Keys to Funding Your Startup
Are you in the initial phase of getting your business off the ground? If you’re finding yourself needing some financing to get started, you’re far from alone. Other people who have followed your same path have had to use one (and often more than one) of these sources: business loans, personal savings, and fundraising. This article details some of the best ways to get the funding that your own startup business needs to reach the next (or even the first) level.
Before you read on, it’s important to note that BBC does not help with start-ups. However, businesses that have gotten up and running but haven’t been around long enough to have two or three years of solid financials in place can also have a difficult time finding bank funding. For businesses in that phase, BBC can step in to provide funding to help things keep rolling smoothly – and to keep growing.
Rollover for Business Startups
This type of funding moves money from your retirement account into an investment in your new business – and you don’t pay a dime in income taxes or early withdrawal penalties. It’s not a loan, and it’s not a cashout. Your business has no new debt, and you don’t have monthly payments to make.
This option does cost about $5,000 to get started and about $140 each month in monitoring fees. Here’s how it works – your retirement account savings move into the new 401(k) plan that your new company has now set up, and the money goes to purchase shares in your business. Then your business can use that new income for any expense related to operating the business – which can include startup expenses.
For a ROBS to work, you have to be a legitimate employee of the business, which doesn’t have a set rule, but a guideline is a minimum of 1,000 hours worked for the company per year. So if you’re taking an active management role, this should work for you. If you’re starting an absentee business, such as a real estate investment concern, then this might not be the best for you.
You’ll need to make sure that your business is set up as a “C” corporation, and your tax deferred retirement account has to have at least $50,000 in it. You can’t use any of that money to pay the $5,000 setup fee, but you can use that money to pay the monthly monitoring fee. However, the flexibility for spending the money on your business is considerable, because you can use it to fund a down payment for a startup business loan from another source.
Home Equity Line of Credit (HELOC)
Do you have equity in your home? Then you might qualify for a home equity loan or line of credit to help infuse some liquidity into your startup. The loan gives you a lump sum up front, along with an amortized payment schedule that you have to start meeting right away. A HELOC is a line of credit that you only access when you need funds, and you only pay interest on the amount that you withdraw. Both of these generally come with a closing cost between 2 and 5 percent and an annual interest rate between 3 and 6 percent rate, although that may skew higher depending on your credit. However, both of those numbers are generally lower with a HELOC than a loan.
For this to work, you’ll need at least 20% equity in your home, but you’ll be in much better shape if you have 30 or 40%, because most loans won’t allow you to take out more than 80% of the equity you have in your home right now.
If you know that you need a large amount of money to put down for upfront business expenses that are vital to your startup, then the equity loan is probably the better choice. However, if you have an idea that you will need money down the road but don’t need much or any of it right now, then the HELOC is the better choice, because you don’t owe any principal or interest until you actually need the money.
So if you have sufficient equity and are willing to put your house down as security for your business, then either one of these choices could be right for your company.
Small Business Credit Cards
Credit cards (whether personal or business) can provide some financing at a reasonable cost. Many of them have introductory periods with 0% APR, or rewards or cashback programs that pay dividends. Every business needs this sort of financial flexibility at its disposal. Once the promotional periods are over though, expect to pay an annual interest rate on unpaid balances at an average of 16%, and some business credit cards have yearly fees that range between $50 and $100.
Obviously, you wouldn’t put a major capital investment on your card, but when it comes to helping keep cash flow smooth, a business credit card can come in handy. If you’re waiting for customer payments to come in, your business credit card can keep the business up and running – while you also accrue rewards.
More than a third of small businesses use credit cards to finance their operations. The one potential drawback is that they will move with your business credit score, so if something happens to your business’ credit, the card company can drop your limit or just close the account with no warning.
Personal Peer-to-Peer Lending
Lending Club is just the largest of a host of online services that matches borrowers with lending institutions as well as individuals who want to invest in the businesses of others. You’ll pay an origination fee between 1 and 6 percent, which comes out of your lump sum up front, and interest rates range between 5 and 26 percent.
Peer-to-peer lending sites provide personal loans with terms ranging from one to five years to help borrowers pay off credit cards or consolidate other debts into one payment. These personal loans also can go toward starting or operating a business. Some P2P lenders have branched out into small business loans, but they are generally not available to startups. You need a credit score above 650 for a P2P site such as Lending Club, although sites such as LoanMe specialize in borrowers with lower credit scores. Their interest rates will be higher, but that’s life with a lower credit score.
