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Why You Should Never Fund Your Own Inventory

As a businessperson, I consider myself to be fairly conservative.

I was raised to hate debt, to avoid investors, and to bootstrap everything, because it was “safer” that way. I pay cash for most of my investments, and I have always bootstrapped my companies.

The idea of taking on funding, seeking loans, or accepting outside capital always seemed like too much of a risk. I believed that taking on other people’s money could crush you financially if things didn’t pan out.

Now, I realize that type of thinking isn’t conservative, it is just plain stupid.

After spending a considerable amount of time with Tribe Member Of The Year, Clement Wan, plus other investors and venture capitalists, I have adjusted my view on utilizing outside capital. I realize now that, in some cases, it makes more sense to use other people’s capital than it does to use your own, and it may even be more “safe” to do so.

This is especially true in the cases of inventory of physical products. In fact, I would go as far as to say that it is stupid to fund your own inventory once you have proven the concept.

I have learned that you can be safe and conservative while still making smart business decisions, and that utilizing debt can be one of the smartest ways to both grow your business and to protect your downside risk. In this post, I’ll outline my thinking on this.

Only Invest In Multipliers

When you are starting a business, it makes sense to use your own money to fund the business. The Tribe is filled with stories of people who started with $5,000 or less, and now they have multi-million dollar businesses. A $5,000 investment has turned into $100,000 per month or more for many of our members. I’m proud of them. But when I see how they are managing their finances today, I cringe.

This is easy to observe when we look at the potential ROI of your capital.

When you start a business, everything you do has a high amount of unpredictability, and thus a high amount of ROI. Is my product going to be a hit? Is there a market for this? Is the strategy that I am following going to work?

That initial investment in your business, whether it’s $5,000 to buy inventory, or $500 to buy traffic to an offer, is what I would call a “multiplier.” The upside on this investment/risk is exponential. It makes sense to take a $5,000 risk when the upside is $100,000 per month or higher. We have Back Room members who do much more than this.

When we hear stories like this, we celebrate. But below the surface, there is an underlying struggle to breakthrough a plateau. The reason for the plateau is because the entrepreneur stops investing into multipliers.

I work with many business owners who are rich on paper, but have very little in the bank account. The story that I often hear is, “Yes, I’m selling $200,000 per month, but I can’t afford to hire people or to expand, because all of my profits are tied up in inventory. I’m not even paying myself.”

Even Robert Herjavec said at Freedom Fast Lane Live that the #1 thing that people invest in after receiving Shark Tank money is the purchase of more inventory.

I think this is a grave mistake. In fact, I argue that it is a mistake to use your own money to pay for anything that is consistent and predictable, because there are better uses of your capital. If you use other people’s money to pay for your predictable or fixed expenses, then you are free to invest into “multipliers” that have exponential ROI.

Funding your own inventory only makes sense when your product is not proven in the marketplace. Developing a new product or buying traffic to an offer have “multiplier” ROIs. Yes they have more downside risk, but the relative cost to prove them is very low. Risking a few thousand dollars makes sense when the potential upside is many millions of dollars.

Utilizing ROI Arbitrage

Once the product is proven and has predictable sales, your future ROI plummets, and it makes much less sense to fund it yourself.

Here is a phantom scenario for illustration:

Initial product cost: $5,000
Sales potential: $100,000 per month
Assumed Profit: $50,000 per month x 12 months = $600,000 per year
Potential ROI: 12,000%

The potential ROI for developing a new product (what we will call R&D) is extremely high, and we obviously want to put as much money here as possible. This is why part of my Zero To $1m In 12 Months plan involves rolling out as many products as you can comfortably handle. Since we always want to have our own money is the highest ROI possible, it makes sense to put our own money into R&D, because it has a multiplier effect.

On the other hand, once the product is proven and we can predict its sales, the ROI in buying more inventory plummets. For example, if we know that we will profit $50,000 from an inventory order that costs $25,000, then we can assume that our profit is 200%.

Inventory Order Cost: $25,000
Sales Potential: $100,000
Assumed Profit: $50,000
Potential ROI: 200%

A 200% ROI would be amazing in most investment cases, especially when we assume that we will sell this inventory in approximately three months. However, our opportunity cost on this money is crippling, because it could be invested into other multipliers.

Since we know that we have a predictable 200% return, we can easily seek financing and utilize ROI arbitrage to use this to our advantage. 

Even paying higher-than-normal rates vai Kabbage or Lending Club would make sense for us. If we pay an appalling 30% ROI to a site like Kabbage, we still come out on top.

