Of the different ways to access your home’s equity, a HELOC is probably the best option for entrepreneurs. It’s like getting a credit card, except it comes with a much higher limit and is secured by your house. The other options lock you into a payment schedule that won’t go away even as you pay back the money you borrowed.
When Using a Mortgage or HELPC Makes the Most Sense
Just like with other debt-financing options, your business model is key to whether it is the right fit. The moment you take on debt you are increasing your monthly payments and impacting your cashflows. This is even more important when your debt is secured by your home if you choose to tap into its equity. Make sure you will have strong revenue from day one so you don’t have worry about the added stress of missing mortgage payments.
This is obvious but this option only makes sense if you have enough equity in your home to qualify to use it. The percent you can borrow will vary from lender to lender, but I wouldn’t expect many lenders to go beyond 80-90% of your home’s value. Before you take the money, make sure you will have enough in your home to meet your business needs.
If you have explored all the self-funding, equity funding and non-collateral options and none of those are viable means to fund your business then using the equity in your home makes sense. While starting a business takes a certain acceptance of risk, putting your home on the line should be a last resort. Would you rather use up some of retirement funds or have your house foreclosed on? It’s a dark reality, but truth is not every business is a success. Be smart about what you risk, no matter how great of an idea it is.
How to Get Started with a Mortgage or HELOC & Where to Find Resources
To get started, you will need to get a sense of what your house is worth today. Zillow’s Zestimate tool is a great place to get a ballpark figure for what your home may be worth. From there, they offer some easy to use mortgage calculators to help you get a sense of what your monthly payments would be depending on the amount of money you are looking to take out.
Once you know how much you need and what you can afford to borrow, you need to choose the type of loan and lender. To learn more about the loans available to you, Zillow has a great Mortgage Learning Center. When you go to find the right lender, it is always worth trying to work with your current lender, but it is always good to have different options so check out this best HELOC lenders list form NerdWallet.
What is Seller Financing?
If you are looking to start a new business or franchise, unfortunately this funding option is not for you. Seller financing is only available to entrepreneurs who are looking to acquire existing businesses. If you are new to the small business world, this option may be completely foreign though 60% to 90% of business for sale included some level of seller financing, so odds are good you will come across it.
Seller financing is when the seller acts like a bank, they would provide you a loan to cover part of the overall purchase price. Typically, they will cover between 5%-60% of the purchase price. Obviously, the amount they are willing to finance varies considerably from deal to deal. You will be hard pressed to get an owner to finance 100% of the transaction, so you need to be prepared to come to the table with a down payment.
Since the seller is acting like the bank, you need to be prepared to go through credit checks, background checks, resume reviews and requests for collateral to secure the loan. The seller will be relying on you to effectively run the business to make monthly payments. It is only fair they do their due diligence to make sure you are a capable business owner.
At this point you might be wondering why would a business owner be willing to finance a business they are trying to sell? Offering seller financing helps the seller entice more buyers because most perspective buyers don’t have the enough cash on hand to buy a business outright, so they let them buy it from them over time. There are entrepreneurs who won’t even consider buying a business unless seller financing is offered. They feel that if the seller isn’t willing to leave some skin in the game, the business might not be worth what they are asking.
The terms will change from deal to deal but here is some of what you can expect. Most sellers will cap out at financing more than 60% of their asking price. The terms of the loan will be similar to what you would get through a bank and likely be at 6-8% over a 5-7-year time frame. You should also expect there to be terms that the business gets turned back over to the seller if you don’t make payments in one to two months, as well an offer of collateral outside the business.
Let’s talk down payment. It is great that the seller will loan you some of the money to buy their business, but you still need to come up with at least 40%. Personal cash or money pulled together from friends and family would be ideal, but there are other means. Rollover for Business Start-ups for example can be used in combination with Seller Financing, allowing you to keep your monthly payment to just the seller. Another option is to get an SBA loan to cover the down payment. Going the route of the SBA loan as a down payment results in some requirements from the lender.
While the SBA lender likes that seller financing is part of the deal because that indicates to them that the seller is confidant in the business viability to make revenue in the future, the lender will have requirements that reduce their exposure in the deal.
Seller will be in full or partial standby:
Being in standby impacts the seller’s rights to receive payment from the loan. Full standby results in the seller not receiving any payment on the loan, while partial standby allows the seller to receive interest-only payments. The SBA requires sellers to be in a standby position for 2 years and most other bank loans follow suit.
Seller will be subordinate to the SBA loan:
Being subordinate to the SBA loans means the bank is in first position. If the business defaults on the loan the get first rights to the proceeds any assets sold. business.
Its obvious sellers aren’t crazy about these requirements, but this helps the SBA mitigate their risk when multiple types of financing are needed to acquire a business. If the seller has confidence in your ability to run the business and knows it has healthy cashflows, then they should be less concerned about the requirements debt-financing from a bank puts them in.
When it comes to seller financing you are going to find most sellers won’t be proactively advertising it due to the risk they would be taking on. Seller financing has benefits to both parties involved so if you are highly interested in a business, see if it is an option available. As you are considering if the deal is right for you, ask yourself if the terms result in a payment that the business can cover and still allow you to make a living wage?
