When you’re just beginning a new business venture, you would want more than one financial resource. You wouldn’t want to put up all the required money yourself; usually, a new business owner can’t even afford to. Nor would you want one single investor who would want to control everything.
It’s, hence, best if entrepreneurs look at several financing sources that can get their business up and running. However, the best investment sources aren’t really clear since they can vary with the kind of business. In order to help business managers and owners figure out the best kind of loan for their startups, we’ll be discussing the top ten kinds of business loans, especially for new ventures:
1. ROBS or Rollover for Business Startups
A new entrepreneur in the business may not know about ROBS since it’s a little-known yet effective way to get investments. By using this option, fresh entries into the business world can get funds channeled directly from their retirement fund.
Usually, when you want to make a withdrawal from such accounts, you’d have to pay certain penalties or at least more income tax. With ROBS, however, this is not the case. Plus, it won’t be a loan taken against the funds, and it’s not a flat-out cashing of the account either.
Furthermore, no payments need to be made against the loan and no debt piles up either. It may sound too good to be true, but it is real! However, one must look properly into this option before they go for it.
There is a cost involved with ROBS, even if it requires no penalties or payments. You would have to cough up around $5,000 to set up this process. There would also be a $140 fee for monitoring the transfers every month.
If you want to use the ROBS system, you would have to possess an IRA or a 401k first. You can invest the existing savings that was originally meant to be for your retirement into your company’s 401k.
The new 401k plan would then purchase your business shares. In such a case, it is the business that finally gets the money and can use it to fund any expenses.
The conditions for investing through ROBS need to be fulfilled, though. They include the following:
- The retirement account must belong to an official employee within the organization that’s benefiting from the funds. This means one cannot use a separate friend or family member’s retirement fund.
- The employee must work at least a thousand hours for this business very year.
- To qualify for ROBS, a company should be labeled a “C” corporation according to its structure.
- As the business owner, one must also hold around $50,000 or more in a retirement account that is tax-deferred.
- The setup fee of five thousand dollars should come from somewhere other than the current amount in your retirement savings. However, the monitoring payments could come from any convenient source.
The above terms mean that ROBS is a system which should work well with businesses that are actively managed. If one is conducting a business that deal in, say, real estate investment, it wouldn’t require much activity. Hence, the ROBS system wouldn’t be a good fit here. We’ll be talking more about what kind of company ROBS is good for below.
When to Consider
The thing to remember about ROBS is that it’s a flexible system. It can, hence, be applied to any sort of company, provided that the requirements are fulfilled. It can also be used alongside other funding choices instead of being the sole source.
One can even use ROBS money for a down payment on any kind of loan. However, it is highly recommended that the owner of a new business should get a consultation before taking such a step. Guidant offers this service for free and would even help with setting it up. Since this whole procedure would take around 21 days or more, you should seriously consider getting all the help you can.
2. Home Equity Line of Credit (HELOC)/HEL
If a business owner also owns a house or any sort of home, they could be able to get an HEL or HELOC. These loans have a relatively lower rate of interest.
HEL and HELOC have different makeups, so it’s worth learning about them. HEL is where one gets a certain amount upfront, which is then returned in the form of payments spread over a period of time. A HELOC is simply a line of credit where one can withdraw the amount as and when they need it. The interest one pays afterwards would only be on the amount that has actually been withdrawn.
One should consider the closing costs when taking loans such as HEL and HELOC. This is because they’re second liens and incur a cost of around two to five percent. The yearly interest rate would be another three to six percent. HELOC is a bit cheaper in terms of initial costs and interest rates than HEL.
To qualify for HEL or HELOC, one should have the following:
- Twenty percent equity or more on a home.
- 30-40% equity is preferred because the LTV (loan to value) usually peaks at 80%.
To better understand both kinds of loans, think of HEL as another mortgage on your house. HELOC can be thought of as another credit card. The following discussion would hopefully clarify which loan is best for your company:
If you already have several accumulated expenses, it’s probably best to go for a HEL. You need to use a decent amount of money right away, so it’s just as well to get it up front.
If you just want funds for running costs that are yet to accumulate, going for HELOC is better. This would get you a lower rate of interest. You would also only pay interest on your existing balance.
Both HEL and HELOC would be using your home for collateral purposes. This would limit the collateralization of any future loans.
When to Consider
Both loans can only be obtained when you have a decent credit score along with the required equity in your main residence. This also requires risking some very valuable personal property. You should be fully informed before going for this funding option.
3. Loans from P2P Sites
P2P or peer-to-peer sites would let a business owner borrow funds using an online matching service. This would match businesses with people or organizations who would be interested in funding them.
With this technology, entrepreneurs could reach sources of funding that may not have been found in any other way. The most expansive example of a P2P site is Lending Club.
The fee for a P2P loan is taken for the originating process. This amount is around one to six percent and is deducted from the sum you get in the beginning. An interest rate from around five to twenty six percent is also applied.
Lending Club and other P2P sites usually provide personal loans for one to five years. These are taken mostly for fulfilling debt or credit card obligations. They may also be useful in starting out, buying a business, or operating your venture. There are also some larger business loans on offer sometimes, but those are meant for larger, more well-known organizations.
