If you have savings, consider using the savings as collateral for a loan, rather than using your savings directly.
For example, you can use your $10,000 savings as collateral for a $50,000 loan, giving you an additional $40,000 to use in your business. If you do this, banks will probably require that you put the $10,000 savings in a certificate of deposit (CD) that you cannot touch.
Remember that by doing this, if your business fails, you will owe $50,000, and you will only have $10,000 to pay it. So make sure that you have a solid plan for paying back the loan.
If you cash out your retirement fund before you are 55, you will owe a 10% penalty plus tax on the amount you cash out. However, there are two other alternatives:
Individual Development Accounts (IDAs) are matched savings accounts that enable low-income families to save and build assets. The working poor agree to save a specific amount per month, which is matched by the sponsoring agency.
The match incentive is provided through government or non-profit sources, such as the United Way.
To find an IDA sponsoring agency in your area, click here.
You can sell stock to fund a business or consider borrowing against your stock portfolio. Borrowing against a stock porfolio is called a margin loan. Brokers can lend you a percentage of the value of your stocks (at most 50%) with interest rates based on the federal reserve rates. There is no fixed repayment schedule, but you may be required to deposit funds if the value of your account falls.
The IRS will only allow interest to be deducted if the borrowed funds were used for a taxable investment.
You cannot borrow against an IRA (individual retirement account). You can withdraw funds for up to 60 days and re-deposit the amount without a penalty. However if you keep the funds for over 60 days, there will be a penalty, plus you have to pay taxes on the amount withdrawn.
You can not borrow against a SEP-IRA account. You can, however, open a Self-Employed Solo 401(k) and do a rollover of your SEP account into your Self-Employed Solo 401(k) account. Once the funds are in a 401(k) account you can borrow against your contributions to the 401(k).
Credit unions are often an excellent place to find small business micro-loans. Credit unions are member-owned and their mission is to invest in their members and their community. Often loans from credit unions are 1% below bank rates.
Credit unions are currently limited to loaning $50,000 to a member for a business. Any amount beyond that must have a state or federal guarantee.
Advantages
Disadvantages
Selling across state lines
If you are selling securities to people outside your state, you are responsible for complying with SEC rules. Generally, you do not have to file with the SEC if you comply with Regulation D:
Click here for more information about SEC filings
Partnership or Loan?
It is critical that you decide whether the funds are to be repaid. If yes, this is a loan and it should be put in your business' balance sheet as a liability. You should document the loan (even in a letter) with the interest rate and repayment schedule.
If funds are not to be repaid, the funds are either a gift or a partnership investment. Unfortunately, setting up a partnership investment has complications. Partners have the same liability as the owner, unless you form a limited partnership, a corporation or an LLC. That means if the business fails, the partners will use their personal assets to pay any business debts. Unless the partner is involved with the day-to-day operations, most people would not agree to this.
To solve this problem, you can get creative and set it up as a loan, with payment terms be based on the company's net revenue. Then document it as a liability on your balance sheet.
If you set up a partnership, limited partnership, corporation or LLC:
Funds from Friends of Friends
To avoid criminal securities violations, you should NEVER publicly advertise the stock and only seek funds from people you directly know. Otherwise, you should work with an attorney to make sure you are following securities laws.
An attorney can help you do a private placement, which allows you to sell ownership interests to "accredited investors" (people with over $1,000,000 in personal wealth).
Never advertise ownership interests to the general public. This is a serious violation of SEC (Securities and Exchange) rules.
If you sell a security, you are responsible for complying with your state's securities regulations. Usually for small transactions there is a simple form to complete (or no form).
Best Practices
Ongoing Responsibilities
Advantages
Disadvantages
Your credit score and negotiating credit card interest rates
Before switching credit cards to get a lower interest rate, consider contacting your existing card company and requesting a lower rate.
How to choose a credit card
Credit cards differ, and it is worth comparing them before choosing one. There are at least 5 things to consider:
http://www.creditcardguide.com/business-credit-cards.html allows you to easily compare online credit card offers. You should also contact your local bank to learn about their credit card offers.
Personal Guarantees
When you get a business credit card, be sure to ask about required personal guarantees. A personal guarantee means that if there are not enough business funds to pay the debt, the guarantor will use his/her personal assets to pay it. If your business is a corporations or LLC, this means that if your business closes, you will still be liable for the credit card debt.
