Money to start your business--without banks or saving

By Philip Brewer on 27 June 2008 (Updated 26 April 2010) 21 comments
Photo: Philip Brewer

Suppose you and your friends all want to start small businesses.  You've all got money coming in, you're all in a position to save up some capital, but it would take you a year to all save up enough--and you'd rather not wait.  There's a solution to this problem that's so obvious its been reinvented all over the world.

In Mexico it's called a tanda or a cundina.  In Korea it's a kye.  In China it's a hui.  In West Africa it's a susu.  Here's an example of how one works (although the details endlessly variable):

A dozen friends arrange to meet every month for a year.  At every meeting, each one contributes $500.  The pool of capital ($6000) goes to one member, who now has enough money to start his or her business.  The process is repeated each month for a year, until each person has gotten the money.

The person who gets the money is usually chosen at random from among the people who haven't gotten it yet, but that's not the only way to do it.  The members could determine the order based on who is most prepared to get their new business started.  Or do it alphabetically.  Basically, anything they can agree on will work.

The person who gets the money last is perhaps slightly less well off than he would have been just saving the money for a year himself--losing out on the bit of interest that would have been earned--but that's not going to amount to enough to affect the success or failure of the business.  (My financial calculator says that he'd have earned $83, if he'd put the money into a savings account paying 3%.)  Essentially, the last guy comes out even and everyone else comes out ahead.

The generic term for these schemes is a ROSCA--a Rotating Savings and Credit Association.  I first ran across this concept in the Korean version, when I was living in Los Angeles, then started hearing about it other places as well.  It seemed like magic to me:  Everybody comes out ahead!  It was so obviously a good idea, I didn't understand why it was only turning up in immigrant communities.  The closest American analog I could think of is a barn raising (where everybody donates a day's labor against a general community obligation to reciprocate).

After thinking about it, though, I realized that it's really an alternative to having access to banks.  

A scheme like this means that the average participant has to wait 6 months.  The obvious alternatives would be either to just save the entire sum (waiting a year) or borrow the money from a bank (not waiting at all--putting $500 down, borrowing $5500, and paying the loan off over the course of a year).  Assuming that the business is reasonably profitable, neither the interest earned during the year of saving nor the interest paid while paying off the loan would make a difference that amounted to success or failure.  Any of the three alternatives is about as good the other.  And, if all twelve borrow the money from the bank, nobody needs to wait.

If bank credit is unavailable, though, this sort of scheme really shines.

Similarly, if bank saving is unavailable (because the banks aren't safe, or they won't let you open an account because you don't have the right kind of ID), then this is again an attractive alternative to the saving option.  (It's also an effective measure for dealing with other kinds of obstacles to savings, such as family members who insist on immediately spending any money that you put aside.)

Another reason that these things only show up in some communities and not others is that it requires a considerable degree of trust--in the other participants, but also in the community as a whole to provide the appropriate social pressure.  (In some American subcultures, I think any social pressure would be exactly backwards--friends and neighbors would consider someone a chump to keep putting in $500 a month after he'd already gotten his $6000.  Even a whiff of that attitude would make a scheme like this impossible.)

I've written before about how sharing can make everyone better off.  This is a rather different example of the same principle.  Everybody can come out ahead.

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Guest's picture
Guest

At the end of the day, any time you start a business you need to cut down as many of the basic expenses as you can that quickly add up. Anytime you buy anything online, take time to find out the promo codes or use sites like htpp://www.coolestcoupons.com. I found myself spending $120 a month at Starbucks? Also if you use any sort of bank credit, make sure you are only placing things on credit that make money and not things like meals or clothes.

Guest's picture
Guest

I think this is a fabulous way for people to go about getting started with a business and would probably make all those involved a lot more committed to the communities in which they live and operate their business.

I personally wouldn't mind attempting something like this if I had any inclination as to the kind of business I want to start...

America needs things like this to give it more community centered spirit and attitude. Too often we tend to treat our fellow Americans like their the enemy... which is often perpetrated by the stereotypical media showing us how awful we all are...

My question is what are the legal ramifications of reneging on the arrangement in the US?

Philip Brewer's picture

The legal structure of an arrangement like this seems to be somewhat unclear in the US.  I saw one reference to a case that went to court where the judge refused to enforce any obligation, calling it an "illegal lottery," presumably based on the fact that the person who got the money each time was based on a random draw from among the people who hadn't gotten it yet.

