Talking about bank loans, and a relatively small class of innovative small businesses that are trying to achieve something new and go big with it.
For those businesses, a loan debt is a cash drain that makes it harder for the business to succeed and is typically secured by a personal guarantee and collateral on the part of the entrepreneur who takes the loan, which greatly increases the risk.
Small business administration loans, for example, are very conservative, they do require personal guarantees, and they usually want to cross-collateralize the loan against every other business and real estate the borrower owns, which means they are risking personal financial collapse for themselves and their family, and it will hurt their ability to obtain cash from any other source.
In other contexts, debt is the cheapest financing you can get. If a going concern can get a loan based on inventory or receivables, that is money at 6-8 percent annual interest that stands out for a month or two when needed, as opposed to an equity investor who is hoping for 100% return year after year.
If you are doing a more conventional business such as real estate development, or building out a supermarket, you are a lot better with debt financing than equity financing. Instead of giving away 50% of the business for half a million dollars, you can borrow a million dollars and pay back $1.1 million in a couple years. If the company fails, you are the same either way, $0. If the company succeeds, you now have 100% of a $3.9 million business, say ($5M minus the $1.1m to pay back) instead of 50% of a $5 million business.
One of the biggest causes of business failure is being undercapitalized, it is hard to know how he can say otherwise. When you run out of cash you run out of cash, no matter how profitable your business, how well you are running it, or how much potential it has.
Cuban is right that people greatly underestimate the commitment, hard work, time, and cost of getting into business. If a loan is easy money it can facilitate bad decisions, and you have to pay back sooner or later. That’s true with equity financing or bootstrapping too, but in those cases you don’t have a bank after you.
