The best startup business financing option for your business will be the one that best suits your individual needs. Understanding your funding options is a great place to start when investigating when starting your new business.
Some of the factors to consider when deciding among startup business loan options are:
- Upfront cash required: Your initial outlay of cash is important. If you do not have much cash, you might want to find a low-cost franchise investment like Executive Image Building Services.
- Long-term cost: You need to consider not only the interest rate, but also how much the financing will cost you in the long term. A loan that is paid off quickly with a higher rate may cost less than a loan with a lower rate and a longer term.
- Amount of equity you need to give up: Some startup funding options require you to give up equity in an asset like your home as part of the financing agreement.
- Personal guarantees: It is important to know if you will be required to sign a personal guarantee which is a promise you will repay the loan personally.
Rollover for Business Start Ups also known as ROBS
A ROBS is a method to use your 401(k) to finance your business. It helps you invest your current deferred retirement account savings into your new company’s 401(k) plan, which uses the money to buy shares in your business. The business can then use those funds for any business-related expenses, which can include startup costs. There are no terms after you get the money because it is not a loan, but rather an investment in your business.
A rollover for business startups is flexible and can be used in conjunction with almost all other startup funding options. The funds from a ROBS can be used as a down payment for a startup business loan or an SBA loan. A ROBS works well as a financing option for business owners willing to contribute $50,000 or more from their deferred retirement account.
SBA Loans for Startup Businesses
The Small Business Administration also known as (SBA) is primarily known for its ability to help small businesses. SBA programs typically serve new or underserved businesses. All SBA loan types can be used for startups, but some are more difficult to qualify for if you do not have an existing business.
SBA loans are not made directly through the SBA, but rather are loans made through an SBA approved lender and backed by a guarantee from the SBA. SBA lenders are typically community development corporations, banks, or nonprofit institutions. Applying for an SBA loan can be a complicated process and we recommend working only with experienced SBA lenders.
Startups will generally be required to have a 20% to 30% down payment on SBA loans, which can be pretty high for most borrowers. One-way people fund the down payment is by using retirement savings through a ROBS.
Microloans from a Nonprofit Lender
For startup business owners who do not have great credit, sufficient collateral, or a lot of other options, a nonprofit lender can be just the resource you need. These lenders have specific criteria they use when looking for borrowers. You will have to find one that matches who you are, and they type of business is the lender is seeking to assist, like a minority or veteran owned business. You must be prepared to show a source of income independent of the business (e.g., a full-time job or spouse generating enough income yet.
Who Are Microloans Right For?
Microloans are good for businesses that need small amounts of funding to start their business. This is because with a microloan, you can typically get loans of up to $10,000 to start a new business. Microloans are often targeted at specific underserved demographics, and startup businesses often fall into these categories. Startups without great credit or other financing options may qualify for a microloan from a nonprofit organization.
Home Equity Loan or Line of Credit
If you are a homeowner with some equity in your home, you may be able to get a low-rate home equity loan of credit (HELOC) to fund your startup. A home equity loan (HEL) gives you a lump sum immediately with amortized repayments, while a home equity line of credit is a credit line that can be drawn against as you need funds. With a home equity line of credit, you pay interest only on the balance you currently owe.
A home equity loan provides you with a lump sum, which acts like a second mortgage, and a home equity line of credit works like a credit card or business line of credit. In either case, you will need to have some equity in your property. You will be limited on the amount you can borrow, as your lender will want to ensure that an equity cushion remains.
A home equity loan might be right for you if you need a large lump sum amount of money for upfront business expenses that are essential to your operations. You will immediately begin making payments on the full loan after closing.
If you do not have an immediate use for all of the funds right away, then a home equity line of credit may save you money through a more affordable interest rate.
Small Business Credit Cards
Both personal credit cards and business credit cards can be a relatively cost-effective way of financing your startup. Many come with 0% APR introductory periods and valuable cashback or rewards programs. This can result in good savings for your business if you use credit cards regularly and can be part of a small business’ financial toolkit.
Small business credit cards are not an ideal way to fund large capital investments for your business startup, but they can be an essential tool for cash flow management. You can cover expenses with your small business credit card while waiting for payments from your customers, preserving cash and earning rewards at the same time. Many small businesses use credit cards to finance business operations They are a great option if you want to manage employee expenses or earn cashback rewards. Business credit cards are also good if your business has little to no revenue or has just started, as qualifying is often based on your personal income and credit score.
Personal Loan for Business
A personal loan allows you to borrow funds based on your personal credit and income. Personal loans rarely have limitations regarding what the loan funds can be used for, and therefore can be used to finance your business needs. However, because the loan is in your name as an individual, you are always personally responsible for repaying the loan.
Personal Loan Costs
Keep in mind that while these loans may be for a business purpose, you are the one who is borrowing and ultimately responsible for the loan. If you do not repay the loan, your credit rating will be affected, and you could lose personal assets. The interest rates can be similar to credit cards, but you will be receiving a lump sum payment that you will be paying interest on instead of a credit line.
