creative Practice?

When you launch out on your own you’re going to need some capital. At a minimum, you’ll need to be able to pay your bills without a steady paycheck for a while. And so it’s important to consider how much capital you can invest in the early stages of your business. Spend time calculating your base level monthly expenses, and assume that you’ll need to cover those costs, without business revenue, for a least three months—six months would be safer. If you have enough savings, and you’re willing to risk it—then go for it! But if you don’t, or worse, if you plan on funding your startup costs with debt—think twice, or three times, or four, or however many times it takes you to determine not to do it.

Of course, creative entrepreneurs don’t typically decide one day to start a company from the ground up, quit their jobs, build a brand and a website, and begin looking for clients. The typical path begins with freelancing on the side, and then when you start to gain traction or perhaps land your first sizable client, you decide to make the leap.

Hidden Leverage Traps

But there is a serious leverage issue when creatives follow this path. It doesn’t account for the overhead of running the business full time.

You see, in the Tank, when a founder tells the investors that they’ve bootstrapped their business without selling equity, or taking debt, the next question they ask is whether or not they’re working on the business 100% of the time, or whether they have another job. If they do have another job—that’s often a deal killer. That’s because investors know what it takes to run a business, and in the case of the moonlighting entrepreneur those costs are real liabilities, they’ve just been covered by their full-time paycheck. What will inevitably happen, when the founder makes the jump, must be factored back into the overall viability of the company.

When Will You Hit the Leverage Wall?

In the case of creative entrepreneurs, however, when you leap from your full-time job into a freelance practice, you won’t likely feel the impact of over-leveraging right away. The revenue from your freelance income might keep parity with your previous salary, but you still have a lot of work out in front of you to build your business. And those costs are a real liability—you’ve taken on serious leverage without knowing it. Sooner or later your work will slow down. Sooner or later you will have to stop doing productive paid work and spend time on your marketing, your finances, and administration. Who will pay the bills when that happens? Do you have savings to cover? Will you incur debt?

Invisible forms of leverage are responsible for the failure of so many creative practices. A Shark would press you on these kinds of liabilities and weaknesses in your business model—but since you won’t ever face a Shark, you need to do a deeper dive into your business plan, and make sure you’re not tying an anchor to your practice which will eventually pull you under.