Everyone knows how risky it is to start a business, especially lenders. Even if your personal credit is stellar, most lenders won't take the risk of lending to a startup. The banks that do offer startup loans for business are normally quite strict in who they lend to. But you have other options. Start with this list of your top eight capitalization sources.
1. Personal assets
Your own assets will definitely come into play, but every decent accountant will tell you that you need to establish separate personal and business accounts as soon as possible. Remember that even if you do everything right, your business could fail or take longer than you projected to turn a profit. Don't put your personal assets at risk if you can avoid it.
2. Personal loans
It's tempting to take advantage of the leverage from personal loans if your credit is good. This is essentially what you are doing if you are trying to fund your business using credit cards. However, in most cases, this can't provide sufficient capital. It also takes away your cushion for dealing with unpredictable personal emergencies. Only consider this when you have great credit and few options.
3. Home equity line of credit (HELOC)
In the movies, this is where business owners go next. Mortgaging your home to start a business is iconic, but it's rarely the wisest financial move. While rates are lower and loan amounts are sufficient, the risk of losing your home is very real. Also, HELOC loans have gotten less attractive and harder to get in the current credit crunch. Consider this for low-risk businesses or if your risk tolerance is extremely high.
4. Friends & family loans
The oldest and most common funding source remains the most reliable. Friends and family loans make the most sense because these people have a vested interest in seeing you succeed. This type of investment in your business will generally offer the most generous terms, but structuring the loans and payments can be complex. This should be your first option, but you need to approach the deal and the follow-through with professionalism (for our tips on how best to do that, click here).
5. Small Business Association (SBA) Small Business Loans
SBA loans were designed for this. The SBA is not a lender, but they do set the guidelines and guarantee repayment. That translates into better terms, lower interest rates and larger amounts. That's also why there's a long processing time and many restrictions on eligibility. These small business loans work best for capital-intensive businesses built on proven business models and managed by experienced operators.
This new sector in the financing industry has developed alongside the growth of individual proprietors and online businesses. If you have low overhead, few to no employees and a simple business, this can open up a functional funding source at extremely low rates. You can typically get these from community development lenders like PeopleFund or LiftFund.
Every business owner dreams of attracting angel investors who commit to the business out of raw enthusiasm for the concept. The reality is quite different. The risk to your personal assets tends to be low, but you should expect to see what is in effect the permanent high interest rate of dividends, together with loss of some control over your business. For unproven business models with big upsides, this can be a great way to get started.
8. Business crowdfunding
Sites such as Kickstarter and GoFundMe have been popular for years. The big news is that the SEC approved business crowdfunding this spring. It will take time to work out the kinks, so many businesses are waiting to see how the deal structuring evolves over the next few years. For now, think of this method primarily as an alternative marketing campaign.
There are many more channels for business financing than ever before, but more doesn't always mean better. Aside from SBA 7(a) loans and traditional equity loans, businesses are still better off funding initial operations the way they always have --with help from friends and family.
Make sure you craft these loans to protect your commercial interests and your long-term relationships. For help with that, check out our tips on how to structure friends & family loans to keep both running smoothly.