There’s good and bad news to share about startup financing for a small business. Keep in mind, we are only looking at debt options so think of loans and lines of credit that you pay back to a lender. We are not looking at any equity solutions such as angel investors, venture capital, etc. The good news is that there are options. The bad news is that nothing is easy nowadays and if you have damaged credit or you’re looking for several hundred thousand dollars it’s much less likely to happen purely with debt.
I have split these 8 solutions into two parts based on the likelihood and value factors. Simply put, likelihood just asks the question, “How likely is it that this type of financing can be obtained by a higher percentage of people?” Value is all about how much value would each form of financing bring to business owners who utilized this form of financing. So let’s get started.
Here are the 4 most likely forms of debt financing for small business startups:
This is absolutely, positively, without doubt the most common form of financing for small business startups. Additionally, credit card financing – when it is done right – is arguably the least expensive form of financing. From a benefit perspective they also do not require collateral like many other forms of financing. The problem is that when credit card financing is not done correctly – and normally it is not – you will hurt your credit profile, pay too much in interest, you will not properly separate your personal & business credit, and you’ll likely miss out on some good tax benefits.
Technically known as Rollovers as Business Startups – are only an option for people who have saved up some adequate retirement funds. It’s also much more risky than most other forms of financing. This is a very popular form of financing for new franchisees. The downside is you’re risking your future basically since you’re tapping your retirement savings. The upside is that you can access a sizeable amount of capital if you have a nice nest egg waiting for you.
Maybe it’s not as popular but it is very common. Examples of trade credit – which is also referred to as vendor credit – would be a line of credit at Staples, or Dell, or any other company where you need to purchase their goods or services for your business. There are many forms of trade credit where you can obtain loans and lines of credit that are revolving in nature…meaning the balances are not due in full and can be spread out over several months or several years. However, the most common “terms” attached to trade credit are Net 30. So there is not the same value or ability to finance nearly as much since you’re only delaying the purchase by a month or maybe two.
Most startup companies need some type of equipment. Ideally, if the goal is to use your capital in the best way possible, you wouldn’t use a working capital loan or line of credit to purchase equipment. Sometimes it is necessary but, often times, you can get a loan or lease specifically for your equipment and then leave your cash, working capital loans, and credit cards available for other uses.
With over 15 years of small business lending experience, Kris Roglieri is the Founder of Commercial Capital Training Group and President of a national commercial finance company. According to Roglieri:
“In the last 4 years, the number one characteristic of defaulted loans or leases in a lenders portfolio were companies that had less than 2 years time in business so most lenders only finance companies that are more than two years in business or their underwriting requirements are very tough and stringent. If you’re seeking to finance equipment as a startup you should have good personal credit, some experience in your industry, and hopefully at least 6-12 months of liquidity.”
In Part 2 we’ll discuss the other 4 most common debt solutions for startups.
Credit Card Photo via Shutterstock
Thanks for this great overview, Tom. When times are tough (and some would call the current environment tough) you have to get creative on funding sources. That’s what I like about this article — it’s about being creative and looking all around you.
Thanks Anita. I hope part 2 will provide some additional options as well. We all wish there were more options or that the hurdles were lowered but, unfortunately, we can’t “make” the rules. So we’ve all got to learn how to navigate the current terrain and we can always do that more effectively if we have a clear understanding of the options.
While I wish there were better ways out there, people are still willing to manage the risks of debt financing to start businesses and I applaud them.
I agree. Debt financing is almost always less expensive than equity so if you need capital then debt is usually the best option for startups…if it can be acquired and you can get enough.
Great article, very informative. Thanks!
I enjoyed reading your article. I feel that of al the “bad” ways to use credit cards, using it for a business is “good.” It’s like financing a fishing pole which could help feed you for years to come. Great stuff! I’m going to check out part 2.
Thanks Javier. It sounds like you must be a fisherman! 🙂 Your feedback is appreciated.