Startup Financing

URL: http://www.entrepreneur.com/article/52718

What It Is: Startup financing is the initial infusion of money that advances an idea or an intention into something tangible.

Appropriate for: Any business

Supply: Even though it's everywhere, it's sometimes difficult to find.

Best Use: Commencing initial operation to the point where outside investors can see and feel the venture, as well as understand that you took some risk getting it to that point.

Cost: Startup financing will possess two of the following three qualities: good, cheap and fast. It will never possess all three qualities.

Ease of Acquisition: If you have nothing, it's difficult. If you have personal assets, the hard part is putting them at risk. But doing so is the rite of passage to both success and failure.

Range of Funds Typically Available: Varies widely.

First Steps
If you're starting a business, it's your baby. This idea may leave you feeling simultaneously liberated and inspired. But it also has an edge. Specifically, if it's your baby, it's also your obligation to finance it beyond the "I've got an idea" stage. How do you get that first dollop of funds that will either advance your idea to the point where it can attract outside capital, or perhaps jump-start you into profitable operations? Here are some options:

• Sell Assets. If you own things, you can sell them. It's that simple. Jewelry, rugs, pool tables, boats, time-shares, second properties--the list goes on. Most people's largest assets are their homes and cars. Homes are covered later. Here's what you can do with automobiles.

  If you drive a nice, late-model car, you can sell it and lease a cheap one without a down payment. This might net you $15,000 to $20,000 and leave you with a small monthly lease payment.

• Borrow Against Your Home. This is the oldest trick in the book. It's also one of the best because you can exert almost total control over the process. Here's how it works: Say you need $50,000, your home is worth $250,000 and you owe the bank $100,000 on your mortgage. You can borrow against the equity, in this case $150,000.

  Of course, once the loan kicks in, you'll have monthly payments. If you're starting a new business, it's a wise idea to set aside some of the proceeds from the home equity loan to help make these payments until the business can pay you a steady salary.

Another way to get money out of your home but maintain a lower monthly payment is to refinance the mortgage with a new one.

• Borrow Against Insurance Policies. If you want to know where all your money goes, look at your insurance payments. Each month you probably pay for health insurance, life insurance, disability insurance, auto insurance and perhaps homeowner's insurance. Unfortunately, you can only borrow against whole life policies, but most have some cash value after three years. Simply write your agent or insurance company, saying you want a policy loan. Most companies will lend up to 90 percent of the cash value, and your policy stays intact as long as you keep paying the premiums as they come due. However, if you die with a policy loan outstanding, the benefits might be diminished, although that varies by policy. But the good news is that loans against your insurance policy are fairly reasonable, since the rates charged are tied to the key money-market rate.
• Friends and Family. Friends and family present a formidable source of capital. Your typical friend or family investor is male, has been successful in his own business and wants to invest because he wishes someone had done it for him, according to Kirk Neiswander, senior vice president of Enterprise Development Inc., a nonprofict subsidiary of Case Western Reserve University's Weatherhead School of Management in Cleveland. "They are not reckless investors, and they have shallow pockets," he says. "They will invest once but not a second or a third time and generally in an industry they know that is close to home. Typically, friends and family will invest up to $100,000."

However, investments with friends and family can turn out bad when things don't go as planned. The situation can be even worse than with professional investors because friends and family react to bad news as much with emotion as with logic. Take the following steps to protect everyone from each other:

• 1. Get an agreement in writing. This will eliminate all conversations that start with, "You never said that."
  2. Emphasize debt (loans) rather than equity (ownership). You don't want friends and family in your company forever. Before you know it, they start telling you how to run the place, and long-buried emotions emerge. Make it a loan, and pay it back as fast as you can.
  3. Put some cash flow on their investment. If Dad says, "Here's $50,000--try not to lose it, and pay it back as soon as you can," that's great. But consider paying some nominal interest at regular intervals so that you and he have a reality check. And it's better to pay this quarterly rather than monthly. This way, when things are teetering, your lender won't immediately know it.
• Borrow Against Your Investments. If you're starting your business part time while keeping your full-time job, a potentially stable investment is borrowing against your employer's 401(k) retirement plan. It's common for such plans to let you borrow a percentage of your money that doesn't exceed $50,000. The interest rate is usually about 6 percent, with a specified repayment schedule. The downside of borrowing from your 401(k) is that if you lose your job, the loan must be repaid quickly, often within 30 days. To see if this is an option, consult your plan's documentation.

You may also want to consider using the funds in your IRA. Within the laws governing IRAs, you can actually withdraw money from an IRA as long as you replace it within 60 days. This is not a loan, so you don't pay interest; rather, this is a withdrawal that you're allowed to keep for 60 days. A highly organized person could possibly juggle funds among several IRAs. But if you're one day late--for any reason--you'll be hit with a 10 percent premature withdrawal fee, and the money you haven't returned will become taxable.

• Credit Cards. They're not terribly creative. But credit cards are quick and easy. In a perverse way, they are also cheap. That is, a minimum payment of $50 per month can hold down a whole lot of debt. Of course, if you only make the minimum payment, your balance continues to grow, and if the business fails, you have to pay the piper. But if things go well and the business pays off the balances without missing a beat, then you look back at your early credit card financing with a nostalgic fondness, and perhaps a twinge of longing for simpler days.