These loans are a good fit for startups or businesses without much history—as long as you are willing to be personally responsible for repayment. Since this is a personal loan, your personal credit is on the line. A personal loan for business is also good if you are willing to put your personal assets at risk (which is often required with business loans through a personal guarantee anyway).
Equipment financing can be used to purchase equipment, vehicles, or machinery. This type of startup business funding can be obtained through equipment dealers, banks, and online providers. Equipment financing can help startups finance equipment and preserve their cash for other needs.
Fair Market Value Leases
Fair market value leases are what most people think of when they think about an equipment lease. You make monthly rental payments in exchange for the use of the equipment. At the end of the lease term, you can purchase the equipment at its fair market value, extend the lease, or return the equipment.
$1 Buyout Leases
Under a $1 buyout lease, you make monthly rental payments to use the equipment. At the end of the lease term, you have the option to purchase the equipment for $1. This is a good lease option if you are fairly certain you will want to purchase the equipment at the end of the lease.
Friends & Family
Relatives and friends who are supportive of your business idea may be willing to lend you their personal funds as startup money for your business. Usually, loans from friends and family have very favorable rates and repayment terms, but you have to have access to a network of wealthy individuals. Remember, it is very important to keep business and personal financial lives totally separate. This way, you always have a good paper trail.
Friends & Family Loan Costs
Friends and family can be a great source for startup funding. While they may be willing to donate the money to your startup, you likely will not want to pay the gift tax on that amount of money. Instead, you can structure it either as a loan or you can sell them shares of your business.
Unless your friends and family are sophisticated investors, taking money as a loan is generally cleaner than selling them a share of the business for three reasons:
Borrowing from family and friends may be a good option if you have a network of high-net-worth individuals and are out of other financing options. Be aware, though, that the lack of documentation in these arrangements could lead to reporting and legal problems, and also could complicate your future fundraising efforts if you do not have formal loan agreements.
If you are going to borrow from a family member or friend, make sure you document every cash investment or loan. It is also critical to keep your personal and business finances separate so you have a good paper trail and can answer any questions about how you used the funds.
Crowdfunding is the act of raising small amounts of money from a large number of people and is a form of equity financing. Crowdfunding investments are usually handled through an online platform. Entrepreneurs looking to crowdfund capital for their business generally give equity or some type of reward in exchange for the funds.
The costs associated with crowdfunding typically include a flat fee of 5% to 10% of the total money raised, transaction costs for each contribution, and the costs of offered incentives or rewards (e.g., gifts, shares of business).
There are many different ways to crowdfund. Some startups just rely on the strength of their business or campaign, believing that their product will inspire contributors. Others offer rewards or incentives to supporters in exchange for their investments, and others offer equity in their business. Crowdfunding campaigns are almost always hosted through a crowdfunding website.
The reward-based crowdfunding strategy is very popular, with one of the most popular programs. Reward-based crowdfunding works by offering a product or service as a reward to people who contribute a certain amount of money to your business. The funds raised must be for a specific purpose (like manufacturing a new product) and that purpose must be acknowledged at the beginning of the campaign.
With equity-based crowdfunding, campaign contributors donate and receive shares of your business in return for their contribution. This method of crowdfunding is much more complicated than other crowdfunding methods. It is recommended that you seek legal guidance when using this form of financing, as there are rules and regulations that you must abide by.
The ability to reach potential crowdfunding investors through an equity crowdfunding campaign requires you to abide by many laws and regulations. These laws are in place to protect the interests of the investors because many of them are likely inexperienced with this type of funding and investment.
Angel investors are usually wealthy individuals who provide your business funding in exchange for an ownership stake. An angel investor invests as much in you, the business owner, as they do in the business’ products or growth opportunity. Angel investors generally give less money than venture capitalists, but they also are less likely to take an active role in your business.
Venture capitalists are a group of investors who make up a company or investment firm. Venture capital is given debt-free in exchange for a percentage of equity in your business. Venture capital investors are likely to take a hands-on role in your business, and often require a seat on your board of directors. A well written business plan with financial projections is a must when soliciting to a venture capital firm.
While not a loan, a grant is another funding option you should consider when evaluating your startup funding options. Many small businesses may be eligible for government grants. All federal government grants are posted on a website which allows you to search for grants that align with your business type.
Government grants are free, and you will never be emailed, texted, or called by a government authority to tell you that you have qualified for a grant for which you have not applied. Do not be fooled by scams trying to convince you that you need to pay to receive a grant.
The terms and qualifications for government grants are all different. When you review the grants to see if they align with your business, you will be able to tell what is required to get the grant. Some examples might be the type of business ownership (e.g., minority-owned), the population you are serving (e.g., an underserved area), or the service you provide (e.g., environmental).
With the variety of government grants available, they can be a great financing opportunity for anyone who meets the requirements of a specific grant. There are set application deadlines for government grants, and you may be required to meet certain objectives (e.g., promise to provide a service for a set amount of time), but grants do not require repayment and are essentially free money for your business.
A franchise company like Executive Image Building Services has experience with a variety of startup loan sources to help new franchise owners reach independence and own their own business.
By Ray Jackson