Funding Education
If you’re like most of our Clients, it’s not an issue of whether you can secure funding – it’s which forms of funding you’d prefer to utilize, whether alone or in conjunction with others. Want to learn a little more? Let’s go!
There are four primary categories of funding a new business endeavor – each with multiple options/methods:
- Self-Funding
- Equity-Based Funding
- Secured / Collateral-Based Funding
- Unsecured / Collateral-Free Loans
Self-Funding
Self-funding options enable you to launch a new business debt-free. However, contrary to the name, it may not require your to tap into your own cash reserves. Options within this category either don’t require you to grant equity in the new company, or take on debt – or both!
Checking and Savings Accounts (and Cash Equivalents)
This refers to the money you have on-hand, easily accessible.
- Advantages
- Simple, quick to deploy
- No credit check
- No debt
- No equity granted to others
- No repayment schedule
- Can use cash as a down payment to enable a loan, if needed
- Considerations
- Your risk tolerance – do you see tapping into your reserves as more risky, or do you see taking on debt (perhaps secured with your home) or potentially giving up some equity as more risky?
- Many people don’t have enough cash on hand to fully fund many businesses
- If intending to use cash alone – will it be enough to fund the start-up all the way to profitability? Consider a burn rate (or cash runway) calculator. Often, money is available until you need it – keep some in reserve.
Rollovers for Business Start-ups (ROBS)
While this program has been around for nearly 50 years, it’s not as well known as many other funding solutions, and misconceptions abound. This option allows you to tap into your retirement funds without penalty, without loan repayments, and without debt. As the ‘rollover’ in the name suggests, it’s a way of reinvesting some of your retirement funds from publicly traded companies to a privately held one – yours.
- Advantages
- No monthly payments
- Converts your reactive retirement portfolio into a proactive investment – your own business
- Unlike taking a loan against your 401(k) funding via ROBS doesn’t require making interest payments, and doesn’t count as taxable income
- No reliance on credit score, personal guarantees, or collateral
- Unlike taking an early distribution, funding via ROBS doesn’t trigger an early withdrawal penalty, or an income tax payable
- Considerations
- It’s a multi-step process (setting up a C Corp, setting up a retirement plan within that C Corp, rolling some of your existing funds into that retirement plan, and the company plan buying stock in the C Corp) , which requires the assistance of an experienced ROBS professionals and has a related cost
- If you need less than $50K to fund your business, the set-up cost may outweigh the benefit for this solution
- Certain types of new businesses (lending, investing, and some real estate-focused ones) can’t be funded via ROBS
- You must be an active employee of the business (20 or more hours), though they can be passive hours – bookkeeping, serving on the board, etc.)
- Must be an active business – not a passive investment
Friends and Family
This is one of the most common ways entrepreneurs secure funding to launch a business. This option could involve granting equity in the company (not considered self-funding), but certainly also includes gifting, or flexible loans. To straddle the line further, a friend or family member could serve as a sort of angel investor by co-signing for a loan for you. But here, we’re focused on gifts or flexible loan scenarios.
- Advantages
- If receiving a gift, the risk shifts away from your own assets
- (Often) flexible loan terms are preferable to a bank’s more rigid terms
- Can be a viable option for those with little cash reserves, or low credit scores
- Fewer hoops to jump through – banks may treat you as a risk statistic, whereas friends and family know your work ethic
- Considerations
- Consider the person whose financial backing you may accept. What role might they want in examining expenses or operations?
- Could it create awkward conversations or frazzled relationships?
- May need to reach out to multiple friends or family members to assemble sufficient funding
- It’s best to know how much you’re asking for, and have a business plan in hand, before starting the conversations
- If you’re receiving a gift, consult with your CPA on possible tax implications – for both you and the giver
- Likewise, any loan should be examined by the CPA, because if structured incorrectly, it could trigger extra taxes.
- Better safe than sorry: even among family or friends, it’s worth drafting a contract so there is no confusion on what the gift means (any strings attached?), general loan terms, etc.
