When it comes to starting a business most people will start by trying to fund it on their own; tapping their personal saving or hitting up friends and family. Who wouldn’t want to start their business flush with cash and no-debt? While these are two common ways people gather the funds to start their business there are other ways you can start a business without taking on debt or giving away equity. We explore all of these options in this section!
What it is Cash (Personal Savings & Checking)?
When most people think about starting a business the first thing they do is check their bank statement to see if they have the cash on hand to get started. Unfortunately, unless you recently received a huge inheritance or just won the lotto, most people don’t have that much cash sitting around.
While your instinct may be to just think about the money in your checking and savings accounts, you might be holding assets that are easy to turn into cash. Turning these assets into cash will likely have some fee and/or tax implications, like the capital gains you would pay on selling stocks, but is a means to start your business flush with cash (and not debt). Before selling your shares on that hot pick you made years ago, keep in mind that you can access your portfolio without having to liquidate your stocks. We’ll cover this option in the Portfolio Loans section.
Keep in mind that while you might not have $400,000 in cash sitting around to start your dream business, you might have 20%-30% of that to use as a down payment. While a mountain of cash allows you to start debt-free, there are ways to make what cash you do have extend further to get your business started.
When Using Personal Savings & Checking Makes the Most Sense
Honestly, it is hard to think of a case where cash doesn’t make the most sense for your business. Launching a business with a bank account that is flush with cash and no repayment schedule gives every entrepreneur the breathing room they need to build a strong business.
Realistically, choosing to start a business with the money from your bank account depends on your risk tolerance. One entrepreneur might see using every spare penny from their checking and saving accounts as a significant risk, as it leaves little to spare for emergencies. On the other hand, another entrepreneur might think it is riskier to take on debt or give away equity to start their business and would rather have the freedom cash offers.
How to Get Started With Cash & Where to Find Resources
Hate to state the obvious here, but to get started you will want to check banks statements to see the amount of cash you have in your accounts. Some other places to get started are:
- • Checking under your couch cushions
- • Looking between your car seats
- • Seeing if any is hidden in your mattress
- • Etc ?
In all seriousness, if you are going to start a business with more than 75% of your on-hand cash we recommend you take a moment to read this article to understand Burn Rate and download this Burn Rate Calculator to make sure the cash you are putting into your business gives you enough of a runway to get it off the ground.
What it is Friends and Family?
When an entrepreneur doesn’t have the cash on-hand to start their venture, they often turn to friends and family. This is actually one of the most common ways a small business gets the funding they need to start, because only about 40% of small business are able to get approved for a standard bank loan. It makes sense: who would be more likely to give you money? A bank that is breaking you down into numbers and a risk profile, or a loved one who knows about all of the intangible things that will make you a successful business owner. (Hint: it’s the loved one.)
When friends and family are involved, the money can come in different forms. Since we are in the self-funding section we are going to focus on friends and family who give you money with no strings attached, or loan with a very flexible repayment schedule.
When Using Friends and Family Makes the Most Sense
If you are lucky enough to have a relative or friend who is willing to give you money with repayment minimal requirements, then this may be a better option than using your own cash, as it shifts the burden of risk away from your personal finances.
Even if you can easily qualify for a bank loan, friends and family would be the best options if they are willing to give you loan terms. Once you have a loan from a bank you are expected to make payments each month, and if you are late the fees start to rack up. Cashflow is vital for getting your business up and running — having the flexibly to make payments whenever you have the money can be the difference between success and failure.
For those with little cash and poor credit, friends and family may be your only option. Since these loved ones understand your work ethic and know you will poor your heart and soul into the business, you don’t have to jump through the same financial hoops a bank would require (pulling your credit, running a background check, reviewing your work history, etc.). To a bank you’re a risk profile — to friends and family you are the hard-working person who knows how to get stuff done.
Although this is a dream scenario, think hard about the repercussion of taking money from loved ones. If they are the type of person who is going to judge every expense until they are repaid or someone who believe it has earned them input in how to run your business, you might want to explore other funding option to keep your freedom and reduce the chance of awkward family dinners.
How to Get Started With Friends and Family & Where to Find Resources
To get started, make sure you understand the amount of money you will need to get your business started. Then see if you have friends or family who have the financial means and desire to support that amount. Depending on the financial health of people in your life, you may need to seek assistance for more than one person. Like funding your business with cash, read this article to understand Burn Rate and download this Burn Rate Calculator to make sure the money you are asking for gives you enough runway to get your business going to avoid wasting a loved one’s money.