It is possible, but not likely, that you can get a business credit card without a personal guarantee. Your business would have to have a good credit rating.
Secured credit cards
Secured credit cards are for people with no credit history. You can build credit by depositing money equal to your requested card limit. Then, if you default, the bank has a way to get its money back.
Generally secured credit cards are only used until you can establish credit and obtain a regular credit card.
Please note that even though you have deposited money equal to your card limit, you are still required to pay monthly payments like regular credit cards. These monthly payments are the only way that you are establishing credit. (Cards where you don't have to make monthly fees are called cash advance cards; however they do not help you establish credit.)
Secured credit cards with lower fees are often available through credit unions. Whatever company you use, it is important to compare fees and service. Watch out for companies that require additional "insurance" or high fees.
Advantages
Disadvantages
Use equity for SBA guaranteed loan?
Instead of using the equity directly in a home equity loan, consider using it as collateral for an SBA loan. Although the loan process will take longer, your money will go further.
For example, if you have $50,000 equity that you could use in a line of credit, consider using that as 20% collateral for a $250,000 SBA loan.
Remember, that you have to pay back the full amount of the loan, so be sure to have a solid repayment plan.
Line or loan
A home equity line of credit allows you to use some or all of your equity (up to the line of credit limit). Payments are based on the amount of the line that has been used. You are expected to continually use and pay down your equity line of credit; there is no loan payoff-date.
Equity lines are best for purchases that you will be able to repay in one or two months. Usually there is an annual fee for a line of credit.
A home equity loan is a fixed amount that you take and use. Payments are fixed each month and you are expected to pay the loan off at a future date. Home equity loans are best for lump-sum purchases that you want to pay back over time. There are no annual fees for home equity loans.
Corporation? Here are some tips
Officially, you are not supposed to combine personal assets with corporate assets. If you use home equity loan to fund your corporation, you should do it as purchasing stock or as a loan between the corporation and yourself. Either way, you should document it in your corporate minutes and advise your accountant.
Home equity lines of credit mix personal assets with corporate assets and really aren't appropriate for funding corporations.
Best Practices
Make a plan.
Equipment loans are used to finance business vehicles, tools, fixed assets, and large computer systems. The equipment can be new or used. If new equipment, the loan can be for the total amount of the purchase. Used equipment is often 75% of the current cost of the equipment. It is easier to finance equipment that has a strong resale market (such as trucks) than specialized equipment with little resale use.
Even though the equipment will be used as collateral, borrowers still need to show they can repay the loan. They must provide business financial statements and business tax returns. Sometimes borrowers may be required to personally guarantee the loan.
Difference between equipment loans and leases
Equipment loans and equipment leases are different. At the end of a loan, you own the equipment. At the end of a lease, you return the equipment and presumably start the lease process again.
For bookkeeping purposes, if you have a loan, you put the asset and loan on your balance sheet. If you have a lease, you do not put them on your balance sheet, the lease payments are strictly operating expenses.
In both cases, if you don't make payments, the lender (or leaseholder) will repossess the equipment.
Information from the Equipment Leasing and Finance Association
The Equipment Leasing and Finance Association has developed Equipment Finance 101, with information on the benefits of equipment leasing, finance types, and loan/lease comparisons. Click here to go to Equipment Finance 101
Advantages and disadvantages of equipment loans
Advantages
Disadvantages
UCC Statements
Best Practices
Ongoing Responsibilities
Advantages
Disadvantages
Lines or Loans?
Corporation? Here are some tips
Best Practices
Micro-loans are usually for $5,000 to $35,000. The loans are often available for start-up businesses.
Advantages:
Disadvantages:
Where to find micro-lenders
Micro-lenders can be found through at least 5 sources:
Local CDBG loan funds
Local banks and credit unions with small business focus
Accion Microloans
Ongoing Responsibilities
Advantages of business lines:
Disadvantages of business lines:
Advantages of business loans:
Disadvantages of business loans:
Business line or business loan?
Businesss loans are used for one-time purchases that you will repay over a period of years. This includes equipment, facilities, start-up costs, and property. Business loans are expected to be paid off.
