by Kelly Deis of SoundPoint Consulting
So, you have a great idea for a start-up or you want to expand your current business. You have the perfect business plan and are confident that both revenue growth and profitability are sure-fire.
Problem is, you don’t have the capital to fund the start-up or expansion. If that is the case, here are a few ways to fund your business. Which one is right for you?
1. Bank Loan or Line of Credit
Borrowing from the bank is probably the most traditional way of funding a business. This can take the form of a traditional loan or line of credit. Some banks may require an SBA guarantee which is a little more expensive than a bank-only loan. Others may require covenants, or conditions, within which the business must perform.
Bankers will review your historical performance and business plan in great detail. Assuming that these pass muster, the bank will require collateral in the form of inventory, equipment or even your house. In many cases they will insist on a personal guarantee.
Bank loans are debt financing requiring periodic payment of principal and interest. However, they do not require you to give up equity in your business; if your business takes off, you keep the profits (after debt repayment).
Consider leasing rather than purchasing major pieces of equipment. This will free up cash and potentially mitigate the need for outside financing. Similar to a car lease, you don’t own the asset and there is a finite term for use of the asset.
3. AR Factoring
Businesses can “factor” their receivables to obtain cash up-front. In this case, you sell your receivables to a factor, who makes an advance payment to you for some portion of the total receivable amount. The factor then collects from your customer(s) and pays the balance to you, less a commission and other fees.
Factoring can be expensive, but can also help smooth working capital ebbs and flows. However, the factor owns your receivables and may require that checks be written directly to them. This may confuse your customers and/or cause concern about your liquidity.
4. Home Equity
Taking out a home equity loan is a good option for those who have built-up equity in their homes. The rate and terms are generally more attractive than commercial loans and they do not require the track record or due diligence necessary for bank financing.
The risk however is if the business fails, or you fail to meet the terms and conditions of the home equity loan, you risk foreclosure of your home. Given the more stringent lending requirements of banks since the Great Recession, this may not be an option for many potential borrowers.
5. Rollover as Business Start-up (ROBS)
A Rollover as Business Start-Up, also referred to as a Self-Directed 401k, enables small business owners to finance their business with their tax deferred retirement savings (such as IRAs and former employee 401ks) without the penalties normally associated with early distributions.
And, while it is attractive because it provides cash for the business debt-free, you do risk your retirement savings if your business does not perform as expected. If you want to consider this option, be sure the ROBS is set-up and administered correctly.
6. Credit Cards
Credit cards are a quick and easy way to fund anything that can be purchased with plastic.
But, buyer beware. Interest rates for credit cards are probably the highest in the market. And, while the minimum payment may be appealing, the debt balance can build quickly. If the business cannot make payments, it could force you into personal bankruptcy.
Credit cards should only be used for expenditures that can be paid back quickly. The owner should keep an eye on balances to be sure they remain within a reasonable limit.
7. Friends and Family
If they have money to invest, friends and family can be another source of funding for start-ups and small businesses. Often business owners seek this alternative when either bank financing is not available or the potential opportunity is so attractive that they want to keep it “in the family”.
Friends and family typically require less due diligence and contractual requirements than traditional loans. And, there is often flexibility in interest rates and payment terms. Financing from friends and family can be structured as either debt or equity. The downside to this type of financing is obvious. Losing your in-laws’ money could cause some pretty chilly holiday dinners.
8. Equity Investors
Equity investors can take several different forms – from angel investors to venture capitalists. Both are looking for a fairly significant return on investment – so your business idea better be compelling.
Angel investors are good options for start-ups and early stage companies. Although investment levels are low relative to venture capitalists, angels often contribute business experience and connections which the entrepreneur might otherwise lack. The challenge is finding the willing and able angel that you want to partner with.
Venture capitalist are serious investors looking to make a return in a relatively short period of time. This type of investment is appropriate for fast growth companies which are beyond the start-up phase and who have a clear exit strategy
It goes without saying that all equity investors have some ownership interest in your business. And, with that comes the challenge of managing potentially divergent interests.
9. Strategic Equity Partners
Strategic equity partners are generally part of the supply chain – either they manufacture the product you sell or they are the wholesale / distributor for the product you manufacture. If you have a strategic partner – and they are well capitalized, there is the possibility that they might take an equity interest in your company.
In this situation, they invest in your company for an ownership interest. And, presumably you maintain a friendly and mutually beneficial business relationship. The downside is that there is the potential for discord should either of you wish to deviate from the status quo.
There is a variety of business financing available. But, like most things in life there are tradeoffs. So, consider your objectives, evaluate the alternatives and choose wisely
Kelly Deis is president of Soundpoint Consulting, based right here in Kitsap County. She earned an MBA at the Wharton School, and offers services as a Certified Valuation Analyst and Certified Exit Planning Analyst. She also helps clients develop a differentiating strategy.