Before you can fling open the doors on your franchise or go live with the app for your start-up, you’ll need to make sure you have your funds ready and available. If you’re like some entrepreneurs, you’ll finance your dream venture by dipping into your personal cash reserves, and then apply for credit cards for the rest. But is that route really your best small business funding option?
Factors to consider include whether you are franchising or starting from scratch, how quickly you need the money, the flexibility of the method, the financial risk involved, and the loan repayment terms. Take a moment to browse the following top 4 best small business funding methods to see which one (or combination) is best suited to you, as well as what it takes to qualify for each. You might be surprised to find out more options exist than you even knew — and one or more may jumpstart or propel you on the path to business prosperity.
401(k) Business Financing (Rollovers for Business Start-ups)
Did you know there’s a method that allows you to finance your business debt-free, and start cash-rich? Rollovers for Business Start-Ups (ROBS), lets you roll your retirement funds from a 401(k), IRA, or other eligible retirement account to start a new business or purchase an existing business or franchise. As part of the structure, the new corporation sponsors a 401(k) plan, allowing you and your employees to continue to save for retirement. Best of all, there is no new loan needed, and no tax penalties, thanks to the Employee Retirement Income Security Act (ERISA) of 1974.
You can learn more about how ROBS works in our Complete Guide.
Rollovers for Business Start-ups (ROBS) Pros:
- Quicker path to profitability. By funding your business with assets you already have, you won’t have to make monthly repayments or worry about interest rates. Plus, because the ROBS structure doesn’t trigger an early withdrawal penalty or other fees, you can put more of your money to work for you. The process is often quick, as well — usually only about three weeks.
- No collateral/credit requirements. No minimum credit score needed. The only requirement for 401(k) business financing is to have a ROBS-eligible retirement fund (more than just 401(k)s qualify) with more than $50,000 in rollable assets. You won’t have to jeopardize your home or personal credit as collateral.
- Speedy cash injection. If you plan on going with a more traditional funding route, you can avoid pulling your personal cash by using the money from ROBS as the down payment for the loan.
- Control of your funds. Unlike the stock market, you can direct your ROBS retirement funds to your business, and you don’t need to worry about market volatility. In other words, you are investing in yourself and your dreams – and you’ll be the one working to ensure you succeed.
Rollovers for Business Start-ups (ROBS) Cons:
- Ongoing requirements. As a part of the ROBS structure, your corporation must sponsor a 401(k) plan. Though this is a competitive benefit for you and your employees, it does require annual filings with the IRS and DOL.
- Retirement risks. Though investing your retirement funds in the stock market is never a sure bet, some entrepreneurs are not comfortable with the idea of alternatively using their retirement funds to start a small business.
Rollovers for Business Start-ups (ROBS) Eligibility Requirements:
- At least $50,000 in a rollable retirement account
- No minimum credit score requirements
- No down payment needed
- Corporate structure requirements including forming a C Corp
Is ROBS the best choice for you? Find out today!
SBA Small Business Loans
Small Business Administration (SBA) loans are one of the most common forms of small business financing. That’s because you can get up to $5 million in financing, which can be used for almost any business purpose including start-up, acquisition, and expansion costs. Take note, however, that the SBA does not provide the loan directly to you, but rather backs up the loan through a bank or other qualified lender. The SBA even encourages banks to lend to small businesses, and in exchange it guarantees 75 – 85 percent of the loan.
If you’re a franchisor, you may even be able to receive approval easier (according to the International Franchise Association, because of a lower default rate for franchisor loans. You can even apply for an SBA loan if you’re a franchisor with poor credit or large amounts of debt. One SBA program that franchisees might want to look into is the 504 Loan Program. This option is popular because it typically offers business loans at fixed rates that can be repaid over the course of several years.
Of course, as with any financing option, pros and cons exist, so let’s take a look at those in more detail, as well as what it takes to qualify:
SBA Loan Pros:
- Cost effective repayment. With low interest rates, extended repayment terms, and no ballooning costs, SBA loans offer affordable repayment options for business owners at all stages.
- Flexible use. Loan proceeds can be used as working capital, revolving funds, or to purchase real estate, equipment, inventory, etc.
- More money to invest. With budget-friendly monthly payments, you can have more money to put back in your business.
SBA Loan Cons:
- Time to funding. The SBA loan process usually takes a minimum of six weeks for approval. Applying for a loan on your own can be even more time consuming as you’ll need to fill out multiple applications and gather a mass of documents. If you’re seriously considering this type of loan, make sure your “Five Cs” are in order: capital, credit, collateral, capacity, and character. You can also work with a third-party company that can help you streamline the process and who already has relationships with lenders in place.
SBA Loan Eligibility Requirements:
- 20 percent down payment for an existing business purchase or 30 percent for a start-up
- 640+ credit score
- Personal collateral required
- Industry experience preferred
- Secondary income preferred
Home Equity Lines of Credit (HELOC)
If you’ve been involved in the real estate market, you’re likely familiar with the Home Equity Line of Credit, or HELOC loan. With this option, you use the equity in your home to gain capital for your ventures. A HELOC acts like a credit card in which you have access to a revolving balance and pay interest only on what you use. Interest rates usually vary over time based on prime.
- Qualifying is quick. Given you have equity in your home, acceptable credit, and a means to pay back the loan, HELOCs can be fairly easy to obtain compared to traditional business loans.
- Affordable debt. Interest rates for HELOCs are usually significantly lower than rates for other loans, and the interest you pay is tax deductible.
- Works for working capital. Since a HELOC loan offers access to a revolving line of credit at any given time, they can be an affordable option to get over a momentary rough patch in cash flow.
- Risky to your home. Should you default on repaying your balance in a timely manner, you could be at risk of losing your home.
- Hidden costs and fees. HELOCs usually come with closing costs, attorney fees, loan processing fees, and sometimes inactivity and early repayment fees.
HELOC Eligibility Requirements:*
- At least 15% equity in your home
- 660+ credit score
- Credit utilization below 45%
*These requirements are approximations only. Actual requirements may vary by lender.
Are you looking for something that is quick to secure but don’t have any collateral? Unsecured loans might be right for you. With an unsecured loan you can typically borrow up to $150,000 without risking your personal property. These loans are based on creditworthiness, however, so you will need to have a positive credit history and healthy score.
Unsecured Loan Pros:
- Personal assets stay safe. You usually don’t need to risk your home or other property to secure the loan.
- Painless process. The process is generally simple and straightforward (no business plans or lengthy underwriting process). Guidant Financial unsecured loan clients secure an average of $104,000 using unsecured loans in only a few weeks.
- Freedom of use. No restrictions exist on what you can use the money from your loan on.
- Low introductory rates. Interest rates begin at 0 – 3 percent for the first year, making it a solid short-term financing option.
Unsecured Loan Cons:
- Rates can increase. After the first year, the interest rates for unsecured loans will rise, making them a less than ideal option if you won’t have the cash flow to pay it back quickly.
- Requires 690+ credit score. Because unsecured loans aren’t backed with property, they do require excellent credit scores to qualify.
Unsecured Loan Eligibility Requirements:
- 690+ credit score
- Credit utilization rate below 50%
- Minimal recent credit inquiries
- No recent derogatory comments on your credit report
Financing is as Individual as You Are
Not every small business or franchise is the same, just as not every entrepreneur is the same. That’s why it’s fundamentally important to do your research and find the best combination of small business funding methods for you.
Sometimes the right bank or lender, timing, and circumstances dictate the best option(s) for you. Thankfully, consulting with a professional can often help you move the funding process along more quickly.