For P2P loan qualification, one should have a credit score of 650 plus. If the score is below the requirement, a lender like LoanMe would be good for small personal loans, though they would have high rates of interest and provide around $50,000 or lower. An online application is usually required for such platforms.
Keep in mind that while these loans may be for a business purpose, you’re the one who is borrowing and on the hook for the loan. If you don’t pay the loan back, your credit rating will be affected and you could lose personal assets. The interest rates are similar to credit cards, but you’ll be receiving a lump sum payment that you’ll be paying interest on instead of a credit line.
When to Consider
P2P loans should be considered when one has a new venture and is ready to take personal responsibility for repayments. Online prequalification for a maximum of $40,000 is available if you use a service like Lending Club. The online form should take a very short time.
4. Credit Cards for Small Businesses
Credits cards can be quite an economical means of financing any venture. Most have zero APR on their initial periods and may also have other benefits such as cashback and rewards. All this is great for saving money in a business.
Credit Card Cost
Usually, credit cards have an average interest rate of sixteen percent every year. A few may also incur $50-$100 fees annually.
Credit cards for small businesses shouldn’t be used to invest large amounts of cash. However, they are quite useful when it comes to managing a cash flow. Using a credit card could tide one over when some payments are late. This way, you could save and earn some rewards in one go.
More than a third of small startups utilize credit cards for their daily running costs. The benefits of this use include the following:
- Zero percent introductory charges
- Interest only applies on the balance at the completion of billing cycles
- Several rewards and cashback programs allow for a little extra earning
- Allowance for issuing employee cards. These can be utilized for limited spending, such as on gas, supplies, and food. This means perks for reliable employees, less hassle in purchase-approval, and even more rewards from the card itself
- APRs are quite affordable, from ten to thirty percent
There is a disadvantage to using credit cards, though. If not used correctly, they can be detrimental to one’s personal credit ratings. If this happens, credit limits may suddenly close or become more stringent without prior notice.
When to Consider
Any business could benefit from using credit cards but mostly as a way to tide it over in the short term. Online guides can aid in finding the best cards for small ventures at any time.
5. Equipment Financing
Loans for financing a business’ equipment are available from banks, online services, and specialized dealers in equipment. Such loans could be taken to buy heavy machinery, vehicles, or any other kind of expensive apparatus. This step would also save money for other uses.
The introductory APR for equipment financing is usually five percent. However, this percentage is influenced by what one needs to buy and who they’re applying to. A dealer could have higher rates than banks, but banks could have extra fees that increase the cost.
Financing equipment could be of three forms. The difference is mostly in the final ownership of the machinery/vehicle. We’ll discuss these three forms below:
When you get a loan for buying equipment, the purchase is yours. The payments can be made over a period of one to five years in most cases.
Fair market leases are the most common form of equipment financing. A business can make monthly lease payments which are essentially rent for the machinery. When the lease ends, a business owner may then buy the equipment at the usual market rate. They may also choose a lease extension or give the machinery back.
Lease ($1 Buyout)
With this sort of lease, a business owner would again pay rent for using the needed equipment. After the lease is up, the equipment may be purchased for a single dollar. This is a good way of going about it if the owner is sure about purchasing. With this leasing agreement, the equipment stays with the company for two to five years. The interest rates could vary from 6-16%.
There are several programs, including an online calculator, which can help you find out the best economical option from the three above.
When to Consider
Financing equipment is a good way to get startups what they need. This is especially true if the equipment is a major part of the business such as industrial bakery equipment for a bakery.
Even if a business owner has the money to purchase such machinery, it’s better to save it for other needs. It’s easy to get approval for such loans, at least more so than the usual unsecured loans for small startups.
You can contact Smarter Finance USA for help in purchasing equipment worth up to a hundred grand. This can be structured in any of the three ways described above. A 650 plus credits score is necessary here, along with a down payment of ten percent. There is no repossession, foreclosure, or bankruptcy involved.
6. SBA Loans to Help Startup Businesses
SBA stands for Small Business Administration. The name is pretty self-explanatory since it guarantees loans to small ventures. However, if you want a good deal for a startup, the friendliest options would be the Microloan and the Community Advantage Programs. Both organizations go for either new or struggling businesses. There are several kinds of loans available here, but it may be difficult to qualify if one doesn’t already have a business.
The yearly interest rates for SBA loans are about six to nine percent, not including other fees such as:
- Origination fees: 0.5% to 3.5%
- Packaging fees: $2,000 to $4,000
- SBA guaranteeing fees: 3% to 3.5%
SBA loans are known for their strict requirements. One needs a credit rating of 680 and above. Plus, there should be some collateral to offer. Additionally, there may be a lot of choice in SBA loans, but the Community Advantage and Microloan programs have their own conditions.
In the Community Advantage process, a startup can borrow a maximum of $250,000. For Microloan, the maximum is only $50,000. Here, the SBA itself is not lending the money but is only guaranteeing that the loan would occur.
The lending entity would be approved by the SBA. One example of this is a community development corporation (CDC). It may also be a not-for-profit venture or even a regular bank.
