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November 08, 2008

Maybe We Don’t Need So Much Credit

A friend of ours has started a "new economy" business; she makes delicious Vermont brownies and sells them online at vermontbrowniecompany.com.

Lots of brownies made with good Vermont ingredients are rolling out of South Hero to the brownie-starved world. The bad economy doesn't seem to have hurt demand. Equally important, the poor credit environment isn't likely to stifle Vermont Brownie Company's growth. There's an important lesson here for entrepreneurs and for those who shouldn't be trying to rebuild the twentieth century's banking system.

When you order from Vermont Brownie Company (or Amazon.com, for that matter), you give your credit card. New economy companies DO depend on the fact that people have credit or debit cards. When the founders of Vermont Brownie Company go their company kitchen to make brownies, they're not guessing what the demand is and building an inventory that has to be financed. They already know how many orders they've got and for what varieties; they know what fresh ingredients they need (so can buy fresh); they know how much to bake of each (so can ship fresh); and they don't need to finance their receivables: you already paid.

Sure, someday they'll invest in a bigger kitchen and/or shipping facility. They won't have to buy a bigger server for orders, though; they use Yahoo's shopping cart. And they won't have to worry about financing huge inventories of product that may go out of style or be stale. If they decide to pay per click to advertise, they'll know quickly whether their ad cost is higher than the net return – and cash from orders'll pay for the ads. Won't need bank debt for that, either.

The need for capital hasn't disappeared from the economy, of course all us capitalists know that; but a surprising percentage of new companies can start on a small amount of invested equity and lots of hard work and can grow on cash flow generated from operations. Information flow and just-in-time manufacturing can reduce the need for financing directly. Information-based products like software and search, of course, have low cash needs so that's why companies like Microsoft and Google flourish atop mountains of cash rather than flounder in seas of debt. But even very tangible - and tasty – products like brownies can use a virtual store and preordering to reduce if not eliminate the need for debt to fund growth.

Debt financing and outside equity are going to be hard to get for a while. If you're starting a new business, it's worth seeing if you can build a plan whose growth is cash-flow funded.

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