One caveat – these are personal loans, so if things go south for your business, it’s your credit rating that will suffer, and your personal assets could be at risk. The interest rates are comparable to credit cards. However, if your startup has promise and you don’t mind being responsible personally to pay off the loan, this can be the right solution.
If your startup needs machinery, vehicles or other equipment, then there are banks, equipment dealers and online lenders who specialize in this sort of lending. The APR generally starts around 5 percent, but it will vary with the type of equipment and the lender. However, just because an equipment dealer has a higher interest rate than the bank doesn’t mean that the loan will cost more, because the dealer may charge fewer fees.
You can structure this financing as an equipment loan or lease. With a loan, you own the equipment, and you have between one and five years to pay off the note. With a lease, you can choose the fair market value (FMV) variety, where you pay each month to “rent” the equipment and use it. When the lease expires, you can buy the equipment at fair market value, negotiate an extension or send the equipment back.
Another option is the $1 buyout lease. In this case, you pay each month to rent the equipment, and at the end of the lease, you can buy the equipment for $1. If you know you’ll probably want to keep the equipment, this is a solid option. Most terms allow you to use the equipment for between two and five years while putting down effective interest rates between 6 and 16 percent.
If you’re starting a business that has a lot of equipment needs, such as a trucking company, financing your equipment helps you free up cash for other business expenses. The equipment serves as the collateral, so startups often have an easier time gaining approval for this sort of financing than for unsecured loans.
Microloans from a Nonprofit Lender
If your personal credit isn’t so hot, and you don’t have the collateral that you need, nonprofit lenders could work out well for you. These entities have a set of criteria that they apply when screening borrowers, so you need to just find one who specializes in your industry.
Interest rates on these loans tend to range between 8 and 22 percent. One example of these is Accion, which allows you to borrow up to $10,000 for a startup and $50,000 for an existing business. You have to make payments on the loans, though, and you’ll have to be able to prove that you have an income stream besides the business, such as full-time employment or income from a spouse. A co-signer who has solid credit and a strong income history can help as well.
Personal Loans from Family and Friends
Your family and friends might want to lend you money at zero percent, because they believe in your idea and want to help you out. However, the IRS often views that sort of arrangement as a gift and may tax you for it. So you want to have records of paying the loan back with interest. As of December 2017, the mandatory minimum for short term loans (three years or less) was 1.12%, and for long-term loans (as long as nine years) was 1.96%.
If your family and friends won’t accept any interest, another way to get around the IRS is to sell them shares in your business in exchange for their investment. A disadvantage of this, though, is that they may feel like they have the right to offer input on your business decisions if they own part. It’s better to pay interest on the loan and keep things separate. If you have some friends or relatives who have significant net worth, and if you can’t find financing elsewhere, this can be a solid option.
This involves raising small dollar amounts each from a large number of people. There are a number of websites that allow you to set up crowdfunding accounts, and in exchange for money, you generally offer a sort of reward or equity. You’ll pay the platform a fee between 5 and 10 percent of what you raise, as well as the costs of any incentives that you offer.
Kickstarter is an example of reward-based crowdfunding. In exchange to those who fund your business, you offer them a service or product. Remember that the funds have to go toward a specified purpose, such as finishing up the manufacturing of the product, and you have to indicate what the purpose of your funding is when you put up the campaign.
If you use equity-based crowdfunding, there are three types right now (but this field is still new, so things are changing with each passing month). You can run it privately through accredited investors, publicly (but only accepting accredited investors), or publicly (while accepting funds from almost anyone). If you choose the third option, prepare to face a great deal of government regulation.
If you have no other source of revenue and want to get your product up and running, this might be right for you, particularly if your product or service has high margin. If you’re looking for a lot of exposure for your business, this can work as well.
Angel Investors or Venture Capitalists
Angel investors are wealthy individuals who are looking to exchange cash for a stake in your company. You’ll give up anywhere between 5 and 50 percent – or even more – of your business, as many angel investors only invest when they get a majority stake in your business, but they’ll still want you to operate the business.
Venture capitalists are groups of investors who are looking to get a return on their investment as well. You can generally get more money out of venture capitalists, but they will also take a significant ownership stake, and they may also want to take more of a day-to-day role in the operation of your firm. They want a very high rate of return, such as 10-15 times what they invested within five years. Angel investors don’t generally want that much of a return, and they will generally let you run the business yourself.