What if you could start or buy your own business without going into debt? Imagine — no interest rates, no monthly repayments to a lender, no impact on your credit score and no collateral.
A pipe dream? No, it’s called equity financing: a small business funding method that leverages assets you already own so you don’t have to take on additional debt.
What is equity financing?
In most cases, equity financing involves raising business capital by selling shares of your business. But it can also refer to reinvesting assets you already own into a small business, whether it’s using stocks or bonds in your investment portfolio, funds from a savings account, or even retirement assets using a process called Rollovers for Business Start-ups (ROBS).
Equity financing can offer several benefits over the traditional debt financing that many first-time entrepreneurs think of. Because you’re launching a business with money you already possess, there are no eligibility requirements and no impact to your credit score. Furthermore, you won’t need to pay the money back, which is especially useful since you’ll be avoiding interest rates. For many business owners, equity financing allows them to generate a profit faster since they have no monthly payments.
401(k) Rollovers as Equity Financing
With the Rollover for Business Start-up financing structure, also known as a 401(k) rollover, you can withdraw funds, without tax penalties or early withdrawal fees, from your traditional IRA, SEP or 401(k) retirement account to invest in your business venture. As a part of this process, your new corporation will sponsor a 401(k) plan to benefit you and your employees, allowing you to continue to save for retirement using an investment you can control.
Advantages of using ROBS as Equity Financing:
- A Quicker Path to Profitability: Starting your business debt-free will lower your overhead and eliminate risking your personal assets, whether it’s your home, boat or other property. Without paying loan interest, you can make money sooner rather than later and use it to reinvest in your business.
- Grow Your Nest-Egg: Since you won’t have to take a taxable distribution with ROBS, you can put more of your retirement savings to work for you. Plus, since ROBS requires you to start a new 401(k) plan, you can continue to save for retirement, potentially allowing your nest egg to grow exponentially larger than it would have otherwise.
- Control Your Investment: Unlike the stock market, you can control this investment as a business owner. Essentially, you’re investing in yourself and your dreams as an entrepreneur.
- Peace of Mind: This tried-and-true structure has been in use since the Employee Retirement Income Security Act was passed in 1974. Since 2003, Guidant’s helped more than 11,000 entrepreneurs invest more than $3 billion in retirement assets in small businesses nationwide.
What about debt financing?
If your personal assets aren’t robust enough to finance your business with equity, or if you prefer to not use your retirement savings, traditional debt financing, including SBA loans and bank loans, can still be a practical option for many aspiring business owners. SBA loans are typically the preferred loan method for small business owners because they’re backed by the government (meaning if you default on your loan, the government will pay a certain amount to the lender), and they promise low interest rates and longer repayment terms (making monthly payments more affordable).
Keep in mind, though, that these more well-known methods of financing are not always the most efficient or cost effective. SBA loans can take 120 days or more to finalize, which is longer than many entrepreneurs prefer to wait, especially if they have a tight time frame. Also, banks typically favor candidates who have a credit score above 640, proof of secondary income, at least three years’ prior industry experience and personal collateral to back the loan.
The Hybrid Solution: Combining Debt and Equity Financing
An increasingly popular option for many entrepreneurs is to combine equity financing with debt financing to increase overall access to capital and reduce the amount they need to borrow. One example of this is combining both ROBS and an SBA loan. This arrangement reduces the amount of capital needed from a loan, thus lessening the amount to pay back. In addition, loans can require a down payment of 20-30 percent. By using ROBS equity financing, you can make that down payment without tapping personal savings.
Equity financing has its advantages, but so do loans. Thinking about your options? Compare the carrying costs of some of the most common financing methods here.