Unlocking the Secrets of Startup Financing | The Paintbrush Loan

Join Stephen, CEO of Paintbrush, as he offers invaluable insights into various funding options available for new businesses. From angel investors to credit card debt, factoring, inventory financing, and revenue-based financing, he highlights the importance of shopping around for the best rates and understanding loan terms beyond just interest rates, such as origination fees, prepayment penalties, and term lengths.

Stephen also shares details about Paintbrush's unique $50,000 startup loan with a non-punitive workout program for defaulting founders, providing new entrepreneurs the flexibility to manage debt while taking necessary business risks. Tune in for these insights and more to successfully navigate the financing landscape for your venture.

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This conversation has been edited and condensed for clarity.

Stefanie: Today, I'm chatting with Stephen, the CEO of Paintbrush, about funding options for brand-new businesses. Let's dive in. Stephen, welcome; we're excited to have you on the show. So, to kick us off for someone starting a brand new business today, what are the different ways that they're funding their businesses?

Stephen: I appreciate the opportunity to speak here. The lack of viable funding options for startups is what inspired me to establish Paintbrush. Let me explain some of the existing options and why they're not the best fit for most businesses.

Firstly, many startup events recommend seeking out angel investors. While not all angel investors are unfavorable, and we do have some at Paintbrush, it's important to remember that this approach only works if you're building a business that can have a liquidity event within 10 years or a secondary event in five to ten years. For the majority of businesses, this isn't the ideal path for financing.

Another common advice given at these events is to accumulate credit card debts from companies like Chase, Capital One, and AmEx. However, many entrepreneurs are unaware that these lines of credit are fully accelerated on default and come with hefty fees. They are designed to cover monthly expenses, not core costs like payroll, rent, and insurance. Moreover, despite the company name being on the credit card, entrepreneurs are personally liable for the debt, posing a significant risk.

Some founders resort to borrowing money from friends and family, which is also high-risk unless they are prepared to lose their money. Others have refinanced their homes, used their home equity line of credit (HELOC), drained their 401k, or emptied their savings. These options, in my view, are quite awful.

Venture capital is another route, but it's only suitable for venture-backable companies, which are very different from most businesses.

Recognizing these challenges, we established Paintbrush to offer a friendlier alternative. We provide a $50,000 loan through our partner bank, along with a non-punitive workout program in case of default. This allows founders to pursue their dreams without the excessive risks associated with traditional financing methods.

Stefanie: You said a few things there that I just want to dive into. So, angel investors. I just want to think about this audience and everyone listening and dive into that a little bit. So one of the things that was just brought up is the idea of a venture-back company versus a normal business.

I think, as small business owners, we need to be really aware that angel investors are for big exits. If you aren't building a company that could potentially exit for a billion dollars, angels really aren't a path or option. 

And credit cards, personal savings, 401ks, the thing they all have in common is personal guarantees. One thing I really like to emphasize in small business lending is that while it's called small business lending, almost always, there's an element of the individual being on the hook for these things. As you said, the credit card might say your company name, but in the fine print of that credit card the company underwrote based on your personal credit. You're generally personally liable If the business doesn't work out. It doesn't mean you just get to cut that credit card up and pretend like it never existed. It's a real thing, a real commitment.

Stephen: Not only is that true for credit cards and most business loans; it's also true for the SBA loan. So the preferred and approved endorsed loan style of the federal government has secured interest on all the assets of the company, often has secured interest on the assets of specific assets of the business owners, and has joint and several liability for the business owners. Meaning if you and I each own 50% of ABC Co and we have an SBA loan together, we default on that. I owe 100% of the unpaid balance of that SBA loan and you owe 100% balance on the SBA loan, and they're going to pursue every which way they can to get repaid on that. Now that's not an awful thing. It's a great thing because SBA allows people to get financing pretty early, usually 24 months after a healthy P&L start. But it's not a free pass.

