Inforgraphic: Using Debt To Finance Startups
An entrepreneurial endeavor is certainly a commendable pursuit, but also an investment that should not be taken lightly.If, having weighed the pros-and-cons carefully, you decide to persevere with this venture, congratulations! Now, you must be prepared to confront the question that’s likely to weigh on everyone’s mind:
“Where are you going to get the money?”
Hopefully at this point you have whittled down your financial options, and it may have dawned on you that borrowed funds are likely to be your only recourse of action. Relax, it’s really not as bad as it may seem! Debt actually has advantages over selling equity in a company to investors. Once your debt is repaid, you can finally reap the rewards of all your diligent efforts.
When it comes to financing startup endeavors, it is essential to have an extensive understanding of all your available options. Listed below are 10 alternative, financing options that use debt investment strategies (rather than equity solutions).
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#1. Credit Cards
40% of business owners have used business credit cards to finance their startup.
Credit cards are a popular financing option for most startups, mainly due to their “no collateral” appeal. However, one big downside of using credits cards is their limited funding. How much money you’re able to glean from a credit card is largely a result of your current credit standing and income.
Furthermore, it is essential that you effectively manage your credit card charges, otherwise you’re more than likely to face some financial repercussions: damaged credit profiles, high accrual of interest, inability to separate personal/business credit and missed tax benefits, for starters.
Also keep in mind that for every $1,000 increase in credit card debt, a startup’s success rate decreases by more than 2%. Be strategic and have a game-plan in store.Lastly, be aware that credit card debt tends to be very expensive. The average interest rate for a business card is about 15%.
#2. Rollovers as Business Startups” (aka. “ROB”)
An estimated 60% of franchises are launched with retirement rollover money.
ROBs are a speculative form of financing for up-and-coming ventures. For this method, prospective business owners tap into their 401(k) funds to finance their startup costs.In the US alone, an estimated 10,000 small businesses and franchises have been launched nationwide with retirement money.
On average, half of ROB startups were able to finance their investments by using only a portion of their retirement plans, and one-third tapped into only 10%- 30% of their assets.The major benefit of ROBs is the fact that they do not operate on a debt model. This allows a startup to invest, without having to pay interest, meet deadline payments or have any payback window.
#3. Trade Credit (aka.”Vendor Credit”)
47% of startup businesses seek trade credit as their default, financing option.
This method occurs when a company extends credit to your franchise; allowing you to buy their products and services upfront, while deferring payment for a later date.There is a cost caveat to trade credit financing; you absorb a higher purchase price, along with the actual cost of trade credit.
Firms that offer trade credit implement a credit policy, and on average operate on trade terms of 2/10, net 30. This means that the supplier offers a 2% discount if you pay your bill in 10 days.
However, if you forfeit that discount and opt for the additional 20-day coverage, you can incur an estimated 36% of the total cost of purchase items.Additionally, interest rate on most trade credit far exceeds that of banks and other financial institutions, by as much as 12-24% in annualized interest!
#4. Equipment Financing
A recent Equipment Leasing and Finance Association survey shows a 3.9% growth in equipment financing activity since 2009.
Equipment financing is especially pertinent if your startup company requires moderate and/or significant inventory of equipment.When startup businesses cannot afford the necessary equipment/device assets, they can either opt for an equipment loan that is secured directly by the equipment vendor, or opt for an equipment lease (rather than fully-committing to a purchase).
On average, an equipment loan can offer up to 100% financing, and lenders may back 80% to 90% of financing.Furthermore, businesses generally pay up to 20% of the equipments costs, and are responsible for low-fixed interest rates. On average, equipment leasing offers lower loan payments, no down payments/up front fees, 100% financing and low monthly payments (with interest for the lease term).
#5. SBA Loans
In recent years, an average of $50 million of SBA loans were provided to U.S. small businesses, per day!
The Small Business Administration is a U.S. government agency that provides financial support to entrepreneurs for their startup businesses.Depending on the SBA-loan lending program, a startup venture can be approved for a loan that ranges anywhere between $35,000 – $750,000.
However, SBA loans do carry higher annual interest rates, averaging between 20% to 60%.Additionally, those eligible for SBA loans must meet specific, SBA-defined requirements, such as collateral, solid credit, industry experience and a well-defined, venture layout.
#6. Home Equity Line of Credit/HELOC
In 2012, HELOC accounted for $554 billion worth of bank equity.
A home equity line of credit can be used by startups who supplement a line of credit from their home equity as collateral for basis of repayment.Some banks offer home equity lines of credit that allow up to 75% of the appraised value of your home.
These loans are distributed upon a set “term”period of repayment, and can either be met with a fixed interest rate or left as a variable rate, depending on the prime lending rate agreements.
#7. Peer to Peer Loan (aka. “P2P”)
An annual 4% of startup ventures rely on P2P financing methods.
P2P loans directly lend non-collateral funds to individual borrowers. This exchange is typically executed online, via peer-to-peer lending sites that employ multiple lending platforms and credit checking tools.P2P loans are generally met with high closing costs and even higher APYS, making this a more expensive financing option for startup ventures.
PCP interest rates, however, are significantly less than standard bank loans. Additionally, PCP loans provide an added benefit of faster transfer and access of funds, due to the nature of online trading platforms.
#8. Contract Financing
This is a relatively new financing option, and offers loans to startup businesses that are either contracted to provide goods/services, and/or in the negotiating stages of contract settlement.
Advances are made to your business against new or outstanding invoices, to provide immediate access to cash. On a 24-hour average, you are given 70% – 90% of the invoice value.This is one of the quickest ways to acquire working capital, without resorting to equity lending or typical loan options.
Additionally, repayments are more flexible and volume amount can be tailored to your venture’s specifications. Before monetizing a contract, lenders must first evaluate existing contract terms and borrower’s creditworthiness.
2.6 % of startup businesses rely solely on financing assistance from family/friends.
If the opportunity to obtain financing assistance from family and friends is viable, repayment terms, lower interest rates and an extended period of repayment may be met with more leniency than standard borrowing options.However, some occasions may call for fixed lending terms, and a borrower’s inability to effectively meet payments can be a recipe for disaster!
This financing method should generally be avoided unless there is a definitive, available resource for repayment.
More than 70% of the nation’s startups use personal savings or assets as a primary source of funding when starting a business.
‘Bootstrapping’ refers to a business venture that does not utilize external assistance and/or capital.Bootstrapping can be a cost-effective, venture option, particularly if savings, an early cash flow and other money-saving techniques are employed as resources.
So there you have it! Using debt to finance your venture startup is certainly plausible, so long as you are fully aware of all your repayment responsibilities. This information has been brought to you by Assets One Funding, for all your capital lending solutions. Visit their website at www.weclozloans.com for further information!