April 1, 2008
Last year, more than 500,000 businesses were formed in the United States, according to recent data from the Small Business Administration (SBA). That means about one in every 200 adults plunged into entrepreneurialism. Though their business goals may have differed, these entrepreneurs shared a common hurdle: They needed startup capital.
The amount of money you’ll need to start a business depends on many factors, including the actual products or services you’ll be providing along with your day-to-day budgetary needs. Be certain to include everything from office equipment and advertising to staffing and insurance.
The bottom line: You need to cover all your bases. To be taken seriously as a potential small-business owner, CNN reports you need “somewhere between $50,000 to $150,000 of ready cash for a down payment and working capital.”
The question is, what’s the best source of funding for you and your business?
Nearly all small businesses will obtain some type of loan, or debt financing, as opposed to acquiring investment partners. This is largely because most venture capital companies and angel investors are looking for more developed projects, with high capital requirements of more than $1 million and high potential profits.
So, let’s take a look at the top sources of debt financing, as ranked by a 2007 entrepreneur survey conducted by The University of Southern California’s Marshall School of Business, with a couple more thrown in for good measure.
No. 1 First national bank of “you”
Personal finances are the most utilized funding source out there. According to Marshall’s 2007 survey, 80 percent of entrepreneurs use their own funds to get started.
If you’re able to finance your business yourself, then go for it. Plain and simple, this will provide you with the most flexibility, freedom, and access to the funding. However, you’re cautioned to use this strategy wisely; you never want to deplete your entire cash reserves.
No. 2 Circle of “friends & family”
Friends and relatives are the second-highest source of funding at 38 percent. Of course, even when they believe in you and your idea, friends and money can be a toxic combination.
When you borrow money from personal friends and family, be sure to draw up a loan agreement with all the terms, including interest rate, repayment structure, late penalties, and any other important details.
No. 3 Take it to the “bank”
Most banks and lending institutions have money available for people who want to start a business. When you and your idea get approved, banks will finance about 50 percent of real estate values, 75 percent of new equipment values, 50 percent of used equipment, and 25 percent of inventories. In addition, you could finance up to 90 percent of your current account receivables’ value.
But remember: If you’re a first-time business buyer and you have no previous direct experience in that business, getting approved for a bank loan is not a slam-dunk. Current rejection rates for small-business startup loans probably exceed 80 percent. To improve your odds, you may want to apply for the loan with a SBA guarantee.
No. 4 Join the “SBA” bandwagon
Unlike a bank, the SBA doesn’t typically loan money directly to a business. Instead, it can guarantee a bank loan, which lowers the bank’s risk and greatly increases your chances of getting approved with favorable interest and payment terms.
Most loans guaranteed through the SBA are between $25,000 and $750,000, but they can take up to three months to complete. And the SBA typically doesn’t offer financial assistance until a bank has turned down the business owner.
Of the few direct loans the SBA does make, most are to existing businesses for expansions rather than funds for a startup. For a list of the groups that are eligible for direct loans from the SBA, visit sba.gov.
No. 5 The “customer” is always right
If your business is offering a new product or service directly to the public, some of your potential customers may be willing to help with funding — if the product or service can be customized to suit their needs. For instance, you want to open an after-school gymnastics facility. You may offer special programs and personalized coaching to the children of interested parents who are willing to help get you established. By gathering their input, you’ll also improve your knowledge of what the customer truly wants.
If you’re making a product, some suppliers may be able to keep inventory on hand for you without requiring immediate shipment and payment. With longer payment terms, your cash flow can stretch further. However, you must be able to guarantee account reconciliation by a certain date to avoid interest payments.
No. 6 “Grant” me a wish
Many local, state, and federal foundations provide business funding in the form of grants, which are awarded to qualified individuals and do not have to be paid back.
If your business offers a product or service that will improve your community in some way, your chances of receiving grant funding improve greatly. You can research available funds through local grant agencies and even professional grant writers. In addition, training institutions offer coaching and paid database access to help you find specific types of grants.
No. 7 Home sweet “home”
Home equity loans or lines of credit (HELOC) are another excellent source of startup capital. Current interest rates for this type of loan are low compared with conventional business loans. So if you have solid equity in your home, this is an option.
Usually, this type of loan can be amortized over 10 years and is best kept under $100,000. As a bonus, the interest expense can be deducted on your taxes.
No. 8 Life has no “insurance”
Life insurance policies sometimes can provide a cash-out portion, or cash value. The two most common types are universal and whole life polices, and the cash value can be drawn from the policy at low interest rates.
This vested amount is equal to what you have paid into the account over and above your premium payments. Technically, you don’t have to pay back the money you withdraw if you choose not to, because in effect you’re paying yourself back. If you don’t repay the withdrawn funds, the overall policy payout is reduced by
