When should a company take on debt to enable growth? Silicon Valley’s longest serving CEO has some answers.
Guy Smith: Hello everyone out in podcast land, welcome again to another episode of the Tough Things First podcast. I’m your guest host today, Guy Smith. And as always, we’re having a little sit down chat with Silicon Valley’s longest serving CEO, Mr. Ray Zinn. How are you today, Ray?
Ray Zinn: Trying to stay dry, Guy. How are you doing?
Guy Smith: Well, it’s warming up nicely out here, and boy I am aching for spring, that’s for sure.
What I want to talk about today, a subject dear to my heart, managing debt and managing growth. Founders in startups face an interesting inflection point during their growth cycle. It’s real tempting to go out and score some debt in order to try to rise up to the next level of growth, certain investments that need to be made around the company.
When should a startup consider debt, when should they just flat out avoid it?
Ray Zinn: Debt never sleeps, it’s going to be there 24/7. When you go after debt is a mater of what your growth needs are, if your trajectory exceeds what your cashflow is. Because often, you can grow through cashflow, if you’re profitable, and that’s the way I prefer to do it is to be profitable, and grow through profitability. But, if you’re growing faster than you can grow through cashflow, then debt is fine, presuming that you can fund the debt.
In other words, debt is something that has to be paid every period, whatever that period that your lender sets or you agree to, so that’s the key. The key is make sure that whatever debt you take on, that you can make those regular payments on that debt.
Guy Smith: Are they any inflection points where you think, in a startup’s life, where debt is truly critical? For some of the startups that I’ve worked with in the past, there often comes a time where they’ve been able to have a growth spurt by taking on a little bit of debt, and using it to either bolster their manufacturing, take care of certain infrastructure needs, hire some really new and unique brainpower. Are there any inflection points that you think are appropriate for using debt?
Ray Zinn: Well, anytime you’re introducing a new product, there’s going to be additional costs upfront to do that. So, whatever you’re developing a product that’s not been mature enough to start generating reasonable cashflow, that would be a decent time, or considered a reasonable time, to take on debt to cover the development of that product. You’ve just got to make sure that product actually flies, because when it comes time to start paying down that loan, you’d better have the cashflow to do it.
The key is to make sure you can always make your payments on that loan, because that’s the surest way of ruining your credit. The word gets around. I guarantee you, you miss a payment, they’re right there and you’re going to hamper your ability to again get additional funding.
Guy Smith: Well, I can see that because if you’ve missed a payment, that’s going to show up in the corporate credit reporting, your vendors are suddenly going to be alerted to the fact that you’re not meeting up to your obligations. It could infect your entire product chain?
Ray Zinn: Exactly.
Guy Smith: Yeah. What other trade offs should founders be thinking about when they look at debt? You just mentioned one. What are some heavy, weighty things that debt might do to the company, in general, and need to be brought in as part of the calculus before one goes into debt?
Ray Zinn: That’s why a lot of companies look for equity financing as opposed to debt financing, because the startup costs for a new product are quite high, and can be quite high, and it weighs heavily on the company’s cashflow. That’s why they do go after equity, as opposed to debt.
So, it depends upon what kind of product line, what kind of corporate structure you have. Your mission of your company will define whether or not you want to go for equity financing versus debt. That doesn’t mean their requirements are not going to be the same, it just means that in equity financing, which is … You refer to it often as VC funding, is you don’t have to make the payments, there’s no payback. I mean, you’re going to have to meet the obligations that you’ve projected, so while they won’t foreclose on you, they won’t punish in the sense of, “We’re going to call in your loan,” because it’s equity and not debt. That’s why many companies, if they have a huge upfront cost to launch themselves, go for equity versus debt.
Now, when you give up equity you’re giving up ownership, and that’s the thing you have to remember is, what’s more valuable to you, ownership or the viability of the company? It’s a very calculated game you have to play, to decide whether or not ownership’s important, or whether you want just to get the company off and running.
Guy Smith: To me, that would be the biggest controversy that I would face is that if you give away too much of the equity you, in effect, give away control of the company. In that process, you can no longer guarantee the success of the company, if you’re not in control of it, regardless of the amount of debt you may or may not have.
What happens to a founder if they take the plunge? They say, “Okay, we’ve got a new product launch,” or, “We have this new strategic initiative, we’re going to take on some debt.” What happens when they take on that debt, and that new revenue doesn’t happen? What are their escape paths, at that point?
Ray Zinn: Well, if you need to renegotiate the loan, which is possible, the covenants are going to be more onerous. Or, you can go and get equity financing, and use that to pay off the debt. I’ve seen both happen, both ways, both renegotiating and also just refinancing through equity.
Guy Smith: Well, that’s a good point. I wish founders had more options than that, it seems that it’s a little too narrow in terms of what they can do, in terms of getting money in order to achieve that growth without building a trap for themselves underneath.
Speaking of avoiding traps, for the founders who are listening in today, by all means get a copy of Ray’s book, Tough Things First. There is not a better end-to-end treatise on the entrepreneurial life, the leadership in business, how to manage and operate your company growing forward. That book, more than anything else I’ve ever read, is going to help you avoid many of the traps and the pitfalls that cause startups, frankly, to fail. It will be the best investment you can make in yourself and your company, going forward.
Guy Smith: Ray, before we takeoff for the day, what else would you like budding entrepreneurs to know about managing debt and growth? Because you had 37 years where you grew a company quite well, and you went through various cycles of obtaining debt and getting rid of debt. What else should a founder know before they go any further down the growth of their company?
Ray Zinn: Make sure that you raise enough money upfront, before you start the company, to take you to profitability. Whether it be equity, or whether it be debt, raising enough money upfront is the key, because otherwise you’re going to spending far too much of your time, out there chasing more funding, rather than running your company. That’s my two cents worth.
Guy Smith: And, you can’t build a company if you’re spending all of your time in VC offices, tossing pitches onto the desk.
Ray Zinn: Exactly.
Guy Smith: Yeah. Speaking of books, by the way, before we break for this episode of the Tough Things First podcast, as long as the listeners are adding to their reading list, also pick up a copy of Ray’s book, Zen of Zinn. That is Z-E-N of Z-I-N-N.
One of the things that I’m impressed by, by people who run businesses well, is their understanding of people and the interrelationship of various organizations. That’s one of the things I liked about Zen of Zinn, is that it went into quite a bit of detail about what are the interconnected points between management, between employees, between the community, between government, between society in general. That’s part of your job as a founder and a CEO, is to manage these relationships, and you can’t manage them if you don’t understand them. So, after you have finished reading Tough Things First, make sure to get a copy of Zen of Zinn, and add that to your list.
