When I was at the cusp of starting Lattice, the first question I faced was “What should we do?”. On its heels came the question, “How will we sustain ourselves?”. In the short term, we needed sufficient cash to get to break-even.

The initial investment required to break-even — and consequently, the financing options available—depend on the nature of the business.

I have worked in three distinct types of business:

  1. Selling knowledge and skills: The team’s knowledge and skills are the service, as seen in consulting firms or solution development companies.
  2. Selling a product or service that utilizes available knowledge: Most businesses fall into this category. They apply what is known to develop and sell a product or service.
  3. Selling a product or service that utilizes newly discovered knowledge: These firms first pursue a discovery, which they then use to develop a product or service. Once the discovery is well-understood, it becomes part of available knowledge (though often proprietary, and limited to the discoverers). Then, this type of business follows the path of the second type of business.

As we move from the first to the second, and the second to the third type of business, the investment needed increases tenfold. If founding a consulting firm takes Rs. 50 lakhs, then a product business can take 5 crores, and a discovery-driven business can take 50 crores1.

While founding Lattice, our first instinct was to start a product business. However, we soon realized that we had access to consulting and solution development opportunities that would generate cash quickly — and place us in a position of strength to purse product ideas2.

Consequently, we were able to start a consulting business with “low” investment — “low” being less than a loan I would take on3 to purchase an apartment. This allowed me to use the same instrument that is used to finance home purchases — debt.

In product/ service businesses, and discovery-driven businesses, the only way to raise funds is to sell equity. Getting equity investors is uncertain. This pursuit takes an entrepreneur’s eyes off their business.

I was glad I could avoid this uncertainty while starting Lattice. Friends and family rallied to our support, and I closed debt funding in two weeks. This approach allowed me to focus my efforts on building the business, rather than hunting for funds. This was a boon — each moment taken away from core business activities is costly, particularly in the early stages of building a business.

I have observed a problematic cycle with equity financing. Initially, entrepreneurs tend to make ambitious promises to investors to secure funding on favorable terms. When the business falls short of these promises, the entrepreneur often needs to seek additional equity financing, committing to even loftier targets. This cycle can quickly spiral out of control.

In contrast, debt is an excellent motivator for fiscal discipline. Debt payback is directly linked to cash flow. And positive cash flow is the foremost contributor to the fiscal health of a business.

My takeaways from this experience can be framed as a set of questions:

  1. Can a low-investment business, launched swiftly, lay the foundation for a high-investment enterprise?
  2. Can the low-investment business be entirely debt-funded? Will the cashflow generated be adequate for repaying the debt?
  3. If my cash flow proves insufficient for debt repayment, does my business even have a viable path to profitability?

Footnotes

  1. These numbers are illustrative only. Readers based in the US can replace “Rs lakhs” with “US$ thousand”. ↩

  2. We actively pursued product ideas for three years, but finally exited the product business in 2018. That journey might become the subject of another essay. ↩

  3. Take on, not qualify for. In other words, a loan amount that I could pay off if I switched to a job. A useful rule of thumb is to limit housing loans to a third of monthly income. The same rule can be adapted to a business loan — limit debt repayment outflow to 25% of monthly cash inflow. ↩