Equity-Based Funding
There are plenty of options within this category, which allow you to raise funds by granting a portion of your business’s equity.
Friends and Family
Funding from friends & family can come in many forms, including self-funding (relatively no strings, or flexible strings attached), as well as equity funding.
- Advantages:
- They know you and may be willing to provide funding with far less questioning than an angel investor.
- Potentially no loan to pay back
- Can be the path of least resistance – no reliance on a credit check, less reliance on a pitch deck / solidly crafted business plan, etc. Friends & family take your work ethic / intangibles into account.
- Considerations:
- Whereas experienced angel investors often stick to sectors they know (and can advise on) well, friends & family’s benefit here may end with the funding itself – no further business value / counsel to add
- By giving friends or family members a stake in your business, they’ll want to know how the business – how their investment – is doing, by receiving updates, possibly making suggestions, etc.
- Consider whether you want to grant pure equity, or structure it as convertible (from equity to a loan, or vice versa).
Angel Investors
Angel investors provide funding to start-up or early entrepreneurs in exchange for an equity stake in the business and, depending on their background, strategic guidance. Think Shark Tank!
- Advantages
- While you’re giving away some equity, it’s typically not a controlling stake; they’re investing in your ability to run a successful model, and don’t want to run it themselves
- If you find an angel investor with experience in the industry you’re looking to launch in, you can gain great insight and counsel
- Considerations
- You will likely be questioned thoroughly on every aspect of the business – it can be a grueling process, and you’ll need a polished ‘pitch deck’ and detailed plan
- Angel funding usually ranges between $25K and $150K
- Angel investors are looking for high ROI, meaning fast growth. If you’re looking at a slower growth rate, this may not be a viable option.
- Talk with our CPA about equity levels – above 20%, they become co-guarantors.
Secured / Collateral-Based Funding
Many people, when considering this funding category, spring to ‘use my home as collateral for a loan.’ While that is one option, there are several others to explore!
Mortgages and Home Equity Lines of Credit (HELOC’s)
For many Americans, their home is both a key part of their long-term wealth planning, and also a valuable source of funds. Funding via this category can involve cash-out mortgage refinancing or a second mortgage, or a home equity line of credit.
- Advantages:
- Relatively simple: no business plans or scrutiny over the use of funds
- If utilizing a HELOC, no firm repayment schedule, and can use the open line again and again as needed.
- Considerations:
- For most entrepreneurial endeavors, the flexibility of a HELOC is preferable to either mortgage option – no interest expense until you tap into the funds, no rigid repayment schedule.
- Only an option if you have sufficient equity in your home (most programs won’t lend beyond 80%-90% of your home’s current value)
- Consider your risk appetite for / aversion to using your home as collateral.
Portfolio Loans (Securities-Backed Lines of Credit)
If you’d like to access funds based on the value of your investment portfolio, but would prefer not to sell them, this can be a viable option. Securities-backed lines of credit (SBLOC’s) provide an inexpensive means of accessing cash, backed by the value of your portfolio. Typically, you can borrow against 50%-90% of the value of your portfolio, depending on the volatility of the underlying stocks.
- Advantages:
- It’s set up as a line of credit – you use it when you need to
- No rigid / defined payback schedule
- Lower interest rates than bank loans / many other funding options
- By borrowing against the value – instead of liquidating it – you avoid capital gains taxes
- Good for those with low credit scores – the lender is evaluating solely based on the value/mix of the portfolio
- Considerations
- If the market tumbles, you may be required to offer up additional collateral, or sell some of the portfolio assets to start paying back the loan
- By borrowing against the value – instead of liquidating it – you avoid capital gains taxes
- If the portfolio’s value is less than $200K, the associated set-up costs make this solution less attractive.
Franchisor Funding
Many franchise systems offer their own in-house funding options when welcoming a new member to the family.
- Advantages
- The lender knows that particular model inside and out!
