Wade Armstrong

Stimulus for Startups

Posted Thursday February 5, 2009 in Entrepreneurship

Washington’s all a-flutter over what the stimulus package to help us get out of this economic slump. Is it tax cuts? Infrastructure projects? Bank bailouts? Startups are a unique breed, and need unique tools to drive growth. Specifically, they need cash. Up front.

What Can Startups Do For Me?

Startups don’t have multi-year product development cycles, and they’re not run by people who are so afraid of making mistakes that they never try anything new. Startups are about generating revenue right now, and that means that any new cash is immediately spent on a capital investment that will either bring down costs or on new employees to make and sell new products. That means immediate growth, over the course of a few months rather than the few years that someone like GM can offer.

Tax Cuts vs. Cash Up Front

One of the biggest debates in Washington is whether spending or tax cuts are a more effective stimulus. For startups, spending trumps tax cuts. First of all, startups are always cash-poor, and many can’t afford to take on new projects without having more money right now. But, more importantly, the returns on any new project financed with stimulus cash dwarf the money that could be saved in taxes. Let’s take an example:

My imaginary company FantastiCo makes red widgets. Right now, it makes $100,000 in profit every year. Since FantastiCo is an LLC, all of that $100,000 flows to the owner as ordinary income and is taxed at my rate of 28%. So, I get to keep $72,000 at the end of the year. If we cut my marginal rate to 25%, I only get $3,000 more - and that in a year from now. Suppose we give me that $3,000 in cash now, what can I do?

• I can hire a commission-only salesperson to increase sales, offering a $3,000 bonus for meeting quota. That’s immediate marginal new sales for FantastiCo, plus a new job!
• I can buy a fancy color laser printer, turning out all of my marketing materials in-house instead of using Kinko’s. That will cut my per-page cost from $0.10-$3.00, depending on the service, to about $0.05. Depending on what I’m printing, I can reach breakeven fast and start to invest more of FantastiCo’s revenues.
• I could buy a ton of advertising space online, either search advertising or banner ads. Assuming a 2% conversion rate and a $2 cost per click, I’ll get 1500 clicks and 30 conversions. If I make just $100 per conversion I’ll break even.

The SBA and Cash Up Front

Now, $3,000 would be nice. But there’s a way to get more. The Small Business Administration’s 7(a) loan program guarantees loans made to startups and other small businesses, and has a default rate of somewhat under 7%. Now, if we budgeted that $3,000 for loan guarantees instead of cash breaks, the SBA could make a new, guaranteed $43,000 loan to every startup that comes asking - the cost will be the same. Since I’m currently paying $28,000 in taxes, that’s the equivalent of a 100% tax cut plus a 53% refund. That means that the SBA can, for the same cost as a 3% tax cut, offer every small business a guaranteed loan equal to 153% of their previous year’s taxes. Even if I doubled my profit every year, it would take me until 2014 to make more on that 3% tax cut then on just one year of that 153% loan program.

And what can I do with that $43,000? A lot more than with just $3,000:

• I can pay to add a top-tier salesman who expects a mix of base and commission, with probably much more of a top-line impact on sales.
• I can make a larger capital investment, including many small manufacturing tools or, for my company, a vacuum-sealing tool that would allow us to cook, freeze, and ship an entirely different set of foods that we can’t currently handle.
• A real PR campaign, keeping a couple of PR contractors employed for a full year - that’s headcount directly into the national economy.

For a startup that makes meaningful investments in projects like these, rather than the marginal investments described earlier, increasing sales by 100% or more isn’t just optimistic - it’s standard. Startups grow fast partially because they’re small to start with, and you see fast, hockey-stick growth patterns with virtually every successful startup.

For years there have been questions about whether or not the SBA matters. The SBA made valiant efforts to help after 9/11 and Katrina, but they didn’t really affect the wider economy. This loan program would. It’s time to give startups the cash they need.