Stefanie: Let's talk a little bit about the SBA because I think it's interesting how it's often pointed to as the solution, especially for underserved small business owners. For the reality of the SBA I think it's only 11% of business loans are SBA loans and actually, I think it's under 4% are funding women and minorities. When you really dive into it, when the SBA is great if you can't get anything else, but it shouldn't be the starting point.

When you really look into the details of the SBA, it seems like the biggest beneficiary is actually the banks, not the small business owner. It's like even though there's a lot more paperwork because the government's backing the loan, they aren't out as much.

Stephen: I'd like to add another perspective. Government initiatives, such as those from the SBA, while well-intentioned, inadvertently discourage banks from innovating with other financing models. It's similar to how Freddie Mac and Fannie Mae prefer the 30-year fixed mortgage. While this is a great way to finance a home, it discourages any form of creative or individual case thinking outside of that model.

The same applies to the SBA. When you approach most banks for a commercial loan, their go-to option is an SBA-backed loan. This is because it significantly reduces the bank's financial risk if the loan is endorsed by the SBA. Consequently, this eliminates any incentive for the bank to consider more creative financing solutions. As a result, entrepreneurs are left with limited and often unsuitable funding options.

I think that Paintbrush just absolutely would not exist if bankers were more creative in the way that they tried to finance real estate companies.

Stefanie: When we discuss traditional loans, we're typically referring to commercial loans from banks or SBA loans. However, due to the regulatory environment banks operate in, their ability to be creative with financing options is limited. We often hear from banks that their hands are tied by these regulations, which unfortunately leaves many potential borrowers out of the market.

That being said, there are certain types of businesses that are well-suited for conventional loans or SBA loans. For instance, brick-and-mortar businesses that have tangible assets, such as a commercial building, can leverage these assets to secure a loan.

Another category that fits this financing model but is often overlooked, is franchising. Many franchise concepts are pre-approved by the SBA, indicating their financial stability. If you're considering entering a franchise, it's worth looking into those that have this pre-approval, as it increases your chances of securing the necessary funding.

Lastly, if you're planning to purchase an existing business, traditional loans can be a viable option. Banks can use the financial history of the business to structure a loan. So, while traditional loans may not be a fit for everyone, they do serve a purpose for specific business models and situations.

Stephen: Another significant factor to consider is the operating time of your business, which often poses a stumbling block for many business owners seeking an SBA loan. Most banks advertise a requirement of 24 months in business. However, this doesn't refer to the date you registered your business with the state; rather, it typically means 24 months of generating revenue. This allows banks to gauge the predictability of your expenses and revenue.

The upside of qualifying for an SBA loan is that the interest rates are usually favorable since these loans are backed by the federal government. This backing makes banks more willing to negotiate the interest rate. If you're eligible for an SBA loan at one bank, it's in your best interest to shop around with several other banks to secure the best deal. You'll find that they're often willing to lower the interest rate or extend the terms of the loan if you qualify.

So, if you meet the criteria for an SBA loan, it's certainly worth exploring. The only thing you stand to lose is time, but the potential benefits make it a worthwhile endeavor.

Stefanie: Absolutely, traditional commercial loans and SBA loans do offer the lowest interest rates. However, they're accessible to a limited number of people. These products were designed for a market that's considered low risk from a lender's perspective.

When it comes to interest rates, negotiation is a crucial aspect often overlooked. Many borrowers feel grateful just to secure a loan and don't consider the possibility of bargaining for better terms. A recent insight I gained is that banks often desire your deposits when you're shopping for loans. They use these deposits to lend further. This can be a bargaining chip for small business owners. By offering your deposits, you may negotiate better terms or rates.

Discussing traditional paths, it's clear that they don't cater to everyone's needs. In response, we're witnessing a surge of innovation in this sector. You're likely more familiar with the innovative trends in small business lending than most. I'm keen to know what you've observed as innovative solutions within technology or banking that small business owners should consider?

