When the SBA's Washington, DC, regional office set out to increase funding to homebased firms around the nation's capital, it took a uniquely aggressive approach: It created a loan program last August specifically for homebased entrepreneurs, one of the most underserved segments of the business credit industry. But there was just one hitch: It couldn't find a single local lender that was willing to make a loan as little as $5,000.
While Washington, DC, lenders were shunning the types of small loans homebased businesses needed, Innovative Bank, an Oakland, California, lender, was busy funding modest credit requests in major western cities, including San Francisco. Joseph Loddo, director of the SBA's Washington, DC, district, recruited Innovative Bank for his Small Office/Home Office (SOHO) lending initiative, which provides guaranteed loans of $5,000 to $25,000 to homebased firms and "small office" companies operating outside the home without employees.
"The applicant is able to get [a loan] within seven days to help them start a business or help them with an existing business," says Loddo. "[Before], when a person who owned a homebased business applied for a loan, they ended up getting a consumer loan, a personal line of credit or a high-interest credit card. We're correcting a mismatch in terms of the sources and uses of funds: a business loan for a business purpose."
Brigitta Toruno was an early recipient. Toruno, owner of UNO Communications, a homebased translation service in Sterling, Virginia, needed financing for a website and marketing. "The program seemed to be a good fit because I wasn't looking for a large loan, and a lot of SBA loans are at least $50,000 to $100,000," says Toruno, 39. While small by industry standards, the $5,000 loan she secured last September provided adequate support. "We work with translators for over 20 languages," she says, "and it's going to help me expand the language base [even further]."
Loddo's exhaustive search to find a lender for his program underscores the difficulty homebased firms have securing credit. Banks argue that homebased firms are difficult to lend to because they lack business assets and that loans to them are costly. A lender may invest as much time lending $25,000 as $250,000, "but you can't get 10 times as much in rate and fee income," explains Lyle Frederickson, senior vice president of Arizona Business Bank in Phoenix.
Even after the start-up stage, getting financing doesn't necessarily get any easier. Chris Millard, 40, who owns a homebased business in Gilbert, Arizona, with his wife, Linda, received a $100,000 SBA loan, but it wasn't easy. "The SBA process on the bank side is difficult, and they don't like to mess with someone only wanting a $100,000 line of credit to start a business," he says. "When you're getting a $100,000 [loan], you'd think they'd be more interested in loaning you $20,000, when, in reality, that isn't true."
The Millards' firm, DIALYassist, which provides nurses to health-care facilities, had a two-year track record and positive cash flow. Linda, 39, a registered nurse, used the loan to expand the business by providing dialysis services to six area hospitals. Even with revenue from hospital contracts, a profitable history and relationships with medical facilities, the credit line required an SBA guarantee.
The Burden of Being Homebased
The reality is that banks, even community lenders, are hesitant to lend to startups. Buying a homebased franchise opportunity may boost your financing chances, although lending to homebased entrepreneurs isn't an industrywide practice, says Ginny Young, president of Orange, California, franchise lender Brava Capital. Her company doesn't finance homebased borrowers, but she knows industry peers who are funding cleaning service franchisees, some of whom may start out as homebased enterprises. "It would be easier to get that financed than a [homebased] mom-and-pop cleaning service," she says.
Even so, the franchise lender still needs assurance that a homebased franchisee has adequate capital levels. Says Young, "A homebased business is not a lender's dream unless it's an SBA loan and [the entrepreneurs] have equity in their house and a good business plan."
Opportunities that homebased entrepreneurs purchase, however, are a different story. "If it's not a franchise, then somebody is getting paid by the new business owner to help them do something, but they're not regulated. It's not an attractive thing for a lender to bite their teeth into," Young says.
Any homebased company has the added burden of establishing legitimacy. But while many lenders have stereotyped homebased businesses as half-serious endeavors, views are changing. Tim Jochner, chair of Innovative Bank, formerly requested photographs of a homebased office. "We always got a picture of a desk and a computer," he recalls. "If the financial institution is going to look seriously at the business, it's not going to with a picture. It's going to be with a business plan. Anything you've done to show you've made a commitment is a benefit." For instance, detailing why your business is better than a competitor's will make an impression, he says. Letters of intent from customers, client references, a floor plan and evidence the firm meets licensing requirements further enhance a credit proposal.
A business plan, meanwhile, serves as the primary link to financing. "I can talk with my banker personally, but the loan committee won't have that information unless it's written in ink," explains Larry Lee, business consultant for the Missouri Small Business Development Center in Kansas City.
