Funding My Business
Finding outside money for
a new business isn't easy.
A new venture may require monies for unforeseen
or unexpected situations. Get a plan in place before-hand.
Use Your Own Assets ...
Money may not buy happiness, but it sure will help you get your new business off the ground. Unfortunately, finding outside money for a new business isn't easy. Banks are notoriously reluctant to lend money for startups. Typically, you'll need to show at least two years of profitability to win a conventional bank business loan. To get their businesses going, most small business owners start out by relying on their own assets.
Here are some options to consider:
Use your savings first. Ideally though, you should retain 90 days of personal and family living expenses in a personal slush fund, just to protect yourself from the possibility that you will be unable to pay yourself or take a draw from the business. If necessary sell some personal assets or investments that you can convert to cash for the business before you deplete your family emergency fund.
Potential Sources For Borrowing
The Most Obvious - Borrow Money from a Bank. Banks have the money, but the chances of a new business qualifying for a loan are very small. Unlike your family, a bank won't lend you money simply because they like your idea and trust your character. Still, some new businesses do qualify for loans. Whether or not you can qualify depends heavily on your business' cash flow, your personal credit history, your equity in the company, and the collateral used to secure the loan. The Small Business Administration (SBA) offers several programs to help businesses get loans. The SBA's greatest aid comes in the form of a loan guarantee to the bank. If you are unable to repay the loan, the SBA will repay the bank a pre-determined percentage of your loan.
Borrow From Friends and Family If you can't fund the business on your own or with a bank loan, friends and family are a great option. Unlike a bank, they know your character well and will probably be more willing to take a risk on your business idea. However, because of the risk that mixing business and friendship may sour the relationship, you'll want to proceed carefully.
Here are some guidelines to follow: Have your attorney draw up a formal agreement with collateral specified and all the terms spelled out, including the interest rate, payment schedule, and what recourse the lender has if the loan is not paid. When you pitch your business idea to your friend or family member, approach the meeting professionally. Present your idea and your business plan just as if you were applying for a loan at a bank. Avoid mixing emotions with business. If a family member offers to loan you money in exchange for having a closer relationship, accepting the offer could create a very bad situation.
Borrow against your 401(k). There is inherent risk with borrowing against your 401(k). Should you lose your job, generally you will have only 90 days to repay the loan in full or else be taxed on the loan as a distribution. This may involve a penalty for premature or early withdrawal. The real kicker is that when you file your tax return, you will have a huge liability because there was no withholding on the monies and now you may be out of a job and your new business is not supporting you and the family yet.
Never borrow more than 60% of the available funds in your 401(k). The remaining 40% will serve as protection against the job loss contingency.
Borrow against Life Insurance Cash Value. This is a very attractive alternative if you have a policy with cash value. Repayment terms are usually very flexible and the debt will be retired in the event of your death. Of course, the outstanding loan may reduce the payout to your beneficiary in the event of death.
Borrow against Credit Cards. One might refer to this as "gorilla tactics financing", to be used only as a last resort. Use this option carefully. The money is easy to get, but it comes with a hefty price tag of high interest rates.
Other Sources of Funding
Check with Minority or Women's Organizations
If you're a woman or a minority, there are many organizations that have been set up to help both groups get their businesses off the ground. Some organizations may offer special financing deals.
Apply for a Grant
Many foundations and government agencies offer grants or incentives to small businesses that meet specific requirements. Some grants are offered as part of an entrepreneurial award. Check your local government for more information.
Other Sources of Equity Funding
There are a few other sources of equity funding worth mentioning. But remember, when you open your company to outside investment, you also open it to some degree of outside control. The more money you get from the outside, the less control you'll retain.
Getting capital from a venture capitalist is extremely difficult, but it is possible. Venture capital firms generally look for entrepreneurs with unique ideas that can't easily be replicated. They're interested in businesses that are relatively cheap to start and that can quickly grow to be multi-million dollar corporations that offer public stock.
Angel investors are private individuals who invest money in businesses. Like venture capitalists, they're hoping to get a large return on their investment. Unlike venture capitalists, they may be willing to offer you money without imposing so many conditions.
This information is provided as a public service, and should not be construed as individual accounting or tax planning advice. For information on how these general principles apply to your situation, please consult your Cook & Co. Agent.
Gregory J. Cook, EA, CPA+
Accredited Tax Advisor
Past President Alabama Society of Enrolled Agents
Past President Alabama Association of Accountants
1-800-551-6253 voice mail 117
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Cook and Co., Enrolled Agents are licensed by the U.S. Treasury Department to represent taxpayers before the Internal Revenue Service (IRS). Greg Cook is a Certified Public Accountant (CPA) licensed by the states of Alabama and Tennessee.