- The loan amount should be quite accurate to what the business requires
- Considerations: if a particular franchise you’re exploring does offer its own financing, make sure to read up on it in their franchise disclosure document (FDD).
Small Business Administration (SBA) Loans
While banks may, on their own, be hesitant to fund aspiring entrepreneurs, it becomes more likely when the loan is partially backed by SBA guarantees. The Small Business Act was created in 1953 for the purpose of strengthening the US economy through a more viable small business environment. Most entrepreneurs who tap into SBA funding utilize either a 7(A) loan, which can be used for almost any business purpose, or a working capital loan.
- Advantages
- Regardless of which lending institution you work with, the rates and costs are basically the same, creating very little variance or need to shop around.
- Due to government backing, bank’s appetite to lend increases to qualified applicants
- No need to give an equity stake to access funding
- May not have to have a home to collateralize
- For Veterans, there are lower costs associated with the programs.
- Considerations
- Paperwork-intense, time-consuming process
- Bank approval requirements vary greatly, and are usually above SBA’s own minimum requirements.
- They will consider your application through the lens of the “Five C’s”:
- Capital (i.e. your down payment). Plan on 10%-30% down, which can’t be borrowed.
- Credit score – 670 or better
- Capacity (i.e. anticipated cash flow, plus how liquid you’ll be after getting the loan)
- Your Character – experience within the industry, bankruptcies and felonies (at any point in the past), while not prohibitive, must be disclosed.
- Collateral
- Even with the backing of the SBA, 70% – 80% of applicants are denied
- Must put together a business plan and projected financials
- The process can often take 4-6 months, sometimes longer. If you’re looking to make a move in the near future, this likely isn’t the solution for you.
Equipment Leases and Loans
If you’re interested in a business requiring equipment – or even just signage, furniture, fixtures and the like – equipment leases and loans can provide protection against obsolete equipment, help preserve cash reserves, and more.
- Advantages:
- Much faster than SBA and USDA loans
- Can be used for equipment, signage, point of sale systems, vehicles, tools and more.
- Collateral is typically the equipment itself (not your home)
- Considerations:
- Fixed rates vary by the borrower’s financial strength, business and industry experience
- The down payment or security deposit ranges from one lease payment up to 20% of the dollar amount being financed
Unsecured and Collateral-Free Loans
The online business lending space has exploded in recent years, as nimble, quick efficient lenders have filled in the gaps left by more rigid, traditional banks following the 2008-2008 economic crisis. This can be a great category of funding options that doesn’t require you to secure the loan with collateral.
Unsecured Personal Loans and Lines of Credit
Personal loans or lines are a highly flexible way to fund a business acquisition. It’s highly recommended that you work with a specialist in the unsecured funding space, who can match you with the lenders with the best rates and terms.
- Advantages
- Often special programs / discounts for veterans
- Turnaround times average 2-3 weeks
- Funds can be used for any purpose, including business acquisition
- 100% unsecured, no home equity or other assets required
- Considerations
- Two key factors are credit score and current income (future income or
target business financials / cashflow are not relevant. - Terms of 3 to 12 years (most clients average 5 to 7)
- If the rate is variable, it can increase quickly
- Two key factors are credit score and current income (future income or
Credit Card Funding
While the idea of funding a start-up via credit card scares some people, the negative reputation around credit cards is largely fueled by people choosing the wrong type of credit card, and/or using them irresponsibly. Today, specialized firms can help find you the best type of credit cards – those with high limits, no cash advance fees, and no interest payments for a year or more. By applying, then cashing out, the right credit cards quickly, any impact (to these applications) caused by changes to your credit score are minimized.
- Advantages:
- No collateral is needed
- Usually only takes 3-4 weeks to obtain funding
- Can be used for any business purpose
- Considerations:
- Typically need a credit score of 690 or higher
- The goal should be to pay off the debts within a couple of years – will the business be able to do this?
- The company which helps shop / secure the funds will charge a % of the funds they secure
- Will negatively impact your credit score in the short-term; over the long term, if utilized correctly can actually increase it