I’ve seen this argument from wantrepreneurs, enthusiastic young professionals, jaded middle-aged white-collars, magazine articles, self-help blogs…
What’s the story behind?
There are two major categories one can use others’ money.
1. Operating with negative Net Working Capital
This is Accounting 101:
Net Working Capital = Account Receivables + Inventory – Account Payables
When a firm sells things but collects cash later, the sale proceed is booked to Revenue, Account Receivables, and no cash. If you collect cash at sale at all times, Account Receivables from sale will be zero. So less Account Receivables normally equates happy.
When a firm finishes a product but hasn’t sold it yet, the accountant books the product value in Inventory. Firms must constantly balance between "having stuffs ready to sell when customers place order" and "limit finished goods collecting dust in our warehouse". Entrepreneur school usually teaches Just-in-time inventory, the Japanese process. Technology can help with the fulfillment process. Amazon does. Many orders placed at Rocket Internet Vietnam companies achieve JIT. Theoretically, if you only need to manufacture or buy the product after customers place the order, it’ll be good. That’s theory.
When a firm buys stuffs from suppliers but hasn’t paid cash, the value is booked to Account Payables. Now you can imagine that if you theoretically delay paying for a long time it’ll be good that you’re using resources for your manufacturing for free. Assuming you can pay off the payables when they due, you theoretically want the Account Payables to be as high as possible.
So NWC is the capital of yours but perpetually gets stuck in the process of operations. If you manage to limit Account Receivables and Inventory, and increase Account Payables, you’re using other people’s money.
The latest (in)famous business model that achieves negative NWC is that of Groupon: collect cash first, and pay suppliers (Account Payables) much later.
2. Take advantage of Angel Investors and Venture Capitalists
What most wantrepreneurs more frequently mean by "using others’ money" is starting a company using money from others.
College Entrepreneur schools persuade students to Bootstrap. Bootstrap means using your own money until you hit the upper limit. Why: you control your own fate. Then, funds raising skills are taught.
College Finance schools teach students to invest, invest, invest. Then they discuss Corporate Governance i.e. exercising shareholder’s control power.
Disclosure: I teach both views and set of skills to my MBA students.
Perhaps the most well-known case study of losing power because of giving up control is the struggle between Steve Jobs and John Scully. In 1983, Jobs invited Scully, then Pepsi president, to be the CEO of Apple with the famous quote "Do you want to sell sugared water for the rest of your life? Or do you want to come with me and change the world?" Scully then sided with Apple BoD and removed Jobs from the company Jobs had founded. Apple plummeted to near-bankruptcy under Scully.
In Vietnam, we have had a highly-publicized and sensational precedent.
From my experience with thousands entrepreneurs I have talked to, the majority hate sharing power. I find the pecking order holds in reality, the majority of business owners I’ve met would rather borrow at a high interest rate than selling their stake to outsiders.
Theory of pecking order: firms should use capital in this descending order: Retained Earning, Debt Instruments, Preferred Share, Common Equity.
Still, many entrepreneurs invite investment early on. I detected some common patterns in this group: Western-educated U35 (thus more open to the idea of investment), or work in the Tech industry which enjoys vibrant VC.
In this case, the entrepreneur team bring on the table their own assets: skills (through prior training), experience (including prior entrepreneurial failure), time, network, idea, and opportunity cost. All sum up to some value that is converted to money through the mystical process known as "valuation".
The easiest way to justify this is to assign a value to the working Prototype, or at least a full-pledged Business Plan.
Then the company needs to justify with regulators in its accounting.
Let’s say the company has $10,000 in total asset, but is valued $1 million post-money by the VC. The Prototype and commitments specified in the Term sheet will be worth $990,000 post-money. The excess after booking to Shareholder’s Equity will be booked to Capital Surplus.
In sum, I work with both the argument and the counter-argument on a daily basis in both theory and practice to be any impressed by sheer enthusiasm for the sake of arguments. But an occasional good fund raising pitch always sparks a delightful (and productive) day.
Image source: Dilbert