Business loans can be guaranteed by the SBA or other state programs. Business loans also require collateral - either from the owner or the business.
Business lines are used for ongoing purchases that are connected to a sale. Usually inventory and overhead is funded with a business line of credit. Business lines of credit are expected to be used each month, repaid and then used again.
Business lines of credit do not have collateral, but the owners are often asked to guarantee the line. That means if the business fails, the owner agrees to use his/her personal assets to repay the line of credit.
Required collateral and documentation
For loans, most banks require either a personal guarantee or specific collateral. A personal guarantee means if your business assets are insufficient, you will use your personal assets to pay back the loan. For sole proprietors and partnerships, this is irrelevant, since your business debts and personal debts are mixed. However, it is significant for LLCs and corporations, which normally are protected from business debts.
Collateral can be cash, home equity, equipment, receivables, or investments. Banks will also require your business and personal tax returns, business financial statements, and a plan for the proceeds. You will also need to provide a copy of your business formation documents.
Lines of credit are usually based on a guarantor's personal credit, with business financial statements showing the ability to repay. You will need to provide a copy of your business formation documents.
Based on your credit score, banks may require that your collateral be "protected" so it is not spent. You may have to deposit cash into a long-term CD, they may file a UCC statement on equipment so it cannot be sold, or they may place a deed of trust on your home, so they are paid if your home is sold.
Federal SBA or state guaranteed loans
Federal SBA or state guaranteed loans protect the lender from 50 to 80% of any loss on an insured loan. It does not protect the borrower - so if a loan is in default, the entire loan goes against the borrower's credit record.
You get a guaranteed loan through your bank. Each bank has its own lending policies, so if you are rejected by one bank, it does not mean you will be rejected by the bank next door.
Click here for a list of preferred lenders for your area.
Building business credit
You will reach a major business milestone when you are able to get business credit based on your business alone. To do that, you need to build business credit.
Click here for information from the Funding Toolkit within the Tools for Business.
Best Practices
Know whether you need a line of credit to deal with cash flow timing, or a loan to purchase something over time.
It is faster, requires less paperwork, and banks make more money by giving you a business line of credit rather than a guaranteed loan. But your interest rate for the loan will be much less for the guaranteed loan than for the line of credit.
Lines of credit:
Use the line of credit for purchases directly connected to your sales.
When you receive payments from your customers, pay the amount of your cost of sales towards your line of credit.
Ongoing Responsibilities
With lines of credit, you are expected to:
Make the monthly payments, paying the line of credit down as you receive payments from your customers
Limit use of your line of credit for expenses related directly to sales.
With business loans, you are expected to:
Make the regular monthly payment
Provide your lender quarterly accounting reports, with a balance sheet and your net profit.
Seller carryback financing is when the seller of an existing business takes a note for part of the purchase price. Usually the note is subordinate to the primary financing, which means if the business fails, the primary funder gets repaid before the subordinate (seller).
About 40% of businesses sold have some type of seller carryback financing. It is usually because the buyer cannot get financing for the full purchase price and does not have enough cash to pay the full purchase price.
Advantages/Disadvantages
Advantages
Disadvantages
The Internet has opened new avenues for financing a business. Person-to-person lending, dubbed Banking 2.0, allows individuals to lend to each other at a set rate on a certain timetable and offers a mechanism for tracking and payment. On these sites you can post your business plan and potential lenders (individuals) can decide whether they want to loan to you. Most sites require that you have a good credit score (640 or higher) to participate.
It is still too early to know the downsides of online lending for borrowers. However, a few have been noted:
Advantages
Disadvantages
What is factoring?
Factoring is a method of financing used to fulfill large contracts. Businesses with large contracts need to purchase inventory and make the product (or provide the service) before they are paid, requiring significant capital. Often the business is unable to get lines of credit or loans using its own credit. This is where factoring comes in.
The factoring finance company evaluates the credit worthiness of your customer - not you. If your customer is creditworthy, the finance company purchases your contract and gives you a percentage of the contract's value. You can use this money to purchase inventory and provide the product or service. When you have completed the job, your customer pays the factoring company, the factoring company keeps the amount it paid you plus interest, and pays you any remaining amount.
