Free Enterprise - Principle 8

Principle 8: When entrepreneurs start businesses they often need to borrow money (capital) and pay it back in small amounts over time.

Most people don’t have enough money (capital) to pay all the costs of starting a new business. In many businesses, the owners (we call them “entrepreneurs”) will need a building, some land, and cars or trucks, office furniture, machines, and the professional services of accountants and attorneys. In some countries, they may also have to pay bribes. All these things add up to a lot of money! They don’t have the money--what can they do?!

The entrepreneurs can go to the bank and apply for a loan. They might get a 5 year, 10 year or even a 20 year loan. The bank asks many questions. Is there a plan for how the business is expected to operate for the next 3 to 5 years? Does it look like the business will succeed? Have all the costs been thought about? Will there be a reasonable profit? Will the borrowers be responsible and pay the money back to the bank? Do they have a personal history of being responsible? If all answers are “yes” the bank will lend the money, and charge interest so the bank can make a profit.

Let’s say the entrepreneurs borrowed $75,000 at 9% annual interest, to be paid back over a period of 10 years. This money gets the business started. But they have to take some of their earnings from the business each month to pay on the bank loan. They have to work hard to make the business succeed so they can pay the workers, buy supplies and raw material, pay the bank and make a profit themselves. They never could have started the business without a loan from the bank. With profit from the business they can pay back the bank each month and still have a profit for themselves.

Story

Allen and Andre had some expenses coming up, but they had no money! There were no banks in their little valley of the plane wreck.

“What are we going to do?” asked Allen in a worried tone. He and Andre both knew they had to be ready to pay salaries, pay for the window plastic, have money to treat customers to gifts, and several other things. If they wanted to be the lead business people, they had to stay ahead of the game. They had to think of business ideas and put them into practice before anyone else did. They wanted to stay ahead. That takes money.

Andre spoke. “We both know who has the money … Sabetha and Marcella! We might just as well change their names to ‘Gold Bars’ and ‘Money Bags’, because they are the closest thing we have in our little valley to a bank.”

Allen laughed, and his laughter brought a grin to his partner’s face. “You are right Andre. We need to go to Miss Gold Bars and Miss Money Bags just like our parents went to the bank back home, hat in hand, when they needed money to start a new venture.”

“Well,” said Andre, “I think it might help if we use their right names—but I agree. We either wait until money falls out to the sky for free, or go for a loan to get our new business started.”

“And you know they will have a lot of questions,” Allen chimed it, “they are going to’ want to know that we can really pull this thing off before they put their money at risk!”

“Can’t say that I blame them,” Andre said. “And besides, it won’t hurt us to have a plan—it is good to know where we are headed—especially using other people’s money that we have to pay back.”

“Right again,” said Allen, “We better be careful. We have to pay all the expenses for each month, and then we have to make a payment back to the BBB! And after all that, I hope we have some profit left for ourselves—that is the point of going into business you know.”

“What is it with this BBB stuff?” asked Andre. “Are you going crazy on me?”

“No, I’m not going crazy,” retorted Allen. “BBB stands for “Bars and Bags Bank!” They had a good laugh, and then headed off to find the girls with the money.

Activity: Get students used to the concept that it takes a lot of capital (money) to start a business. Ask them to guess the cost of opening up a mechanic’s garage to work on cars and trucks. Lead them through deciding the cost of buying or constructing a building, buying and installing equipment in the garage, hiring people, and so on. Educated guesses are fine. Lead them through the cost of starting some other business that might exist in their area. The point is to get them to see that it takes a lot of money to start a business.

Ask: “How many of you have $ ___?___ (whatever amounts the class decided it would cost) to start one of these businesses?” Most likely none will. Ask them: “If you get money from the bank, what questions will the bank have?” Let the students suggest questions the bank will ask. Teacher can write these questions if so desired. Make sure students understand: the bank is protecting itself; it does not want to lose money!

Finally talk with the students about repayment of the loan. Have them guess how much the monthly loan payment is on the mechanic’s garage. After they guess, you can figure it in class with a calculator if you or a student is familiar with using a calculator for figuring amortization schedules. If not, here is the information. The loan amount was $300,000 at 8%, for 20 years: the monthly principle and interest payment to fully pay off the loan in 20 years is $2,509 a month. The total payback, counting principle and interest, will be about $600,000 over the 20 years. This may surprise the students! It is double the amount borrowed. However, you can remind them: “If you don’t borrow money, you can’t start a new business. You don’t start a new business, you don’t make any profits.”

Final point: borrowing money is expensive, but, it pays off in profits if the business is successful!