Financing a hire before the revenue arrives

A hire made ahead of demand has a predictable cash shape: full cost from day one, partial output for months, and a cumulative hole that reaches its deepest point well after the person has started performing. Financing that hole is reasonable. It only works if you have measured the hole first and if the repayment schedule fits the ramp rather than the calendar.

The hole, measured

Gross profit per closed deal is 1,450. The expected ramp: nothing in month one, then 1, 2, 3, 4 deals, reaching a steady 5 deals a month from month six.

Monthly net: -6,116, -4,666, -3,216, -1,766, -316, then +1,134 from month six onward.

• First cash-positive month: month 6
• Deepest cumulative hole: -16,080, in month 5
• Cumulative position at month 12: -8,142

Two things stand out. The business is still behind at the end of the first year, even though the hire has been profitable for seven months. And the deepest point arrives in month five, one month before the first positive month, which is the moment owners typically conclude the hire is failing.

What borrowing changes, and what it does not

Borrow 25,000 over twelve months at an illustrative 16 per cent. The payment is 2,268.27 and the total repaid is 27,219 — a cost of 2,219.

The cumulative cash position at month 12 goes from -8,142 to -10,361. The loan did not fund the hire. It moved 16,080 of requirement out of month five and spread it across the year, for 2,219.

That is a fair trade if the alternative is not making the hire, or making it and running out of cash in month five. It is a poor trade if you had the 16,080 available, because you paid 2,219 to borrow money you did not need.

The scenario that actually causes damage

Now halve the ramp: 0, 0, 1, 1, 2, 2, 3, 3, 4, 4, 5, 5 deals.

• Deepest hole: -32,160, in month 10
• Cumulative at month 12: -29,892

Twice the hole and four months later. With the 2,268.27 monthly payment running, month six looks like this: two deals produce 2,900 of gross profit, the loaded cost is 6,116 and the loan payment is 2,268, for a monthly net of -5,484. The payment alone consumes 78 per cent of the gross profit the hire is producing.

This is the ordinary way a healthy business gets into trouble on a growth decision. Nothing was reckless. The hire was sensible, the ramp was slower than planned by a completely normal margin, and the repayment schedule was set by the lender's product rather than by the ramp. The business is now short every month and the obvious repair — borrow again — makes month seven worse.

Structure the money around the ramp

• Match the term to the payback, not to the hole. A twelve-month repayment against a ramp that reaches steady state in month six leaves six months of overlap. Against a slow ramp it does not.
• Ask for interest-only or deferred payments for the ramp period. Some lenders will; many will not; asking costs nothing and the answer tells you how the lender views the use of funds.
• Prefer a revolving facility to a term product. You draw what the hole requires as it deepens, and repay as it fills. On the plan ramp that is materially cheaper than borrowing 25,000 on day one.
• Avoid fixed daily remittance for this. A daily debit is indifferent to whether the hire has started producing.
• Size to the pessimistic ramp. If the realistic hole is 16,080 and the slow-ramp hole is 32,160, arranging availability for 32,000 and drawing 16,000 costs an unused line fee. Arranging 16,000 and needing 32,000 costs a second application at a worse moment.

The instrumentation to put in place first

You need to know whether the ramp is on schedule by month two, not by month six.

1. A leading indicator, measured weekly. For a salesperson, meetings booked and qualified opportunities created — not closed deals, which lag. For a production hire, output per shift against the standard.
2. A written ramp expectation, agreed with the hire on day one. Both of you should know what month three is supposed to look like.
3. A decision date. The date by which the ramp must be within a stated distance of plan, and what happens if it is not.
4. The cumulative cash line, updated monthly, next to the plan. This is the number that tells you whether you are in the plan case or the slow case, and it is visible from about month three.

Before you commit

• Model the ramp month by month with your own conversion rates, and find the trough and the month it occurs.
• Model the slow case at half speed and find that trough too. Fund against it.
• Check whether the loan payment during the ramp is coverable from existing operations with the new hire contributing nothing. If it is not, the hire is being funded by hope rather than by capacity.
• Ask for interest-only through the ramp, and for no prepayment penalty so you can clear the facility early if the hire outperforms.
• Set the decision date and the leading indicator before the person starts, because afterwards the sunk cost makes the conversation much harder.