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Starting your Business: Financing

Friday, June 02, 2017

When I talk with people considering starting a business, financing the purchase is almost always one of their major considerations. It’s a widely accepted truth that one of the biggest contributors to any new business failing, is going in undercapitalized.  With that in mind, here’s a quick review of the most popular ways businesses get financed:


The first and most obvious option, is to look at your savings. If you have mutual funds, bonds and stock market investments, you can liquidate (taxes will be incurred) and apply towards your business.  Many people feel more secure investing in their own abilities - which they can control - rather than suffer the unpredictability and lack of control inherent in the markets.  If your portfolio exceeds the amount of money you need – you can quickly and easily borrow against your securities by contacting the custodian of those securities.  Interest rates are good, and you simply pay yourself back when you can.  If your need for funding is half (or less than half) of the value of your securities, this is a good route to go.  Using some of your savings to help fund your franchise is always ideal – and in fact lenders will always require you to use SOME of your own dollars. When it comes to fully funding your business from your own personal assets, one thing to keep in mind is that experts recommend that you never invest more than 75% of your cash reserves. For example: If you have $100,000 in savings, invest no more than $75,000 of your own cash.  

Rollovers as Business Startups (ROBS)

Another option is to use your retirement funds. There are specialized financial companies that will set up and facilitate the (tax free) transfer of your retirement funds into your business. This can be a very attractive way to go if you feel that your business will grow in value and that you may want to sell it in the future.  The retirement account will own the business, and when you sell, the bulk of the capital gains can be sheltered inside the account.   ROBS allow you to access your retirement funds without incurring taxes regardless of your age.  And best of all, this option allows you to start your new business completely debt free – you don’t have to pay back the money you withdrew unless you want to replenish your retirement savings. This account is now your business retirement plan which you can fund or not fund going forward.  There are plenty of caveats, not the least of which is that your business will be electing a C Corporation entity, but talk to your tax advisor as this may be the most attractive option for you.

Bank and Credit Union Loans

If your business is a startup – this is not going to be an easy option. The important issues in landing bank financing will be your credit rating, collateral you are willing to put up and your background and skillsets.  You will need to present a complete loan package including a personal financial statement, copies of personal tax returns for three years, and verification of the source of your down payment as well as a well thought out business plan.  

 Resale opportunities, which are already cash flowing and have some operating history lend themselves to this option.  If you have a good relationship with your bank, strong assets and are willing to sign a personal guarantee, this option is the best in terms of rates.

You should also be prepared to be asked to put in your own money. Banks will, in the case of SBA loans, usually ask that you invest between 20% – 30% of the amount needed so that you have “skin in the game”.

SBA Loans

Another option is to try to get a loan backed by the U.S Small Business Administration (SBA).

One reason SBA loans are so appealing to banks is because they are partially guaranteed by the government, which makes them less of a risk to the lender. These loans provide short-term capital (typically 7 or 10 year terms) that can cover equipment, lease buildout (tenant improvement) and working capital.  These loans carry different interest rates, but usually are 2.75% over prime and will also require you to inject anywhere from 20-30% of the loan in cash.

Expect onerous paperwork and preparation – you’ll need, among other things, three years of tax returns, a thorough business plan and other types of documentation.  As in straight commercial loans, your background and skill set will be an important consideration.  But remember, without collateral you are unlikely to find a bank willing to take the risk.

Unsecured Lines of Credit

No discussion of funding would be complete without talking about unsecured lines of (business) credit.

A non-traditional line of credit in the form of business credit cards are among the easiest lines of credit you can get. It will provide fast access to cash, and payment flexibility typically associated with a traditional credit line but without all the drawbacks.

Qualifying for this type of revolving credit line is FICO® driven and doesn’t require the yearly reviews, excessive documentation and level of scrutiny that comes with a traditional credit line.

Some of the advantages of non-traditional business lines of credit are as follows:

1) Access to cash quickly – With unsecured business credit cards, you can utilize as much or as little credit from your line as you want to, anytime and anywhere

2) High credit limits – Business credit cards carry high credit limits, making it extremely convenient to finance larger business purchases. Many cards even offer 0% APR for the first 12 months.

2) Flexibility – With business credit cards you have flexible payment options compared to a fixed month-to-month payment that comes with a business loan. When you tap into your credit line, you have three options every month. You could pay the full amount due, pay at least a minimal portion of the balance or pay greater than the minimum amount due.

3) True separation – Business credit cards enable business owners to separate personal and business expenses while benefiting from business credit reporting. This makes it possible for business owners to establish the creditworthiness of the business itself.

4) Personal credit protection – small business credit cards that report solely to the business credit agencies allow business owners to protect their personal credit ratings while building their business credit.

Of course, these lines of credit have significant drawbacks as well: once the introductory interest rate is over, the rates jump and you can get into trouble quickly. It’s important to manage your debt responsibly, make large payments when you can, and get those credit card debts paid off first.

For this reason, we generally recommend using another source as your primary source of funding, while also lining up unsecured lines of credit as a supplemental form of “insurance” so you can be well capitalized for those first few months when cash flow will be minimal.

Home Equity Lines of Credit (HELOC)

From Home Equity Line of Credit (HELOC) is a type of mortgage loan usually taken using the home equity as a security for the loan. HELOC is used for home improvements, medical bills, and purchases. The funds are obtained by writing checks against the line of credit. Interest paid on the loan is generally tax deductible. The difference between a conventional loan and a HELOC is that in HELOC, a borrower is not advanced the entire sum up front. The customer uses a line of credit to borrow sums that total no more than the credit limit.

Home equity lines of credit are a great option to consider - assuming you have home equity.  Most banks will loan up to 80% of the value of your net equity – the difference between your current market value and your mortgage balance.  Market value is determined by an appraisal – which you’ll pay for.  These loans are inexpensive to initiate and relatively quick and easy to tap - and allow you to access the built up equity in your home with very little paperwork and fees.

These are just some of the more traditional methods of funding your business.  Most businesses are started using a combination of these options along with OPM (other people’s money.  Many large and successful business (Whole Foods is one that comes to mind) were financed in the beginning by friends and relatives.

Jane Stein
Previously with a large Wall Street firm, Jane Stein was a Certified Financial Planner for over 25 years, and provided comprehensive wealth management solutions for a large base of families – representing over 250 million in assets. She wrote an investment column, and conducted public seminars titled “Money Matters for Women”, in an effort to empower women to take charge of their investments. Now she helps men and women achieve financial security through business ownership. Jane Stein is the founder of
Your Franchise is Waiting, a consultancy firm for men and women exploring franchising as an alternative career path.

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