As you approach friends and family, you are much more likely to receive a favorable answer if you come prepared with a business plan (as opposed to a sketch on napkin). To help you put together a business plan that will get you whole family interest, download the eBook How to Write a Winning Business Plan.
One place people frequently get tripped up when obtaining money from friends and family is the tax implications. If you are fortunate enough to be given money that you don’t have to pay back, make sure you consult with your CPA and that your friends and family consult with theirs, as there can be tax implications on both sides of the transaction. Here is an article on the gift tax to give you a starting point.
If you are getting a loan from friends or family, it is equally important to adhere to a standard process and consult a CPA and attorney beforehand. If executed improperly, any loan you received could be classified as a gift and be subject to extra taxes. Review this article on Promissory Note for Personal Loans for an overview of what to include and the implications of interest-free loans. Check out this free template generator as well.
Lastly, to avoid the drama and awkwardness that mixing money with friends and family can cause, it is worth taking the time to draft and agree upon a contract. Whether the money is in the form of a gift or loan, it is important to get in writing what it entitles the giver to — if anything.
What it is Rollovers for Business Start-ups (ROBS)?
When it comes to self-funding, many would-be entrepreneurs are sitting on a treasure trove and don’t even know it: their retirement funds. The simplest way to describe Rollovers for Business Start-ups is changing the investment funds in your retirement account from shares in public companies, like Apple, Amazon and Microsoft, to shares in your own private company. You are literally investing your retirement funds into your own business.
The Rollovers for Business Start-ups structure has been around since 1974 when the United States government passed the Employee Retirement Income Securities Act. While this has been available for decades to entrepreneurs, it isn’t a widely known structure. This is partially because it runs counter to the business models of financial planners and Wall Street. They operate and profit when you own share of public offerings — they don’t collect fees when you are invested in private offerings.
It’s important to understand that Rollovers for Business Start-ups is significantly different than taking a loan or an early distribution from your retirement account. For example, with a 401(k) loan you have interest payments to make or risking having to claim that money as income. And with an early distribution you typically pay an early withdrawal penalty on top of having to pay income-tax on the funds. However, as the name Rollovers for Business Start-ups suggests, with this method you are simply rolling over retirement funds into a new retirement account. This transaction is not a loan, and therefore does not require repayment. Even better, tapping your retirement account using the ROBS structure ensures you won’t be hit with early withdrawal penalties.
While the concept of Rollovers for Business Start-ups is simple on the surface, setting up and facilitating the transaction is quite complex — courtesy of Congress and the IRS. Here are the steps that make this transaction possible:
Form a C Corp First, you need to create a C Corporation. Due to IRS business transaction requirements around qualified employer securities (QES), the business you start/buy must operate as a C Corp. (Other entity types such as an LLC, LLP, S Corp or Sole Proprietorship either do not have ‘stock’ and therefore cannot issue QES, or the specific prohibited transaction exemption ROBS relies on does not apply (S Corps).
Setup a Retirement Plan for Your C Corp After establishing the C Corp, a retirement plan needs to be setup for the business. You get to choose the plan type; most people select a standard 401(k) plan. However, you have other options such as defined benefits, defined contributions, profit sharing or a combination of plans. Once a plan type is selected, a custodian – Fidelity, Charles Schwab, Merrill Lynch, etc – needs to be picked to manage the actual investments in the plan.
Roll Funds to the Company Retirement Plan Upon having the retirement plan setup in the C Corp, you then roll your retirement funds from your original, account to the new retirement plan of the C Corp. This is where the “rollovers” part of Rollovers for Business Start-ups comes from.
The Company Plan Buys Stock in the C Corp Now that the funds are in the company retirement plan, the plan purchases stock in the C Corp through a QES transaction. This takes us back to Step 1 and is why a ROBS structure must operate as a C Corp — without it the QES transaction wouldn’t be possible.
Use the Funds to Operate Your Business Once the QES transaction is complete, your retirement funds are now available to the corporation to begin operating and paying for business expenses like buying equipment, leasing space, franchise fees, hiring employees, etc.
The final result is that you are able to start a new business, launch a franchise or acquire an existing business through a cash investment from your retirement funds. The best part of Rollovers for Business Start-ups as a funding option is that your new business is not responsible for monthly payments. This increases your cashflow, which is vital in the early stages of growing a business. As an extra bonus, your business can also offer participation in the company’s 401(k) plan — a great benefit to attract top talent.