When Seller Financing Makes the Most Sense
Seller financing is frequently the bridge to business ownership for people who don’t have large amounts of cash at their disposal. It also works great with other self-funding and equity financing options like Rollover for Business Start-ups and an Angel Investor. While it fills the gap for people who don’t have the means to self-finance, it can also be hugely beneficial for those who aren’t able to obtain a standard bank loan to due to poor credit or a lack of overall credit in the market. If you need seller financing because of poor credit, expect to have a higher interest rate and come to the table with more money to put down.
If you are new to business ownership, having guidance as you get your feet wet can be worth its weight in gold. When seller financing is used, there will typically be a transition period built into the agreement where the seller agrees to help you as you take on the new business. This is great for you because you get to learn the ins and outs from someone who was in your position and it is great for the seller because they can make sure you have everything needed to run the business so you can make your payments.
If you feel the seller’s price on the business is a bit too high, trying to negotiate seller financing into the deal can help you get a better price or overall deal. By including seller financing as part of the deal you are forcing their hand, because if the business can’t sustain the percent you are asking them to finance they won’t want to include it. If they refuse to keep some skin in the game, then that can give you some room to push the price lower.
While seller financing is an option to finance the purchase of a business, it is a funding option that is all about negotiation. If you aren’t comfortable negotiating, make sure you are working with someone who is or plan on exploring other funding options. The terms will change from deal to deal and it is critical you have your basis covered.
How to Get Started with Seller Financing & Where to Find Resources
Seller financing is an option that has plenty of nuances and will change from deal to deal, so take the time to read The Basics of Seller Financing and The Dos and Dont’s of Seller Financing. These articles will provide more detail around essential elements of a seller financed deal, as well as what seller financing looks like from the seller’s side.
If you know seller financing is an option you will need to or want to include, you will want to focus your business search. Business listing sites such as BizBuySell.com have a checkbox under more search options that will allow you to filter your business search to only show business where seller financing is offered.
Once you have a business you are interested purchasing, make sure to consult your business attorney and CPA as you negotiate the terms of the deals. If you are just getting started, sites like RocketLawyer, LegalZoom and Avvo can be great resources as you work through some of the basic documents like the letter of interest, deal contract, promissory note and bill of sale.
What is a Portfolio Loan (Securities Backed Line of Credit)?
Have you been diligent about saving for your future by building a strong investment portfolio? When looking for a way to fund your business you may look at the money in your investment portfolio but might be hesitant to sell them because of the capital gains tax you would have to pay in order access these funds. If only there were a way to create liquidity out of your investment portfolio without having to sell it off…I think you know where this is going.
Portfolio Loans, formally known as Securities Backed Lines of Credit (SBLOCs), offer you an inexpensive way to access the cash in your portfolio without having to liquidate your securities. A line of credit is setup where the securities held in your portfolio act as the collateral, like how your homes equity is the collateral in a home equity line of credit. You can typically borrow 50-90% of the value of the assets held in your investment account. The amount a lender offers will depend on the value of your overall portfolio and the types of assets in your account.
The most attractive part about portfolio loans is their incredibly low interest rates. While it varies between lenders it can range from 2-5%, which are rates you won’t find on any standard bank loan. As you borrow the money, you only need to make interest payments. There is no defined payback schedule, you can pay back some or all the principle at any time.
The low interest rate brokerage firms charge for portfolio loans is due to the risk you are taking on with this loan option. If you borrowed 80% of your portfolio value and the market tumbles by 20% you will be given a maintenance call, where you are required to offer up additional collateral to secure the loan. If it tumbles below the value of the portfolio, they can require you to start liquidating assets to pay back the loan. While the benefit of these funds can be great, it is important to understand you are taking on the risk if your portfolio drops in value, not the brokerage firm.
When a Portfolio Loans Make the Most Sense
If you have at least $85,000 in securities in your portfolio that trade $5 per share or higher, then a portfolio loan may be the right option for you assuming you are looking to fund your business with a secured/collateral backed option. You won’t find lower rates on funding that is secured through collateral. If your stock portfolio is the only place you have the money needed to start your business, using a portfolio loan to avoid having to pay capital gains is the cheapest way to access that money.
They are also perfect for someone with less than perfect credit, because the brokerage firm typically is only evaluating the amount of money you can borrow based on the value and mix of your portfolio, although bankruptcies can be a roadblock.
The funds come with no strings attached, meaning there is no requirement for what the funds can be spent on. Unlike an SBA loan, with a portfolio loan you could start a business that is legal in your state, but illegal at the federal level. This would be a risk you would be taking on by doing so, but there aren’t any restrictions for how you spend the funds from your portfolio loan because the brokerage firm has leverage to ensure they get their principle back.
How to Get Started with a Portfolio Loan & Where to Find Resources
The best source information on portfolio loans, securities backed lines of credit (SBLOC’s) comes from articles on FINRA and the SEC. These articles do great job of getting into the details of SBLOCs and the risks that come with them. While these articles lean heavy on the risk, which makes sense given the sources, we believe it is important to understand the risk and be armed to ask the right questions if you decide to explore portfolio loans as a lending option.
To assess whether you can use a portfolio loan you will need to evaluate your portfolio ensuring you have the $85,000 minimum value required from most SBLOCs. From there you can see if your brokerage offers Portfolio loan programs. If not, you can give us a call today at 888-472-4455 to help you find the right portfolio loan program to fund your business.