Part of the America’s Entrepreneurs Special Report
Launching a business at any age is an exciting undertaking. But starting one can also be capital intensive and can come at a high cost if you make the wrong funding choice. When you have funds tucked away in retirement accounts, it may be tempting to go after that money to launch your company. But keep in mind how many years you’ve worked, and how hard you’ve worked, to earn that money for the purpose of retirement. You may not have the time to start over and take advantage of the wonders of compound interest.
Instead of dipping into your retirement funds, consider alternative funding sources. Aside from applying for a traditional bank loan, there are many other ways to obtain financing to start a business.
Here are seven of them. If you have a financial adviser, discuss them together to determine what may be the best fit for your personal finances and for your company’s operating funds.
1. U.S. Small Business Administration (SBA) financing The SBA has loan and grant opportunities ranging in purpose from starting a company to equipment purchases to helping a business recover from a disaster. Visit the SBA site to learn more about these opportunities. Currently, the most popular type of SBA loan has a maximum interest rate of 6.25 percent (loans over $50,000) to 8.75 percent (loans under $25,000).
You may be surprised to learn there are many industries with grant money that can help someone start a business within that field.
2. Industry grants You may be surprised to learn there are many industries with grant money that can help someone start a business within that field. Health care and clean energy industries are two of the larger ones offering grants.
3. A home equity line of credit A home equity line of credit (HELOC) lets you borrow money as needed and only pay back the portion of the amount you borrowed. You must put up your home as collateral and often the loan limit is between 80 to 90 percent of the mortgage and line of credit value combined. There are tax advantages to using a HELOC, but it’s important to consider the risk of listing your home as the collateral. Currently, the typical interest rate on a home equity credit line is around 5 percent, but rates are on the rise. The Federal Reserve has indicated it will raise rates again this year.
4. A life insurance line of credit If you have a life insurance policy, you may have the option of getting a line of credit based on the cash value of that policy — at up to 95 percent of the cash value. Interest rates now range between 3 and 4 percent typically. Monthly payments are interest only and have no defined payback period. They are simply subject to loan renewal.
5. A stock-secured line of credit Here, you use stock you own to secure a credit line. Banks and brokerages are the primary resources for this type of debt. A stock-secured line of credit is often less costly than a HELOC or a brokerage margin account; the current rate is typically 3 to 4 percent. You’ll still be able to earn your stock dividends, but you can use the line of credit to help cover business start-up expenses. Often, repayment is interest only. The risk for using stock to secure a line of credit: it may result in negative credit implications if you are unable to repay the loan.
6. Signing on with a joint venture partner Bringing on a joint venture partner allows you to bring additional income into the funding of your business. However, your business will no longer be only yours. Ownership interest is typically 10 to 49 percent, depending on the contribution of the joint partner. Your partner will most likely provide experience, knowledge and capital, though, and will benefit from the same costs, risks and rewards as you.
If you choose to go this route, be sure to set up an end-of-business agreement between you and your partner. This could prove useful if one of you chooses to no longer be involved with the business. Then, you’ll have an agreement for how a partner can exit. This could require your business partner to buy you out or for you to sell your partnership to an outside party, for example.
7. Crowdfunding With this relatively new business-funding opportunity, a crowdfunding website (such as Kickstarter or Indiegogo) gives entrepreneurs the ability to set up a public platform and ask the public for donations to help establish the business. The goal is to ask many people for small amounts of money, instead of trying to convince a small number of people to make larger donations. Terms vary greatly, including a percentage of profits to a percentage of ownership.
Business owners should be aware that pursuing financing through percentage of ownership could be an impediment to obtaining traditional financing later and that crowdfunding sites do not typically offer intellectual property protections. Also, this space is very new, so the tax laws here are largely undefined and could change to the negative.
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