When Rollovers for Business Start-ups Makes the Most Sense
Unless the previous two options of cash and friends & family are viable options, Rollovers for Business Start-ups is one of the last ways many entrepreneurs can fund their business without getting a loan or giving away equity.
Due to the complexity of setting up the ROBS structure, you will want to work with an experienced ROBS provider. This will come with a cost to get everything setup, so a good rule of thumb is if you need more than $50,000 to fund your business, Rollovers for Business Start-up is a great option. If you need less than $50,000 it will probably be more cost-effective to take a loan or early distribution from your retirement account.
Unlike getting a loan, ROBS does not take your credit score into account. It also means that there is no personal guarantee required, where you would have to collateralize your home or other personal asset. If you fund a business with ROBS and it fails, it is viewed as the same as taking a loss on a stock. Think about people who were invested in Enron, Bear Stearns or Blockbuster —they only lost their initial investment, they didn’t take a credit hit or lose their homes.
The type of business you want to fund is a determining factor in whether you can use the Rollovers for Business Start-ups structure. The IRS says you must be an Operating Company, which is any business that offers goods or services in exchange for money. Most businesses meet this criteria without issue. Some examples of business that don’t are: lending and investing. Real estate is a tricky one though, because you can fund a property management or flipping company, but the legality depends on the scale at which you operate. Lastly, when it comes to businesses that are legal at the state level, but illegal at the federal level, the IRS has not come out and said you cannot use ROBS for these types of businesses. However, at Guidant we are conservative in our approach so will not take on these types of businesses — For example starting a pot shop in a state where marijuana is legal is not something Guidant will fund with ROBS, as marijuana hasn’t been legalized federally.
Another important component is that, even if you are looking to fund an Operating Company, you must be an active employee of the business. Guidant recommendation to clients is that they work 20 hours per week at a minimum. This means you can’t be a passive investor in your friend’s brewery or use the funds to help your partner launch a franchise. However, the active status doesn’t specify the type of work you do. While you may work the cash register for 20+ hours a week, you could also meet this requirement by keeping the books or serving on the board of your corporation.
Lastly, while ROBS is a great way to start your business cash rich and debt-free, your retirement funds may still not be enough to start or buy your business. Fortunately, ROBS is an excellent method to use in conjunction with other financing solutions. If you don’t have the 20-30% in cash for an SBA loan or for the down payment in a seller financed transaction, you can use Rollovers for Business Start-ups to obtain the debt-financing you need to get started.
How to Get Started With ROBS & Where to Find Resources
The first step in getting started with ROBS is to take inventory of your current retirement accounts. This can sometimes be challenging if you have changed jobs a few times and didn’t roll your funds into your new employer’s plan each time. If you don’t know the custodian of each plan, try using LinkedIn to find contacts in Human Resources or the Benefits Departments of your former employers.
While we hope this section helped you gain a solid understanding of ROBS and when it makes sense to explore it further, we’ve just scratched the surface this topic. To get an in-depth understanding, read 401(k) Business Financing: The Complete Guide or give us a call at 888-472-4455 to speak with a ROBS expert over the phone.
When further exploring ROBS and ROBS providers, naturally we hope you will choose Guidant Financial. However, this resource section wouldn’t be complete if we didn’t mention other ROBS providers, such as Benetrends and FranFund. We believe our status as the top ROBS provider, excellent customer service, three layers of risk mitigation and dedication to small business owners set us apart from the competition. However, if you don’t choose to work with Guidant, we strongly suggest you use Benetrends or FranFund — other ROBS providers may try to sell you on the structure even when it doesn’t make sense for you.
To get a third-party view on how the ROBS Providers stack up, check out the Best Rollover for Business Start-ups Providers from FitSmallBusiness.com.
What it is Crowd Funding?
In the business funding landscape, crowd funding is relatively new to the scene. Originally crowd funding was a bit of a novelty for funding a business, but this Forbes article states it will pass venture capital as a way to finance a business. Why give away equity in your business when you can get money from people who simply want to see your idea come to life?
Crowd funding generally comes in two forms: general backers and product presales. General backers are willing to give you money in exchange for something of little monetary value, like their name on the wall of your restaurant. Product presales are a more common way a business can get funding. This option typically offers the delivery of the product at a much later date, but sometime can include bonuses like early access or a discount on what the price will be at launch. Who wouldn’t want a list of order to fill and all the cash on hand to get through the production process before even officially opening the doors?
Crowd funding is typically run and managed through a crowd funding website (examples in resource section). However, you don’t have to use one of those platforms. Some companies use their own website to take pre-orders or offer up incentives to early adaptors. This offers a considerable advantage, as companies that use their own site aren’t required to operate within the fine print that a crowd funding site requires.