Stephen: I've noticed some intriguing developments in the financing of specific items. There are numerous factoring options if you have an invoice. If you possess a purchase order from a customer and want to advance potential revenue that might be weeks or even months away, there are numerous fantastic tools available to help draw that revenue forward to cover current expenses. The sheer variety of options means you should absolutely shop around to find the best solution.

Inventory financing is another area seeing growth. If you have the inventory you believe can be leveraged for finance, there are options available. Revenue-based financing is another emerging trend, offering alternatives that didn't exist just a few years ago.

We're seeing a lot of innovative solutions tailored to specific industries. If you're running an e-commerce business or a trucking enterprise, there are financing companies dedicated to serving your needs. These niche-focused lenders often understand your specific requirements and can provide exactly what you need more swiftly.

While banks are open to everyone, they may not fully grasp the intricacies of your business or industry. This is where many online lenders are stepping in, offering more specialized understanding and solutions.

Stefanie: So it sounds like what you're saying, and the advice you're giving is to know your industry, and when you're going to do Google searches, try to search for capital either specific to the industry you're in or specific to what you're trying to get funding for, like equipment, inventory stuff like that.

Stephen: My advice really is just to shop, just shop. Like it's exciting to get an offer from a creditor, but if you're eligible for one, you're probably eligible for a lot of others, and you just owe it to yourself to absolutely shop. There are so many lenders out there who are offering a merchant cash advance, for example. It's really hard to figure out exactly how much those costs and the reason is that they cost a lot. It's just an extremely high APR rate.

Stefanie: You've touched on an interesting aspect of small business financing that I enjoy discussing – interest rates and the cost of capital. In the realm of small business lending, there's often talk about predatory rates. This concept struck me when I first became a business owner. I was told that the cost of capital is high, but this is primarily because we tend to compare it to our personal finances.

Before we become business owners, we are consumers with a limited understanding of business finance. We usually compare business loan rates to those of student loans or mortgages, which are historically low due to government backing or market conditions. This comparison often leads to shock when we see the higher rates associated with business loans.

However, an early advisor explained to me that the difference lies in the potential return on investment. With a business, you could potentially turn $10,000 into $100,000 in monthly recurring revenue - something rarely achievable elsewhere. So, the cost associated with that potential growth might not be as daunting when viewed from this perspective.

Still, I'm curious to hear your thoughts on how you perceive interest rates in the context of business lending.

Stephen: It seems that mortgage rates are the only ones many people keep track of, likely due to their visibility and general discussion around them. However, business loan rates are considerably higher.

It's crucial to remember that the interest rate is just one aspect of a loan. Other factors like origination fees, prepayment penalties, and the loan term length are equally important. In my opinion, the term length should be a top consideration for business owners. A low rate with a short term might not provide enough time to effectively utilize and reap the benefits from the borrowed capital due to high monthly repayments.

Many business owners might find it more advantageous to accept a higher rate with a longer term, which would spread out the loan repayment into more manageable monthly amounts. I've advocated for offering a five-year commercial term loan, which was met with skepticism from many banks. They found the notion of offering a term longer than 24 months for an early-stage business almost comical. However, from a business owner's perspective, a 24-month commercial term loan can be impractical. The high monthly repayments leave little room to invest the borrowed capital productively.

While the top-line rates might shock those unfamiliar with commercial loans, it's important to consider what they aim to achieve with the borrowed funds and understand the other terms that could impact how they deploy this capital.

Stefanie: I love what you said about prepayment penalties. If you have a business that is going to generate cash really quickly, negotiating hard on getting no prepayment penalty, it can wipe out your interest rate. If you're allowed to pay it off, who cares? I was able to negotiate with a bank to have six months of interest-only payments, which can really help in the early days of a business too.

