Small Business

Small-Biz Talks: Using Debt as Working Capital

We sat down Leonard Petracci, co-founder of Leo's Books, to get his perspective on debt financing and how he uses loans to help his business expand.

For many people, making money from a hobby is only a dream. Leonard Petracci founded Leo's Books with that exact goal in mind. His passion for writing has transformed into a real money making business.

Similar to other small-business owners, Leo faced a number of problems involving cash flow and delayed payments. Due to the nature of the business, there is a significant lag between the time a book is sold and the time payments come in. Understanding this, Leo quickly turned to debt financing to secure working capital, and to boost his business to a level that most likely would have been unachievable without it.

What is unconventional about Leo's approach is his use of personal loans to move his business forward. Although doing so may not be as common as using a business term loan or a line of credit, taking out a personal loan for business use can be advantageous for those looking for smaller forms of financing.

We sat down with Leo and we were able to walk through his thought process and approach to debt financing. He was able to share his insight and give advice for other small-business owners who are also considering debt financing.

This interview has been condensed and edited for clarity. If you're a small-business owner interested in sharing your funding story, tweet us at @ValuePenguin.

In our initial emails, you cited cash-flow problems as the main reason why you sought out external funding. Can you describe those problems a little bit more?

As an indie author, there's quite a bit of lag between when a sale occurs and when you're actually paid. That lag is usually from eight to twelve weeks. The majority of money is both spent and earned when you launch a new product, meaning this time period can be tight on cash flow. You then turn to financing options if the lag on that earned payment is so long that you don't have enough cash currently rolling around in the bank account. I typically spend tens of thousands of dollars on marketing and promoting. That means that I, a lot of times, will have to take a loan in order to pay that off.

What financing tools are you currently using?

A mix of personal loans and credit cards.

Are those credit cards personal or business credit cards?

Personal cards. As my business becomes more of a full-time effort, I will consider business cards. I'll typically only use credit cards if I know I can pay off the balance by the end of the month, considering the high APRs. If I think I'll carry a balance, I'll then use a personal or business loan. You also have the added benefit of rewards programs with credit cards. If I'm running $30,000 through on advertisements or something like that, that can easily be a couple free flights.

Why did you seek out personal loans rather than a business line of credit if these expenses are regular?

Actually, my biggest expenses are marketing campaigns, and I only do those when I launch a new book—so maybe one to two times a year. There isn't a set amount of time between them, but I usually just use financing to cover me from two to four months. It really depends on how long the cash flow takes to come back. I don't think it's necessary for me to have a full line of credit, as I only usually need it when I go through tight squeezes. As I move forward and start to get larger, that's something I would look into. But really, I'm in between making that big jump and being at the point where I'm still a good-sized player in that field. Just recently I've opened up a line of credit with Kabbage and look forwards to working with them in the future.

What was the thought process in determining whether or not you'd be able to pay these debts back?

Fortunately for me—and I don't know how this would necessarily work with other small-business owners—it worked out because I can see what my sales are, and I know how much I'm going to get; it's just a question of when I'll get it. Most of my business is with Amazon, and while it's not 100% guaranteed, I have a pretty good amount of faith in their system based on past interactions. I can tell how much cash is coming to me, but I have to survive during that delay. Since I'm able to see that number, that gives me a high degree of confidence. There have been times when I might put something on my credit card. Typically I won't get a huge business loan if it's more risky because I'm not going to take out a large amount. But there have been times when I put something on my credit card where I estimate my profits. Again, that's more something where I know that if I go through a couple pay cycles, I'll be able to pay it off with my day job. But it's not something that I would leave myself stranded if it were to go completely south.

Have things ever gone south? Did things ever not gone according to plan?

Absolutely, but I've been extremely careful with my larger loans. There certainly are marketing campaigns that flop, and you don't get your money back. I've had book launches that I've expected to earn several thousand dollars, or a large amount, that earned me $200. Again, I've been smart about the way that I pay those off or that I'd have an emergency fund to cover it. I definitely keep my risks pretty low so I'm not too exposed. Overextending in my opinion is the biggest danger when it comes to debt.

How do you determine if expenses like advertising are a success or not?

The way I determine if it's successful or not is I look at it in time chunks: how much I spend within a certain month and how much I earned back in that month. As long as I'm on a net positive, I'm happy. I really couldn't tell you exactly how effective my advertising campaigns are. It's really tough to be able to distinguish which of my multiple expenses are net gains or not, but I do know whether my business as a whole experienced a net gain/loss in a given month.

Granted, that kind of accuracy is something I want to have in the future for optimization purposes but it's not possible right now with the tools I currently have.

Why did you choose debt financing rather than equity financing?