In addition, entrepreneurs should consider a demonstration, says financial manager Frederick Scenna. Recalling a business plan from a cell phone product inventor, Scenna says, "When you read about the product, it just didn't make sense. But when he brought it in to show us, [I thought], 'That's a very cool product.'" Scenna, who advises homebased firms in the Philadelphia area, also recommends joining a local chamber of commerce, which typically provides free office space for business meetings.
Planning on using your own money to start your business on the cheap? Read Bootstrapping Your Business for crucial tips on making your low-cost venture a success.
All in the Family?
Is it okay to use a family loan to fund a homebased business? As long as you stay on the IRS' good side.
Calling it a loan doesn't necessarily make it so in the eyes of the IRS, warns Larry Lee, business consultant for the Missouri Small Business Development Center in Kansas City. "The IRS has strong opinions about low- and no-interest loans among family members. When loans are made below market rate or at no interest, it could be subject to the federal gift tax."
Stay on the agency's good side by formalizing loan agreements, which lets you reap tax benefits available to other business borrowers. Put the deal in writing to demonstrate the interest is a legitimate business deduction. Says Lee, "Know the parameters so you don't get yourself into trouble and have to pay the gift tax on something that truly was a loan."
If the family contribution wasn't intended as a loan, entrepreneurs can avoid the gift tax by accepting no more than $10,000 from a parent. "My mother could gift me $10,000," Lee explains. "My father could gift me $10,000, my mother could gift my wife $10,000, and my father could gift my wife $10,000. There's $40,000 [in business funding] you can do with a gift."
For many aspiring entrepreneurs, family assistance is the most sensible option. Lee urges loan recipients to draft a business plan, even if a parent or sibling is writing the check. "Put together something that everybody understands, including financial statements, projections and payment details. Make sure you document the loan terms." Additionally, a life insurance policy to cover the debt will make a family member more comfortable with repayment prospects.
Another popular funding source is customer financing. One of Scenna's clients received a loan from a store owner interested in selling her product. "If you've got one major customer selling [your] product or service, [investing in the business can] only help them," he says. Draft a proposal in advance, and be prepared to answer questions from customers you approach.
Meanwhile, some entrepreneurs choose to stretch operating funds by delaying payments to suppliers. "I'm not saying to stretch payments out to 180 days," Scenna advises, "but try to get vendors to work with you."
The ability to respond creatively to a credit crisis is crucial for cash-strapped entrepreneurs. "That's the secret to small businesses--to structure loans to meet your needs," says Lee. Indeed, communities are rich in financial resources, including microloan funds and other programs targeting homebased entrepreneurs. Major colleges also offer support. Dorothy Gerstenfeld, 51, started baking Irish soda bread in 1991. She sold the bread to local stores, eventually supplying a food chain from her basement bakery. But it wasn't easy for the Havertown, Pennsylvania, resident. "When I first went in for financing," she says, "they asked me what my business plan was. I said I was going to bake a loaf of bread, sell it for $1, and I was going to do it a lot. They said, 'You're going to have to be more detailed.'"
Graduate students at the University of Pennsylvania's Wharton School helped Gerstenfeld draft a business plan. But even aid from a premier business school couldn't break down barriers to credit, prompting Gerstenfeld to turn to local programs geared to businesses like hers. She learned of an economic development initiative through a friend's husband who served on the group's board. From that organization, she got a $25,000 loan. Financing from two other local groups enabled her to restructure debt by paying off credit card balances she had racked up renovating her bakery, The Irish Bread Shoppe, now located outside her home. Gerstenfeld credits those local loans with helping her break bad financial habits, including her dependence on credit cards.
While not in her case, microloans often serve a dual purpose: A homebased entrepreneur secures startup funding, and that loan, in turn, serves as a springboard to conventional financing. "If things go well, they're going to need a better loan," says Frederickson of Arizona Business Bank. "What happens is, [a bank] often pays off the microlender, and [the business] moves into a bigger loan."
Even a home equity loan used for business funding can make a statement regarding creditworthiness, Scenna says. "It's a small step, but a bank can see the business is making payments."
But don't settle for products geared to nonbusinesses. "People make the mistake of not opening a business checking account," Scenna says. "Go in and establish you're a business."
Plan for Success
Whether you're looking for outside funding or relying on your own money, you need a business plan to guide you on your path to success.