To use factoring, you must have a purchase order and it should be from a reputable company.
Finding finance companies that factor
In addition to looking on the Internet, you should ask for references from your banker and accountant.
Factoring process
You will need to complete an application, provide your company's most recent accounts receivable and accounts payable aging reports, a master customer list and a sample invoice. You will also need to provide your company's legal formation document (articles of incorporation, articles of organization or dba).
In order to provide you a quote, the factoring company will evaluate your customer list and the age of your accounts receivable.
Once you are approved, your customers will be notified that receivables are handled through them and that payments should be made to them. New invoices should be processed through your factoring company. You will immediately receive a percentage of the invoiced amount (90% is common), with the balance sent to you when the invoice has been paid.
Best Practices
Use factoring funds to fund a specific job. Do not use the funds for outstanding bills or other jobs.
Ongoing Responsibilities
Provide your factoring company new invoices.
Forward any payments received by you to your factoring company.
The SBA typically handles export loans for amounts under $2 million through its SBA Export Working Capital Program.
The Export/Import Bank processes export loans for amounts over $2 million. Global Trade Financing: Who takes the risk
Financing to operate a business involved in international trade is complicated. But it all comes down to who will take the risk that:
In addition, shipping time means that payment can be delayed for weeks or even months.
All this requires choosing reliable vendors and customers plus a combination of financing and insurance.
Here are 4 ways global trade is financed:
Cash in advance benefits the seller; the buyer takes all the risk.
Open account (extending credit to the buyer for 30, 60 or 90 days) benefits the buyer; the seller takes all the risk.
Letter of credit is mutually beneficial. The purchaser's bank issues a letter of credit saying that it has the money and will release it on certain terms.
Documentary collection is also mutually beneficial. The buyer sends document to the purchaser's bank and after the buyer agrees to the terms, the bank releases funds according to the terms of the collection.
Forfaiting
Forfaiting is the process where a middle-man (intermediary) purchases the accounts receivable from the seller at a discount, takes all the risk of non-payment, and makes money when the accounts receivable is paid. It is most commonly used in Europe.
Loans against import
Loans against import are bank loans that allow you time to convert the imported goods into manufacturered and saleable items. When you use an LAI, technically you do not own the goods until you have paid for the loan. However the goods are released to you by the bank under a TR (Trust receipts) agreement during that manufacturing period.
You must use Documentary Credit or Documentary Collection terms with the seller.
With Documentary Credit, the seller receives documents from the buyer's bank listing the documents necessary to release the funds. The seller must present those documents in order to receive payment.
With Documentary Collection, the seller ships the goods and presents documents to his or her bank specifying that the documents should be released to the buyer only upon payment, or acceptance of a time draft promising payment at a later date. The seller's bank sends the documents to the buyer's bank in order to collect payment.
Clean import financing (loan against supplier invoice and evidence of shipping)
The benefit of a Clean Import Loan is that it provides a business owner with the money to pay suppliers without having to wait to sell the merchandise first. The loan is funded based on a supplier's invoice and evidence of shipping.
Mezzanine debt uses a combination of subordinate debt and equity options to raise money for an acquisition or business expansion. The lender/investor loans the company part of the money and invests in the company for the remainder. The debt is subordinate to the company's other debt, meaning it has claims on the cash flow after the primary debt has been paid. The investment is usually in the form of warrants or conversion options that are paid out when the company goes public or refinances all of its debt.
Mezzanine debt only works for companies with healthy cash flows. Service companies with little brick and mortar collateral required by traditional lenders, can benefit from mezzanine financing.
Mezzanine debt is for middle-market companies with total revenue of generally less than $500 million.
Because the lender/investor has two roles, they are concerned about short-term cash as well as long term equity gains.
Advantages/Disadvantages
Advantages
Disadvantages
Legal requirements
You are not allowed to advertise ownership interests in your business or sell to people you do not know unless you have registered with the SEC (Securities and Exchange Commission). Registering with the SEC is a cumbersome process, and few non-public companies go through the process.
You can, however, sell an ownership interest to people who meet the SEC requirements for an "accredited investor" through a private placement. There are multiple ways that someone can be an accredited investor, but usually it means they have a net worth of $1 million at the time of purchase. Click here for complete information.