I definitely see some crowdfunded novels occurring in the market today. I would say, when you look at venture capital, the closest thing I would equate to that in my business—because, again, it's an indie publishing model, where I'm pushing my books—would be a traditional publisher. One of the areas that I pride myself on is that my business is completely done by me. I don't have to go through anyone; I don't have to play by anyone else's rules besides the market's. I absolutely love the independence of it. The equivalent of that with the venture capital is they own a piece of your business. Really, the publishers own a piece of your books, and I want to avoid that. I want to keep my hands free; I don't think that's something I need. So if I were to go that route, I'd have to be selling a piece of me, my books, or my business. I don't want to be owned by someone else.

Also, my only concern with crowdfunding is if a project flops, you are still obligated to get it out there and to produce it. I like to have the freedom where, if something were to flop, I'm not obligated to that crowd to still produce it, if that makes sense. I don't want to be put in a position where I'm spending a ton of my time on very low-profit-driven investments. I want to spend it on the area that people are most interested in, even if there are a bunch of people who have bought in theoretical shares or some sort of crowdfunding situation.

Do you have any regrets about the debt financing decisions you've made?

Absolutely not. It's really what drove my success this year. I've grown multiple times over this year through that debt. It's something, again, you have to be careful with it. But that money is absolutely fuel for growth. If I didn't have that money for marketing, I definitely wouldn't have sold half the copies I did this year. And that was huge; I think it was around thirty thousand copies this year sold compared to maybe five thousand the prior year.

How did you decide how large your initial loans would be?

The scenario I had is, when I first started selling on Amazon it took me about four to five books to get the knack of the market and understand when something is catching on or not. The way that the book market works, typically, is the more you promote, the longer you push, the more you keep that driving flame underneath sales, the more profit a book drives. All books eventually die. No matter how popular the book, eventually, after a couple months or years or whatever it is, it'll drift down and people will stop buying it. You want to prolong that period as long as possible. When I published one earlier this year and it took off, I knew I had to sustain those sales, and that was really my gravy-maker. At that time, when it started hitting very high sales early on, and especially when I knew there was a high amount of interest when it came out, that was when I decided I was going to start pumping money in. The question, as you mentioned, is: how much? How much is it worth to invest? Starting off early, I spent around a third of the amount I earned per day. That way I knew that I would be seeing at least two-thirds come back. So, even if my advertising campaign did nothing, I was still willing to hedge that risk in order to get a longer burn.

Is there anything you're going to do differently for future loans?

I used SoFi last time for a personal loan, and I thought they were great. I absolutely loved how hands-off it was; that was absolutely fantastic. I do anticipate small-business loans and recently have a line of credit instated through Kabbage. In addition, as my product line grows, I can definitely take on more debt that is long-term. I paid off my most recent loan in four months which is pretty quick. That's something that in the future I can avoid, or I don't need to do, because I can pay off those longer loans or lines of credit.

I'm assuming you're definitely not going to explore the equity financing route this time.

It depends. It's like a startup where you look at the valuation. If the startup has a great valuation, and someone approaches them, and they're willing to make a great deal, I think they'd be foolish to overlook it. However, I'm not in a situation where I'm actively looking for investors. If they happen to find me and things work out, great. However, the current business model that I have is working well, and there's no reason for me to hunt them down. One of the biggest reasons why they're able to drive sales through the roof is because they really push lower margins. If I want to retain higher margins, I don't want any of that type of equity coming in. I might look at crowdfunding. But I wouldn't actually do that for the money. It would be more to raise awareness because that is an incredible marketing platform. That would definitely be something where it would be more about getting the word out, as opposed to bringing the money in. I'd definitely use that money, don't get me wrong—it would be great to use it for advertising and to develop the book—but to be able to get on the front page of the site with your book cover on there is a huge thing. If that's a possibility, it's absolutely something I would not turn down and it's worth much more than the cash.

Why did you like SoFi so much?

As a business owner, a few things stood out to me. The application process itself was incredibly smooth, and it only took 14 days. The last thing I want to worry about is having to push my loan application through a bank or lender when I really need to focus on the five or 10 competing products that can kill my product. I didn't take out a huge loan, which probably helped. I also liked that there was no prepayment penalty, and the rates were low enough for me to pay off a $15,000 loan in just four months.

Finally, do you have any tips for our readers?

Don't be scared of debt, just be cautious. I draw a distinction between personal and business life where debt is a friend in business but a foe in personal. This is primarily because debt usually does nothing but make you lose money in your personal life. Unless of course, you're using personal debt to buy some sort of investment that will earn you net gains, such as education or property. But when you look at a business, you measure your risk and use debt to help you make money. Figure out how much risk you can take based on your standard deviation, how much you're making and losing per month. You need to find the balance where you're not taking huge amounts out where you could potentially put yourself under, but you're pulling in enough that it gives you fuel. Test and make sure that the waters are receptive to wherever you're going to be pouring that money in. Experiment before acting.

Justin Song

Justin is a Sr. Research Analyst at ValuePenguin, focusing on small business lending. He was a corporate strategy associate at IBM.