Today, as banks continue to be tight-fisted when it comes to small business lending and investors remain cautious, business owners in need of financing might be tempted to use their personal assets to fund a business. But any source of funding that taps into personal assets comes with a high potential cost.
While some established business owners will seek financing through business loans and capital financing programs, personal financing in many cases is a new business owner’s most relevant option. Here is a rundown of the different ways to fund a business.
Cashing in on retirement funds is more likely to harm than help. First, borrowing from a retirement fund generally triggers an early withdrawal penalty, and you also have to replenish the account later to make up for the loss to your retirement nest egg. If your business fails, or is simply unprofitable for a few years, you will have little means of repaying the funds.
If business owners saved and set aside seed money for their businesses, they can seemingly dip into those funds with a light heart. Savings have no borrowing cost, no payback terms, and no liability. But this financial cushion can quickly evaporate, mean the loss of one’s savings. Personal savings that were intended as an emergency back-up can get sucked into the business, never to be seen again.
Editor’s note: Cash you have set aside specifically for small business investment is by far the best funding source. Hands down, this is the most ideal way to begin your journey into self-employment. Regardless of what happens you’ll come out of the situation debt free.
Credit card companies are usually “generous,” offering an endless stream of 0% balance transfers; just don’t look at the interest rates or fees. Unfortunately, that quick and easy cash comes at a high price. There are many reasons to not use credit cards to fund a business. Interest rates can range from 16-23%. Furthermore, if a business owner cannot repay the loans, his or her credit profile will be negatively affected for years to come.
Home equity loans typically give the longest payback period of all the funding options. The relatively low interest, plus the possibility of borrowing 100% of your home’s value, makes this cash source attractive.
On the down side, the fear of missing home equity repayments and placing your house at risk creates stress. Additionally, home equity loans cause monthly mortgage payments to increase, adding pressure to earn more money.
Taking Out a Personal Loan
It is becoming more and more popular for entrepreneurs and business owners to turn to family and friends for a business loan. The option is usually an attractive one since family and friends tend to be flexible about repayment, and usually request no or low interest. Depending on their means, the size of the loan can also be large.
But, “friendly” loans can often put relationships in jeopardy. If the lenders question your use of the funds, or worse, if your business fails and you cannot repay them, they might not forgive you.
Some entrepreneurs may try their luck with a commercial finance company or a consumer loan office. But at 14-30% interest, business owners have to question whether these loans are affordable or worthwhile.
In short, while tapping into ones personal assets may seem like the quickest and best way to fund your business, there may be many potential nightmares down the road.
photo by rogerimp