Self-Financing Your Startup
Explore these potential sources of capital for financing your business.
Once you have decided on the type of venture you want to start, the next step on the road to business success is figuring out where the money will come from to fund it. Where do you start?
The best place to begin is by looking in the mirror. Self-financing is the number-one form of financing used by most business startups. In addition, when you approach other financing sources such as bankers, venture capitalists or the government, they will want to know exactly how much of your own money you are putting into the venture. After all, if you don't have enough faith in your business to risk your own money, why should anyone else risk theirs?
Begin by doing a thorough inventory of your assets. You are likely to uncover resources you didn't even know you had. Assets include savings accounts, equity in real estate, retirement accounts, vehicles, recreational equipment and collections. You may decide to sell some assets for cash or to use them as collateral for a loan.
If you have investments, you may be able to use them as a resource. Low-interest-margin loans against stocks and securities can be arranged through your brokerage accounts.
The downside here is that if the market should fall and your securities are your loan collateral, you'll get a margin call from your broker, requesting you to supply more collateral. If you can't do that within a certain time, you'll be asked to sell some of your securities to shore up the collateral. Also take a look at your personal line of credit. Some businesses have successfully been started on credit cards, although this is one of the most expensive ways to finance yourself.
If you own a home, consider getting a home equity loan on the part of the mortgage that you have already paid off. The bank will either provide a lump-sum loan payment or extend a line of credit based on the equity in your home. Depending on the value of your home, a home-equity loan could become a substantial line of credit. If you have $50,000 in equity, you could possibly set up a line of credit of up to $40,000. Home-equity loans carry relatively low interest rates, and all interest paid on a loan of up to $100,000 is tax-deductible. But be sure you can repay the loan--you can lose your home if you do not repay.
Consider borrowing against cash-value life insurance. You can use the value built up in a cash-value life insurance policy as a ready source of cash. The interest rates are reasonable because the insurance companies always get their money back. You don't even have to make payments if you do not want to. Neither the amount you borrow nor the interest that accrues has to be repaid. The only loss is that if you die and the debt hasn't been repaid, that money is deducted from the amount your beneficiary will receive.
If you have a 401(k) retirement plan through your employer and are starting a part-time business while you keep your full-time job, consider borrowing against the plan. It's very common for such plans to allow you to borrow up to 50 percent of your vested account balance up to a maximum of $50,000. The interest rate is usually 1 to 2 percent above prime rate with a specified repayment schedule. The downside of borrowing from your 401(k) is that if you lose your job, the loan has to be repaid in a short period of time--often 60 days. Consult the plan's documentation to see if this is an option for you.
Another option is to use the funds in your individual retirement account (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. This is a withdrawal that you're allowed to keep for 60 days. It's possible for a highly organized entrepreneur to 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 becomes taxable.
If you are employed, another way to finance your business is by squirreling away money from your current salary until you have enough to launch the business. If you don't want to wait, consider moonlighting or cutting your full-time job back to part time. This ensures you'll have some steady funds rolling in until your business starts to soar.
People generally have more assets than they realize. Use as much of your own money as possible to get started; remember, the larger your own investment, the easier it will be for you to acquire capital from other sources.
This article is an edited excerpt from Start Your Own Business, Fifth Edition, published by Entrepreneur Press.