You think you have an excellent idea for a product or service. You’ve shopped it around to friends and family, and it has been received with enthusiasm, and you are excited to get started.
You have to figure out a way to get this thing off the ground. Every business needs some funding, whether to purchase parts or inventory if you are offering a product or fund employee training and wages and various insurances if offering a service. Even if your business is just you in the beginning, what do you need? Supplies? A computer and printer? If not able to work from home, do you need office or studio space?
There are ways to fund any and all of this. It is unlikely you would qualify for a conventional business loan, as your business has no credit rating in that you cannot show revenue history or years of operation in the black. Short of using your personal credit cards, taking out a second mortgage on the house, or borrowing against your 401K – which people do! – these days there are smarter small business debt solutions. Here are some types of business debt that a small start-up should consider.
Conventional Commercial Secured Debt for Small Businesses
If you need equipment, machinery, or real property to house your business, these secured business debt options are available to you.
Equipment or Machinery Financing Loans
If your business is in manufacturing, you should look into procuring this type of secured loan. In equipment financing, the equipment you purchase serves as collateral for the loan, meaning, if your business defaults, the lender can repossess the equipment. Typically these loans are low-interest, and the term of the loan will match the expected lifespan of the collateral equipment.
Both the lender and your business take a risk that the equipment will not be outdated sooner than the term of the loan. Some manufacturers of commercial equipment take advantage of this by offering to roll the remainder of the loan into a new loan for new equipment – much like trading in your car for a new car when you still owe the balance on the first loan. Be careful – you could end up paying much more for the second generation of equipment than you need to.
Commercial Real Property Loans
If your business needs a place to manufacture your product or store your product, a commercial real property loan can help you obtain the property you need.
The only downside to commercial real property financing is that you will have to come up with a down payment. The upside is that the loan’s repayment term will be much longer than for residential property, and the interest rate will likely be lower as well.
A commercial real property lender will look to the LTV, or loan-to-value ratio, to determine how much you can borrow and how much of a down payment you will need. It is common for commercial lenders to finance 75% or 80% of the value of a property, so you must come up with the rest.
It is also common for these lenders to offer a balloon loan, which is where a business makes smaller monthly payments for a term with the remainder of the loan coming due at the end of that term. Such a loan may be attractive to a start-up for its lower monthly cost, however, the business is on the hook for the balloon payment in 15 or 20 years. It may be that the business has grown and can afford to pay it off, however, if it cannot and the business has a positive credit history, the lender may offer to refinance the balloon.
Unsecured Commercial Debt for Small Businesses
One of the most exciting and easy-to-use methods of financing a start-up is crowdfunding. In short, you put your product or service out there on the web and ask for contributions to make it happen.
Typically you will have a template or working model or sample of your service or product and know how much money you need and how long you need to produce it for delivery. You then offer it to contributors in exchange for contributions. You have complete control over what you offer, how much you ask for, and the threshold at which you consider your project fully funded.
Kickstarter and Indiegogo are popular online platforms for crowdfunding. They have made it relatively simple to set up a campaign, and in exchange for hosting it, they take a small percentage of contributions. All costs are disclosed up front before you go live with your campaign, so there are no nasty surprises.
Who Uses Crowdfunding?
Inventors, painters, musicians, weavers, potters, video game developers, sculptors, app developers, writers, film producers, and anyone with an idea and a way to make that idea happen can be found on crowdfunding platforms. Check it out – it may be just what you need to get started.
What if My Crowdfunding Campaign is Not Fully Funded?
If you set up your campaign correctly, there is no risk that you will be obligated to complete your project with insufficient funding. If your campaign is not fully funded, your investors can be paid back, and everyone can walk away from the project, no harm no foul.
You’ve probably heard of LendingClub, which is an online peer-to-peer lending service matching lenders with borrowers. This has become so popular that other peer-to-peer services have popped up, such as Upstart and Funding Circle.
How it usually works is that potential borrowers are assigned a level of risk, and lenders can choose who to fund. Interest rates vary according to risk in that higher risk borrowers must pay higher interest rates, and lenders get a higher return. Lower risk borrowers pay a lower interest rate, and lenders get a lower return.
Peer-to-peer lending is available for both personal and commercial loans.
These are small commercial loans, generally $50K or less. Non-profits, not-for-profits, and other organizations offer these to businesses that meet their criteria. Criteria can include:
- Minority or veteran or woman-owned businesses
- Businesses based in an economically-disadvantaged neighborhood
- Businesses offering a certain type of service or product that is needed
- Businesses meeting the lending organization’s mission
Businesses meeting the lending organization’s criteria will be eligible for low-interest loans, and in some cases, for additional training or mentoring. If there is a lending organization looking to fund your type of business, you’d be well-advised to look into it.
The SBA partners with microloan lenders to off these loans for working capital, supplies, or machinery or equipment. The limit is $50,000. The criteria for eligibility will be based in the business owner’s personal credit history and the term will be a maximum of six years. Commonly these loans are available to businesses such as freelancers, food trucks, day care, yoga studios, and the like.
The SBA may require collateral to secure the loan. This can be in the form of business equipment or machinery or the business owner’s personal assets, such as real property.
Short of funding your start-up by assuming personal debt on credit cards or through a line of credit or second mortgage on our home, you can use any or all of these types of debt for small businesses to get started. Good luck!