Whether you’re dreaming of starting a business or financing a franchise in the near — or far — future, you may want to explore financing options as your next step.
If you’re like many entrepreneurs, you’ll reach into your own pockets first, then supplement that with other options such as small business loans, 401(k) business financing, lines of credit and more. It’s also important to note that most entrepreneurs don’t use just one method for bankrolling a business, but instead a combination to comprise the solution that works best for them. Let’s take a look at the top financing methods for 2018 and see how they stack up:
1) Cash. Look no further than your own accounts when it comes to financing your dream business or franchise. Approximately 59 percent of survey respondents for the Guidant 2018 State of Small Business survey, completed in partnership with LendingClub, agreed. This isn’t surprising as many entrepreneurs use their own cash to finance at least a portion of their business. What is important to note is that external investors such as lenders view this positively since you’re essentially investing in yourself with your own money—a strong sign you’re driven to succeed. Investors also see that you’re saving on interest payments since you won’t be paying yourself back for your initial cash investment. On the flip side, using your own cash can mean you have less personal savings to fall back on if the business ever underperforms, so keep that in mind, too.
Eligibility Requirements: None
2) Friends and Family. When you’ve depleted your cash reserves, many people turn to friends and family as a resource for funds, according to the survey. In fact, 23 percent of respondents said they felt comfortable seeking monetary assistance from this trusted group. According to the Small Business Administration article titled “6 Tips for Borrowing Startup Funds from Friends or Family,” you may be able to get money quickly from a close friend or family member, and with fewer requirements such as good credit or time and effort applying for a small business loan. That said, if you don’t pay your friends and family back on time, you may damage those relationships, so be true to your word if you chose this route because you have a lot more than just the money at stake.
3) 401(k) Financing. If you’ve never heard of this type of financing (formerly called Rollovers for Small Business Start-ups or ROBS) you’re basically using your eligible retirement account to buy a business debt-free. Approximately 22 percent of survey respondents utilized this type of funding that requires no loan—just an investment in yourself and your business. 401(k) financing is a quick path to profitability because you have no monthly loan payments or interest, and it’s easy to qualify because you don’t need a certain number on your credit statement. Additionally, 401(k) financing does not trigger tax penalties or an early withdrawal fee so you can keep saving for retirement at the same time. Your corporation will, however, need to continue to sponsor a 401(k) plan, performing annual filings with the IRS and DOL.
Eligibility Requirements: You have at least $50,000 in a rollable retirement account
4) Lines of Credit. According to the survey, 17 percent of respondents are utilizing lines of credit to finance their franchises and start their businesses. That may be in part because of how flexible this type of financing is, as well as the variety of types. And, you only pay interest on the money you take out, in stark contrast to a small business loan, where you are given a lump sum, and pay interest on that. You also get access to cash with a line of credit card, and at a lower rate than traditional credit cards. An Entrepreneur.com article titled “The 4 Lines of Credit Now Available to Small Businesses” outlines the common types: Traditional line of credit, short-term line of credit, equipment-backed line of credit and invoice-backed line of credit.
- Your business is more than 3 years old
- The company is profitable
- Your business shows a positive net worth
5) Unsecured Loans. Unsecured loans were popular with about 13 percent of survey respondents. However, there are a couple of items to keep in mind when dealing with unsecured loans—a notoriously quick financing method that doesn’t require any up-front collateral. What is required, however, is a squeaky clean credit report with no red marks on it, and a healthy credit history and score. With those in line, you can get up to $150,000 without risking any of your personal property. Also, while interest rates are low the first year, they will likely escalate after that, so while it’s a convenient short-term solution, remember the rates will rise so you’ll need to be able to pay the higher rates on time later.
- 690+ credit score
- Credit utilization rate below 50%
- Minimal recent credit inquiries
- No recent derogatory comments on your credit report
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6) Equipment Lease. According to the Guidant survey, 8 percent of entrepreneurs are funding their businesses with an equipment lease. This type of lease is pretty straightforward: You pay the owner for the use of the product, so you don’t have to purchase it. This could be handy when starting a business that requires a lot of equipment up-front, and you don’t have the capital. According to Inc.com, there are many types of equipment leases that they classify by “ticket.” For example, there are “small ticket,” “medium ticket,” and “large ticket” leases based on the value of the equipment. Inc. states you should know the terms of your lease, as well as the type since a “small ticket lease rarely involves much more effort than qualifying for a credit card.” Of course, beware of late payment penalties and any tax implications. For more information on equipment leasing, see the Equipment Leasing Association website.
7) SBA Loans. About 7 percent of survey respondents are utilizing Small Business Administration (SBA) loans to finance their dreams. One of the most common types of loans, SBA loans are cost-effective, and generally have low interest rates, no ballooning costs, and offer extended repayment terms. They’re also extremely flexible: You can receive up to $5 million in financing, which can be used for almost any purpose for your business, including start-up, acquisition and expansion costs. While they’re a relatively easy way to grow your business, the approval process can be lengthy—up to six months—so you’ll need to plan ahead if you go this route. Additionally, you’ll need to spend a fair amount of time filling out paperwork and gathering all your business documents. You can streamline this process working with a broker, however.
- 20 percent down payment for an existing business purchase (30 percent for a start-up)
- 640+ credit score
- Personal collateral required
- Industry experience preferred
- Secondary income preferred
8) Peer-to-Peer Loans. According to Entrepreneur.com, peer-to-peer loans are online intermediaries who connect lenders to borrowers. While not extremely common (coming in at only 4 percent in the survey results), these loans are newer and all digital, so many entrepreneurs may not even be aware they exist. Because you provide your identification and banking documents online, they are quick (you avoid the hassle and time of filling out lengthy paperwork). Additionally, you won’t generally need as high of a credit score or salary. Interest rates are low as well, and there are no hidden fees or charges. Entrepreneur.com also notes you can even get your loan within 72 hours in some instances—that’s pretty fast.
9) Home Equity Lines of Credit. Home equity lines of credit, or HELOC, were listed as a loan source for just 4 percent of Guidant’s survey respondents. With a HELOC, you use the equity in your home to gain capital for your business or franchise. Similar to a credit card, you’ll only have access to a revolving balance, and pay interest only on what you use. These loans are flexible and easy to qualify for with relatively low interest rates (which vary). In fact, they are fairly easy to get compared to traditional business loans. Don’t forget you are risking your home however, if you ever default on paying, and there are sometimes hidden fees and closing costs so keep your eyes peeled for the fine print.
- Minimum of 15 percent equity in your home
- 660+ credit score
- Credit utilization below 45 percent
10) Refinance of Existing Mortgage. The final type of loan from the survey is refinancing an existing mortgage, and only 2 percent of Guidant survey respondents used this option. Different from the aforementioned HELOC, with this option you pay off your old loan and replace it with a new loan. Of course there will be costs associated with this option, and according to the Federal Reserve, when you refinance and take out equity, you own less of the home so it will take more time to rebuild your equity. On the plus side, if the market is strong, it is a way to gain cash for your business.
- Strong history of making your mortgage payments
- Equity in your home
- Good credit score
*These requirements are approximations only. Actual requirements may vary by lender.