That particular issue could probably be dealt with by not having the random draw at the meeting, but instead doing it up-front and making a list of who got the money when.  Of course, knowing that they were going to come last might make the people at the end of the list less interested in participating.  (There would be an up-side to knowing the order in advance, though--knowing when they would get their money would make it possible for members to get the wheels turning on their new business--finding a store front, making arrangements with suppliers and employees, etc.)

It would almost certainly be possible to create a proper legal structure--probably setting the whole thing up as a trust, and having the trust sign a contract with each member.  It would probably also be possible to get insurance for the trust to protect against members who were unable to contribute (as well those who just didn't want to pay their share).

Guest's picture
Dianne

Not to rain on anyone's parade, what if the first person fails? What if they don't make enough in the first month or even the first year so that the next person can have their share of the money (and very few new businesses make money immediately) The failure rate of new businesses are very high, and this arrangement doesn't seem to give protection for that possibility. You could not only end up in Small Claims Court, but also lose some of your friends in that eventuality.

And it's not that I don't believe in communal sharing. I give regularly to Kiva to provide small loans to start ups to people who otherwise might not be able to support their businesses. But that is $25 I can afford, rather than $500 a month! (I'm quoting you: "At every meeting, each one contributes $500.")

I would think long and hard before getting involved in such a scheme.

Philip Brewer's picture

The system has all the risks that you mention.  They loom a bit large, mostly because we're so used to systems where much of the risk has been removed.  I don't personally know anyone who has lost money in a bank failure, for example, but that's due to modern innovations like bank regulation and deposit insurance.  For times and places where the banks were risky, a scheme like this might well be just as a secure as saving the money up in a bank.

It's also a good example of the importance of cultural support.  If this is a familiar system that everyone uses and everyone thinks is important, then coming up short would be the sort of big deal where you could lean on your friends and relations to make up the difference.  Saying, "The check from my biggest customer hasn't arrived, can you spot me $500," might draw just sneers, but saying "The check from my biggest customer hasn't arrived, and I'm due to make my contribution to my ROSCA tonight," might have your family digging into the cookie jar and your employees promising not to cash their paychecks for a few days. 

Guest's picture

Maybe to offset the disadvantage of being a recipient towards the end of list, the amount of each contribution should go up slightly each month. So that way there's an obvious time-money tradeoff. You can get your payout sooner, but you get less. Or get the money later but get a little extra, like a typical interest-bearing product.

Philip Brewer's picture

@George:

Yeah, I thought of that too.  If you increased the amount by just $1 per month (so that the contribution was $501 the second month and $511 in the last month) that would make the last person entirely whole--he could have gotten $6083 by saving up the money in a savings account (assuming 3% interest), but he'll get $6132 this way.  On the other hand, the simplicity and obvious even-handedness of going with equal amounts every month are also an advantage.

There are obviously infinite variations possible.

Guest's picture
Kelja

As someone who has started a number of businesses, I have an ironclad rule born out of experience.

Do not go into business with a friend or family member. It's a recipe for disaster. You will most likely end up losing a friend or becoming estranged from a family member.

Philip Brewer's picture

@Kelja:

Throughout most of history, all over the world, family enterprises have been so normal and natural that it's only been in the past few hundred years that it was even possible to do otherwise.  Whether the business was a farm or a mill or a shop, the (male) head of the household owned it and everyone else worked in it.

Families have had business disasters throughout history, of course, and they often caused family estrangement to some degree.  But, because almost nobody was rich enough to just say, "Screw this--I'll strike out on my own," families usually worked things out.

Guest's picture
Lucille

I think this is a great idea. There are so many things that are nickel, diming and 35% interest-ing people to death, anything that removes that outside greed factor puts people ahead.
I would love to see more co-op situations to help get people into homes, access affordable food and those kinds of things.

I see the risk in something like this a far better option than people who have used high interest fee ridden credit cards to try to launch a business.

Guest's picture
SharkGirl

I did business with a large company and we had an agreement that they breached. Contracts in America mean nothing if the courts don't back them when the one who signed it decides to breach it.

I seriously doubt anyone in America trusts anyone else enough to do something like this. There are too many scams where people (especially senior citizens) lose their money.

I am looking for ways to raise money to start a business, but I couldn't trust enough to do it this way...assuming I could make that much in a month to hand it out like that.

Philip Brewer's picture

There have always been people who will reneg on their promises, as well as people who will make commitments that they end up being unable to keep (due to foolishness or bad luck).

You see it more in two circumstances. 