Stephen: Indeed, one of the benefits of debt financing is its negotiability. Both of us have raised venture capital, and once those documents are signed, and shares exchanged, the terms are set in stone. However, with credit, if your lender is satisfied with your repayment pace and the state of your business and industry, you can renegotiate. You can propose new terms, or even shop your loan to other lenders who may offer a better rate. Debt is much more fluid than equity in this respect.

It's also important to remember that there's no absolute good or bad when it comes to interest rates. It's all about what works best for your specific situation. In some cases, accepting a higher interest rate might be the better option, especially if there's no prepayment penalty and you expect to pay off the loan quickly. This could end up being cheaper than a lower interest rate with a prepayment penalty.

There are also options like variable interest rates and warrants, which add another layer of complexity to the mix. The intricacies of finance can indeed get complicated. At Paintbrush, we strived to simplify our contract to the point of being uninteresting, simply to make it as straightforward as possible for our clients.

Stefanie: I love that. Let's talk about Paintbrush, because I think it's interesting. You guys are in this space doing something new and creative. Paintbrush does $50,000 startup loans, but tell us more. Tell us the details, tell us about the boring contract, and how do you guys approve people? What does it look like once they get approved?

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Stephen: I'll start with what the loan is. It's the Paintbrush loan. It is originated from our partner, bank Continental, and we help facilitate the approvals through that partner. What we look for is people with a good credit score, with a good income history. They need to have incorporated; they need to have a commercial bank account, just the basic setups of that business. The outcome of that is we're not looking through a business plan or P&Ls or bank statements or anything like that. That means we can approve loans for a business that was incorporated yesterday.

We are just so, so much earlier and faster than anyone else on the internet. The loan is only $50,000. We don't offer above that or below that. That might change in the future, but that's what we're starting with. $50,000 tended to be a number that came up a lot as we were talking to customers about exactly how much they needed to get off the ground, how much they racked up in credit card debt to get off the ground, how much they borrowed from friends and family to get off. That tended to be a good number.

Our APR is 15%. That's for everybody who is approved on our platform. The term on that loan is five years. There's no origination fee. There's no variable interest. You pay the exact same amount every month from month one all the way through month 60. My goal was to make it really, really easy for a business owner to understand what they were signing up for and how it affected their ability to perform at their company. If you know exactly how much you need to allocate every single month to manage the repayment of that debt, I just think it makes it so much easier to plan out your other expenses.

Our application takes less than 10 minutes. We've seen people end-to-end apply and are approved in six minutes or less. We just need basic information Your SSN, your EIN, your address, your other business owner's information, birth date. It's very basic information. We run that through a fully automated process that we purpose-built for this exact type of loan. Then it's approved instantly. For most approvals, we get you a decision in a minute or less. So everybody that we approved every day gets batched up, and our bank originates and wires out that money the next day. 

When we're done with that, then the last thing that's really important for this conversation is the personal guarantee. We created a wholly new type of personal guarantee structure. It's what separates Paintbrush from any other type of loan available anywhere in the world, and we're extremely proud of the fact that it allowed us to unlock capital at day zero for small businesses without punishing them and sending them to collections or bankruptcy.

And the way that works is, if you fail to make a payment on your Paintbrush Loan at any point in time, we can move the repayment of the loan to the founder personally and create repayments based on how much somebody is making personally. So if you're out of work, we pause repayments until you're back making income again. If you're making a ton of money, you're going to pay a lot more. It would probably be better for you just to keep paying the loan off under the commercial term loan, but it's a structure that allows us to be flexible with people as they're working their way out of a business that doesn't survive and back into W2 employment or their next startup. I think it's extremely innovative. I think it's going to change a lot of people's lives, and it's not going to unduly punish them the way that credit card debt or wiping out your life savings would do to start a small business.

