Many businesses must seek creative business financing for the first few years. This is because many commercial lenders view new businesses as too risky of an investment. If your credit is negatively impacted by late payments or other issues, you may not qualify for a small business loan. Fortunately, there are other financing options.
Personal Savings and Credit Cards
Although many entrepreneurs dream about finding an angel investor, most finance their new business ventures first by tapping into their personal savings. Be sure to use only money you can afford to live without right now, since many small businesses take years to become profitable.
Using credit cards is perhaps one of the easiest and most common ways to acquire funds to fund a business. You can either use your current personal cards or apply for a new one in your business' name. Many credit card companies require very little information, if any, about your new business before issuing you a card.
The benefits of using credit cards are that they provide you with access to money with very little effort. You can also borrow against your credit line, if necessary, and acquire cash advances if you require it.
There are also drawbacks to using credit cards to finance a new business. Interest rates on credit cards are high. Minimum payments add up and can become a burden if you lack cash flow. Moreover, even one late payment can trigger a huge interest rate increase on your all your cards, regardless of those you haven't missed one payment on or which has a zero percent interest rate. Why? Because credit card companies rely on credit reports issued by Experian, TransUnion and Equifax to track your payment history. Credit companies wait for you to make one mistake they can capitalize on. One late charge on one card can be picked up by all your creditors and, the next thing you know, your interest rate skyrockets, doubling or tripling your minimum payments.
Even cards with zero percent interest rates can be problematic because they have an established date after which you begin to pay interest on everything you've charged and often at a quite high rate. You may find the cards jump from zero to a 14% or higher interest rate, depending on the card.
Many new business owners turn to family and friends to help finance their business endeavor. Often by borrowing from multiple sources you can compile the total amount of money you need.
The good thing about borrowing from friends and family is that you may obtain funding at low or no interest. Also, friends and family usually do not require collateral or as much evidence of a business plan banks or other lending institutions might demand.
The drawback is that the friends and family you borrow from have a personal stake in your business. Every decision you make they will watch with interest, wondering when they might be repaid. Additionally, you might put your relationship in jeopardy by borrowing those who love and trust you the most, particularly if you are unable to repay the loan as agreed.
An often overlooked drawback to borrowing from friends and family is that the Internal Revenue Service (IRS) might view their loan as a gift. Low or no-interest loans may qualify as "gifts" under the federal tax code, subjecting the giver to taxes. You may even find yourself taxed in the future on these "gifts" if you draw an income from them. Review the IRS guideline to tax-free gifts to understand any potential taxes due, and speak with a financial professional if you have any questions about what constitutes a taxable gift.
Home Equity Loans
Before the 2008 housing crisis, home equity loans were a viable source of financial support for a new business. Since then, however, they have become hard to come by. This doesn't necessarily make them less viable, just less available.
You often do not need to inform the bank what you plan to do with the credit you receive, meaning there is no examination of your business plan. This can make it easier to obtain financing. You may pay a lower interest rate than using credit cards to finance your business and can pay of the loan by adding a small amount to cover it in your mortgage payment.
The main problem with using a home equity loan is the difficulty in obtaining one. Most mortgage companies and banks are extremely cautious about who they loan money to these days, even if you have a small mortgage and a good payment history. You may find this option is unavailable. In addition, with the housing market crash many homes are less valuable today than they were years ago. Your home may not be worth as much as you thought, and the bank may not be willing to grant a loan. Should you obtain one, these loans also have increased risk because they place your home in jeopardy. If you default, you could lose your home.
Why Can't I Get Financing?
Being denied for business financing doesn't mean you don't have a solid entrepreneurial idea or plan. Rather it can mean the economy isn't the best or that your documentation isn't in order. Remember, however, that you always have other sources for funding.