Creativity goes a long way when it comes to financing your startup during
tough economic times.
The credit crunch that began with mortgages has now spread to consumer loans and
small business financing. Banks have tightened their lending criteria and
business owners will need to look elsewhere for financing. This shouldn't
be a surprise because banks tend to ignore startups even during normal market circumstance.
The credit crunch has resulted in rising defaults for revolving credit in addition
to mortgages; this could translate into higher fees and tougher underwriting standards
if you plan to finance your business with credit card debt or home equity lines
of credit. It's time to look for alternatives.
Borrow from yourself
It was never supported the notion that entrepreneurs should borrow from their 401(k)s
or retirement assets to finance a startup, but in these difficult times, it's worth
considering how to best use your savings to fund your business. Typically,
business owners rely on their savings for about 30 percent of initial startup funding.
Rather than taking this money from your retirement assets, consider liquidating
some appreciated stock and lending it to your company. Lending the money to
your company is better than purchasing equity in your company because you can pay
yourself back at a later date if you've documented the loan properly. You
should already have enough founder's stock. For amounts as low as $15,000,
it's perfectly reasonable to use proceeds from future revenues or even future investors
in your business to pay yourself back.
Borrow from your family and friends
Loans from family and friends are the time-honored way to finance startups.
These loans are typically cheaper and more "patient" than other forms of capital.
Your parents might give you a no-interest loan. Your friends and business
associates might give you a rate that is slightly higher than they are earning in
their high-yield savings account. On average, private business loans from
relatives and friends have interest rates 2 to 3 percent lower than market rates
and 1 to 2 percent higher than high-yield savings rates. If you're like most
entrepreneurs, you would prefer to take the money in the form of equity rather than
debt. Resist the temptation unless you are certain that your startup's equity
will one day provide your relatives and friends with a return.
Keep in mind that you can arrange to have the same patient repayment feature of
equity by creating a long-term grace period on debt. For example, arrange
to borrow money with a three-year grace period and create bonus payments paid to
your friendly lender if you reach certain business milestones. This allows
the loan to feel much more like an equity investment, but it avoids the problem
of adding your relatives and friends into your equity capital structure. They
have been cases in which entrepreneurs are unable to repay relatives because they
subsequently raise money from professional investors who do not look kindly on business
owners who try to repay one class of equity investors before others.
Borrow from strangers online
Many person-to-person loan websites now allow borrowers to get money from strangers
online. Typing "person to person loan" into a search engine will lead you
to several online loan companies that enable borrowers to ask for funds and enable
individual lenders to earn a good return for making private loans online.
Although interest rates tend to be higher, these sites are a great resource for
entrepreneurs seeking funds during the credit crunch.
Borrow from the SBA
Funding for SBA loan programs does not appear to be on the chopping block in this
year's budget. Therefore, banks will continue to make loans that are guaranteed
by the SBA and the underwriting standards for these loans should not be radically
altered by the credit crisis.