When Crowd Funding Makes the Most Sense
If you click around popular crowd funding site, you’ll see a wide variety of business types being funded. There are restaurants, cookbooks, shirts, cosmetics and art projects. There is no limit to what type of business can seek funding, so this is a source of funding that it doesn’t hurt to test before you go seek a traditional loan.
Even though almost any business can be listed, there is definitely a pattern of what types of businesses find success through crowd funding. Do a Google search for “successful business crowdfunding campaigns” and you will find list after list of successful campaigns. When you look at the common thread across these you will see that most of them were offering up a product, where backing it meant you would be one of the first to get this new product.
The entry cost to try a crowd funding campaign might be minimal, but unless you are committed to investing in a marketing campaign this may not be the best use of your time. Visit any crowd funding site and look at the campaigns that have hit their goal: one thing they all have in common is a well-produced video that tells their story and communicates why people should support their campaign. Creating a page and video isn’t enough — you will also need a social strategy to promote your campaign.
How to Get Started With Crowd Funding & Where to Find Resources
As you research which site is right for your campaign, pay attention to the fine print. Here is a quick summary of what you can expect to pay to run your campaign on each platform.
$179 per month to create and manage your campaign. For rewards-based raises a 3.5% + $0.30 per credit card backer processing fee is added.
4% fee charged from every raised fund, plus a 3% credit card processing fee. They offer a Flexible Funding Plan where if your campaign fails to reach the goal, you will be charged 9% to receive the funds you raised.
5% fee on each backer, plus 2.9% to 3.5% fees from processing payments.
5% fee charge for every successful project, plus there will be a 3-5% credit card processing fee to receive payment through Amazon Payments.
The idea of creating a video and marketing campaign can seem daunting. Thankfully the internet has made connecting with reputable freelancers as easy as it has ever been. If you need some help with your marketing plan and video production, we recommend checking out Fiverr and Upwork. If you already know what you want the video to look like and just need help bringing it to life check out VideoPixie, which lets you put projects out to bid.
What it is Bootstrapping?
Bootstrapping is a core element in the spirit of the American Dream. The term is derived from the phrase, “Pulling yourself up by the bootstraps.” In a business context, this refers to the practice of using earned revenues to grow and expand your business.
This is the path many entrepreneurs would prefer to go down as it leaves them, and the small business they own, in control of how and when they expand their business. Since you are funding expansion with the revenue from the business, there are no investors to worry about or loan payments that drag on cashflow.
(Bootstrapping is near and dear to our hearts here at Guidant Financial— it’s how our founders, David Nilssen and Jeremy Ames, grew the company over the years after its inception in 2003. It started with the two of them helping one client use Rollovers for Business Start-ups to launch a small business. Luckily for them, that entrepreneur loved to tell people how they could fund their dream of business ownership. And as the client list grew, so did Guidant Financial.)
When Bootstrapping Makes the Most Sense
Not all businesses are suited to starting and growing through bootstrapping. If your business needs a large office space, lots of employee, big machinery or a massive stock of inventory, bootstrapping might not be the best way to get started.
Bootstrapping works well when you can deliver the service or meet production requirements at the early stages of the company, and then add more employees or business expenses as your capacity to meet demand diminishes.
Bootstrapping as a business funding method can be taxing on your time and energy —not because of the work involved, but from going at it alone. Things may begin well, but six months in you may realize you need help. But, because you’re bootstrapping, you have no financial support to turn to. An entrepreneur with investors can tap them or their networks to serve as an ad hoc advisory board, where bootstrappers must spend extra time and energy building those types of relationships themselves.
How to Get Started With Bootstrapping & Where to Find Resources
First you need to take a step back and see if your business idea is one where you or a business partner can fulfill orders and meet service agreements on your own. As your accounts receivable start to grow, there are creative ways to increase your cashflow. One of them is factoring, which we address in our Unsecured and Collateral Free Financing section. In short, it allows you to take a loan against your accounts receivable — trading tomorrow’s money for money today.
As mentioned, bootstrapping can be tough because you only have your network to rely on. Luckily, there are thousands of entrepreneurs out there just like you who have already gone through whichever scenario you are facing. To connect with them, look at joining a local EO Network. You can also take advantage of a site like Townsquared, which allows you to easily connect with other local businesses to arrange service swaps or seek advice.
Ways to Self-Fund your Business
Secured Business Loans & Collateral-Based Options