This is why I cringe when I hear people say, “I can’t invest in hiring or education or more products because I just put all of my profits into buying more inventory.”

Once a product is proven, you should not fund your own inventory, because you can predict the ROI, and thus can utilize ROI arbitrage.

How To Best Invest Your Profits

Your goal is to put your money into as many multipliers as possible. A multiplier is something that has an exponential return. If you don’t know if something is going to “work,” then it has a high probability of being a multiplier.

I’m not encouraging uncalculated risk; in fact, I recommend just the opposite. Put your money into multipliers that have a high probability of growing your business, but also have low initial capital requirements (thus giving you HIGH upside with LOW downside risk).

Multipliers include:
– education
– buying traffic
– advertising
– building customer lists
– R&D (new products)
– relationships (events, mastermind groups, etc)
– hiring people
– software tools
– testing new strategies
– testing new channels

Each of these has an initial cost of $10,000 or less. Even hiring someone has an initial cost of just a few thousand dollars (their first month’s salary) to assess total ROI potential. Therefore, these multipliers have high potential ROI, but their initial costs are low.

Spending money to advertise on Facebook might make you lose $5,000. But it also might become your best source for new customers and add $1,000,000 to your bottom line. High upside, low initial cost.

You might lose $5,000 by hiring a bad freelance copywriter. But they also might write the next sales letter that becomes your biggest profit center. High upside, low initial cost.

To re-state, you want as much of your profits to be reinvested into multipliers, because they have the greatest ROI. This is possible if you use outside capital to fund your predictable inventory (or any fixed cost that has an ROI, like buying Facebook traffic to a proven offer). Once a product is proven in the marketplace (or about a year’s track record), you have some degree of predictability, and you should thus use outside capital to fund future orders.

There are many ways to fund your inventory, but my favorite is Amazon Lending, due to the fact that it shows up instantly, comes out of future orders, does not require a personal guarantee, and is low cost. If you sell on Amazon, it would be stupid to not use Amazon Lending to fund as much of your inventory orders as possible.

To illustrate how this may practically look to a typical physical products seller, let’s explore the following example:

If you take a $100,000 loan from Amazon to fund your inventory, you will likely pay between 5-10% in interest. That’s a total cost of money of $5,000 – $10,000 (and you pay it out of future profit!). Instead of paying $100,000 for inventory, you only pay $10,000, because you are utilizing debt.

Initial cost before utilizing outside capital: $100,000
Cost after utilizing outside capital: $10,000

If you would typically profit $200,000 from selling your purchase order, than you would normally stand to see a 200% ROI. But since you only spent $10,000 (the interest paid on the debt), your ROI is now 2,000%!

ROI using your own money: 200%
ROI using someone else’s money: 2,000%

More importantly, you have freed up $90,000 in capital that you can put into other multipliers.

That means that you finally have the capital to launch that next product that you have been considering. Or joining that Mastermind group that you’ve been thinking about joining. Or FINALLY building the list that you have been putting off. Or maybe you can afford to hire a copywriter to put a funnel together for your business.

Or (gasp!), maybe you even can take a larger-than-normal distribution from your company, so that you can finally enjoy some profits or go on a much needed vacation, where you will get creative ideas again.

As long as the sales of your product are somewhat predictable, it makes sense to do this.

Yes, you have a “cost” of $10,000 when you pay back the loan. Your job now is to put the capital that you freed up to good use so that it brings back more than $10,000 in ROI or in total happiness.

With the $90,000 that you have freed up, can you get that to profit more than the $10,000 in “extra cost”?

Could you put that $90,000 into a new product, new funnel, or new advertising source that brought back $10,000 in profit?

Think back to when you started your business. That first $5,000 order was risky. It was scary. It was uncertain. But now it has an exponential return. You’re so glad that you spent that initial money.

If you applied that type of entrepreneurial thinking to the $90,000 that you just saved, do you think that there is a chance that it can bring a $10,000 profit?

Your goal is to put as much capital into multipliers as possible. You do that by getting other people or institutions to finance your fixed costs. You put your profits into growth (business and personal growth).

All money has an interest rate, even if it’s sitting in the bank, because you are missing certain opportunities (opportunity cost). And everything that you do is an investment. As an entrepreneur, every activity that you put time or money into has an ROI. And although it is a necessary piece of the business to get more inventory, it does not have a multiplier ROI.

Managing capital and investing for passive cash flow is one of the main topics inside our The Millionaire Class Workshop. If you’re an entrepreneur who worries that it will all “go away” because you lack predictability, sustainable cash flow, or the financial knowledge to make strong long-term decisions, this workshop is a must-attend.

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