Stefanie: Yes, I really like that, Stephen. A couple of things that stand out to me about what you all are doing that's so cool is that I think $50,000 feels like a good number to take a risk and for people to bet on themselves, right? Yes, it's that right number to be like, I'm going to quit my job, and I'm going to try and do this thing. But it also gives them that backup plan because the reality is not all businesses make it. A lot of them do fail, and instead of like shying away from that, you all created a solution that embraces that, and so it's like this idea that you know I love.

This line is like the business failed, but the person didn't. They still took a risk on themselves, and they have a path to pay that off, but at least they don't live their life wondering what could have gotten like they went and tried and did the thing like I think that's really cool. And then just the straightforward payment plan. I think like I can't even emphasize enough, like five years for $50,000. It's a really big deal.

Stephen: I wanted to do eight years, by the way, but the best I could do, was five years. I'm hopeful that down the road, we'll be able to stretch out even more.

Stefanie: Right, because a normal commercial loan from the SBA is going to be seven years, but you know, we're talking $300,000 to a few million dollars over seven years.

Stephen: Those are for businesses that are already many years in revenue, have a lot of inventory, and have a lot of assets. Like those are not startups anymore.

Stefanie: Right. So I want to ask you about one scenario with Paintbrush. So say I'm a startup founder, I'm going to do something venture-backed, and I get your $50,000 loan, and in four months or in six months, I raise a pre-seed $2 million round. What do I do with the loan?

Stephen: This has already happened to us. We already have customers who have done this. They can do whatever they want about it. So we've had founders who have said, like, you know what? I'm just going to pay off the entire rest of the loan from the proceeds of this, and because the Paintbrush loan does not have a pre-payment penalty, there's no punishment for just closing out your loan early.

And if that's a good option for you, do it, absolutely. When I was figuring out exactly how to structure this loan, I talked to a lot of founders who were in the middle of Y Combinator, and you might not be shocked, but I was shocked to find out that even in Y Combinator they're racking up credit card debt, and accepting that their venture investors will bail them out of that credit card debt after demo day. So you know it's not like hundreds and hundreds of thousands of dollars, right, but I even heard people that were up to like $150,000 in credit card debt spread out over multiple credit cards and multiple failures that they expected just to pay back.

I think that the credit card industry is probably the biggest venture investor in the world. They just don't realize it, and they're taking any equity for it. And so, you know, that's just a well-laid path that VCs already understand. They understand that there's credit card debt at that early stage that they're going to be paying off.

But if they want just to keep paying off the loan slowly, they're more than welcome to do that. The other thing I would advise people to consider is just starting more aggressively paying down debt instead of paying the bare minimum of principal interest every month. Double your payments. If you have the capacity to work through your debt more quickly and you want to kind of balance out your risk, that's something that we're very well capable of taking off your hands.

So the truth is like the whole goal of Paintbrush is to let it be in the hands of the founder. I believe they can run their business a lot better than I can and a lot better than their VCs can. So give them the option to make the decision. Pay it off, don't pay it off, etc., and the last thing I'll say about that is we don't have any conversion. So this is not a convertible note. This is not an equity instrument. We're not taking shares. There are no warrants, and there's no right to purchase any kind of stock at any point in time with the Paintbrush Loan. I think that's extremely high value-added compared to all of the other financing out there.

Stefanie: That's amazing. I've learned so much today, and I feel like my biggest takeaway, specifically with the Paintbrush Loan, but really all loans, don't get hung up on the wrong thing, which is oftentimes interest rate, and it's because we relate it to mortgage interest rates. But it's all those other terms because I think about all the terms you just listed for the Paintbrush Loan, and those are also favorable to that founder, to that business owner, and creates that flexibility for them to chart their own course, absolutely.

Stephen: We're called Paintbrush because we think we're a tool for founders to create, and giving them the flexibility to do that meant that we had to take a haircut on a lot of things that we probably, economically, should be doing but we just feel very, very strongly that there ought to be a new path for founders at day zero to go up and get started and retain that kind of that ownership of that creativity to let them do what they do best.

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