Private placement means that the sale was made to someone known to the financial intermediary or the seller; i.e. there was no advertising to the public at large.
Even if you use a private placement to an accredited investor, it is strongly suggested that you work with an attorney experienced in private placements.
The difference between angels and early stage venture investors
Angel investors are wealthy individuals who invest in businesses on a part-time basis. Early stage venture investors are professional investors who invest for a living.
Angels are willing to invest in people - they like the founder and the idea. Venture investors are looking for the highest chance of success and profit
Angels want to be part of the process of growing the business and are more open to how that is done. Venture investors want to use their professional, "proven" teams to grow the business quickly and then sell their interest.
Expectations of early stage investors
Ongoing Responsibilities
Online Sources of Capital
The Internet has opened new avenues for financing a business. Person-to-person lending, dubbed Banking 2.0, allows individuals to lend to each other at a set rate on a certain timetable and offers a mechanism for tracking and payment. On these sites you can post your business plan and potential lenders (individuals) can decide whether they want to loan to you. Most sites require that you have a good credit score (640 or higher) to participate.
It is still too early to know the downsides of online lending for borrowers. However, a few have been noted:
The loans are fixed, with both principal and interest due each month. If you can't make a payment, you have to negotiate online (if that is even possible). It is much easier to go visit a local lender and negotiate face-to-face.
These private lenders aren't regulated, so the documentation and fine print are critical. You should definitely consult an attorney before signing a loan agreement.
Never advertise shares for sale at any site. It is illegal to advertise securities to the general public.
Private placement debt allows larger companies to obtain long term capital without giving up equity in your business or registering with the SEC. The private placement market operates through banks and investment companies with access to wealthy individuals and institutional funds. The benefits include:
Early stage investors are usually angel (individual) investors who invest in a business and help scale it so that it is attractive to venture capital investment. Early stage investors are likely to be very involved in developing the business' strategic plan and creating a good management team.
Once you have early stage investors, the business becomes separate from the founders, and decisions are made on the best interest of the company only. This means that founders are often replaced because their skills are not what the business needs to grow.
Is your business ready for an equity investor?
Your business is ready for equity investment if
Early stage investors are looking for companies that have created traction - which shows you have a good idea, you can get it ready for sale, and the market likes it. The investor's expertise will be to provide capital so that your business can be scaled and sold it to someone with lots of money. Legal requirements
You are not allowed to advertise ownership interests in your business or sell to people you do not know unless you have registered with the SEC (Securities and Exchange Commission). Registering with the SEC is a cumbersome process, and few non-public companies go through the process.
You can, however, sell an ownership interest to people who meet the SEC requirements for an "accredited investor" through a private placement. There are multiple ways that someone can be an accredited investor, but usually it means they have a net worth of $1 million at the time of purchase. Click here for complete information.
Private placement means that the sale was made to someone known to the financial intermediary or the seller; i.e. there was no advertising to the public at large.
Even if you use a private placement to an accredited investor, it is strongly suggested that you work with an attorney experienced in private placements.
The difference between angels and early stage venture investors
Angel investors are wealthy individuals who invest in businesses on a part-time basis. Early stage venture investors are professional investors who invest for a living.
Angels are willing to invest in people - they like the founder and the idea. Venture investors are looking for the highest chance of success and profit
Angels want to be part of the process of growing the business and are more open to how that is done. Venture investors want to use their professional, "proven" teams to grow the business quickly and then sell their interest.
How much equity should you give an investor?
Here is a simulation tool that helps you see the effects of having several investment rounds. Investment simulation tool
What is the investment process?
The most important contribution of early stage investors is their expertise, not their money. This is because they will be working with you to identify which business model and strategy will be most profitable and sustainable. So, you are looking for angel investors that have expertise in your industry. This involves a lot of networking and research. One way is to hire attorneys and accountants with expertise and connections in your industry and then ask them for contacts.
You are looking for one investor. That investor will open doors to others. So it is much better to carefully target who you talk to, rather than pitching your idea to lots of people hoping for a group to be interested.
For additional insight into attracting investors, consider reading these books:
Click here for books on angel, venture and other forms of business financingExpectations of early stage investors
Ongoing Responsibilities
Where to find early stage investors seeking business investments