First, when people are anonymous.  If you live in a village of just 50 or 100 people, half of whom are related in some way, the consequences of being known as a cheater or a loser is pretty bad.  (Even being known as the parents, spouse, siblings, or children of a cheater or a loser is bad, so they'll step in to cover for a relative who has made a commitment but is in danger of failing.)

Second, when people are in a position of power.  If everybody's roughly equal, you see less cheating than if one person owns all the land or all the water rights, or if the judgets are corrupt.

The US tends to be bad on the first--there are so many people, and they're so mobile, it's easy to be anonymous.  The US isn't so bad on the second--there's less corruption than many places--but the US legal system is too slow, too expensive, and too unpredictable to be really useful for settling the sort of small legal dispute that would arise from something like this.  Better to stick to using it within smaller subcommunities where people's reputations are worth preserving.

Guest's picture
fathersez

This is a great system.

In Malaysia we call it "tontines", in South India "koottus" and in Indonesia "Arisans".

The system is informal and illegal in many places, like in Malaysia. However the system provides about the only way for many people to get a lump sum of money so the system persists.

Its not just for starting a business, it may also be for a mariage, school fees etc

The most trusted people become the bankers and some do run off with the money.

Philip Brewer's picture

The way I understood tontines, a group would invest a sum of money together, which remains invested until only one member of the original group is left alive, at which point he gets the whole thing.  It turns out to be a bit more complex than that.  There's a fascinating wiki page on tontines.

I'm glad you mention school fees, because I think there a great example of the fact that everybody does this all the time, within families.  Money for tuition comes from all different sources (savings, gifts, borrowing), but a central part of the money comes from parents paying the tuition, first for their eldest child, then the next, then the one after that. 

Looked at that way, it's really the exact same structure.  So, of course, it's vulnerable to all the same failure modes that any other sort of ROSCA is.  In particular, the parents could suffer a financial reversal after paying for one education and before paying for a second, or they could just decide that they'd rather keep their money.  We're aware of these problems, but we don't imagine that family finances need to be fundamentally changed--nobody suggests that we need "tuition insurance" to protect against a child losing his shot at college because his or her parents keep arguing about money.

Financial arrangements within the family structure are different from financial arrangements between families.  Since whether or not someone is "part of the family" are culturally determined, you can expect very different notions of whether a scheme like this can work.

Guest's picture
jasmine

I've heard my grandmother describe this before. And yes, when it works, its great. But when the 'head' person runs away, a lot of heartache is involved. its not the safest way to get a loan.

Guest's picture
Guest

When my parents first started out in business (in Asia) in the early 70s this is a very common structure of non-bank financing. My parents were attracted by the high interest offered (if you are one of the last brave soul to receive the principal & interest back). However as people who initiated the structure tend to be desperate for cash, and in days of high inflation, many things didn't pan out, so default was high even in those more innocent days.

Thus I've been brought up seeing that this financing structure as something to avoid unless I am prepared to part with the investment ...

Guest's picture
Suz

Of course it would require a large amount of trust and working together, but if everyone is in it for the common good, then it makes sense... also, it's not about gambling that someone will make money on their business, it's about setting aside the money each month, but using a structure other than a bank. Of course, it would be very hard for one of the first people to keep contributing if they had already gottent heir money and then squandered it...

-Suz

Guest's picture
Guest

While doind some research for a business I had in mind, I discovered that the vast majority of mom-and-pop (i.e. non-corporate chain) convenience stores in my area are owned by Asians.

Also it appeared that most of these were bought as existing businesses and not started from scratch. Buying a going concern would probably reduce the risk of business failure.

Guest's picture

This is a great idea. Any more ideas on how to get money for a business?
I run an online blog and don't have much money to startup. I also don't have many friends to liase with like this

Guest's picture
Janie

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Guest's picture
Karla m.

I love that a lot of you like the idea, i my self have participated in a "cundina" in fact i am in one right now. The way ours works: First you are asked if tou whant to partcipate in a cundina? My question to this person is who is making it/organizer? and how much is it for? Then after i say yes, i talk to the organizer, and ask her what numbers she has available? I pick a number of the list that is avila le, and i can see what who else is participating in the cundina. This cundina is only composed of 10 people, we give 100dlls to the organizer every other friday, she collects money from all the 10 participants, on fridays saturday and sunday, and by monday she turns in the money to the first person on the list, and so on. Usually if someone does not pay, the organizer is responsable for making up that money.