The main benefit one gets from SBA loans is the low rate of interest with a long allowance for repayment. However, SBA loans are for those companies that have some sort of self-finance already in place. SBA wants to see startups having enough confidence to invest in themselves. Hence, the owner should have put at least a third of their assets in the business.
When to Consider
The SBA would look favorably upon businesses where owners are somewhat experienced in management and their respective sectors. As mentioned above, they should also have some sort of self-investment.
SBA 7a loans are the most popular of these programs. They’re also heavily controlled by people who believe in stringent requirements and very high standards for underwriting. A business owner is best off applying for a loan with a lender who personally knows them or their society very well.
Additional requirements for SBA loans include presenting a proper workplan. One can make use of a software especially formulated for such purposes. You can get several templates and guidelines here so that nothing important is overlooked. It’s also good to check out some of the many examples on hand so that you know what to aim for.
Lastly, make sure you have enough to put down a third of the SBA loan as a down payment. This could be out of reach for many entrepreneurs. One way to get the cash here is to use a ROBS. For the best guidance, you can look to a service like Guidant.
7. Nonprofit Lender’s Microloans
If the owner of a new business has a low credit score and not enough collateral, nonprofit lenders may be the answer. Such lenders are usually looking to back up an idea or project that fulfills their criteria. For instance, they may be willing to support the launch of a new bookshop if they have an interest in that area.
The yearly interest rate would be 8% to 22% on average for such loans.
One example of a nonprofit lender is Accion. It gives microloans to new business ventures across the nation. It lets one borrow a maximum of $10k for a new business or $50k for an already-running venture. Another example of such a nonprofit is Kiva, which can lend a maximum of $10k for startups.
These loans are not like grants, nor are they given freely. Accion is available just for those entrepreneurs who have enough cash coming in to meet the repayment terms. The borrowing owner should also prove that they have some income outside of the venture (if the venture isn’t making enough). This could be their day job or spouse’s income. If one has a cosigner with a large cash flow and high credit rating, getting a microloan approval would be easier.
A little word of advice here: if your credit score is not up to at least 640, you may want to try building it up with the help of certain services. Read up on those to decide on the very best.
When to Consider
One should consider a microloan from nonprofits if they don’t have a good credit score. The interest rates from Accion can be as little as eight percent. Anyone can see if they qualify for such a loan by filling in a speedy application online.
Crowdfunding occurs when you try to get many people donating money, even if it’s a small amount. Such investments are usually conducted online though platforms like Kickstarter and GoFundMe. When entrepreneurs seek such capital, they also need to consider giving equity or rewards in return.
Crowdfunding usually costs around 5-10% of the money collected, along with any rewards or shares handed out.
For crowdfunding, it’s important to have a strong business, campaign, or idea. If people are inspired by what the money is for, they will contribute. Other requirements may consist of the potential reward that people get for donating. Lastly, the process should go through a known crowdfunding website.
Kickstarter is a well-known example of crowdfunding with rewards. Those who donate a specific amount would get something in return. This may be a product or service, like free vouchers to a salon. For this, the donation should be for a specified project that is made clear when the business asks for money.
This is a recent kind of crowdfunding and has yet to firmly establish its place online. However, the rulings surrounding this method are a bit relaxed now, so this option is easier. Below are the three kinds of equity-based crowdfunding:
- Equity 1: This is a private process that is conducted with endorsed investors. This may limit the number of investors but would also mean least legal limitations.
- Equity 2: A company can announce their crowdfunding here, but only endorsed investors are allowed to donate.
- Equity 3:This is an SEC-regulated option where one could advertise their crowdfunding and have almost any one donate. The regulations are in place to protect novice investors.
Many investors who donate to crowdfunding projects are unaware of their rights when they’re promised some equity in return. This is why there are several laws in place for equity-based crowdfunding.
When to Consider
If there’s just not enough to even launch a startup, an entrepreneur should consider reward-based crowdfunding. This would also be the best choice for products and services with a high margin. The crowdfunding here would create awareness among potential customers and trigger pre-sales of upcoming items.
Crowdfunding based on equity is a good choice for a business that is fine with giving up control in favor of expansion. It’s not widely spread or accepted yet.
If you’re considering crowdfunding in general, do read up on which sites are the most effective and what this option would mean for your company.
9. Angel Investors
When rich people want to invest in a business, they’re called angel investors. This means a new venture can get the money they need for launching their product or service without getting into debt. Angel investors do demand at least part ownership, though, since they’re investing in the owner as well as the company. While the investment may not be as much as a venture capital investment, the interference is usually limited as well.
An investment from an angel usually comes at no monetary cost. You would be required to give at least five to ten percent of your ownership and equity to the investor, though. Even if the angel gets more than fifty percent ownership, they would probably let the entrepreneur manage the daily operations.
Below is some information on their demands, especially when compared to venture capitalists:
- A lower rate of return than venture capitalists
- Angels would like to have some input on the running of the business but eschew control for the most part
- Angel investors mostly give around $25k-$100k at a time
How to Raise Money from Angel Investors
Getting in touch with angel investors usually depends on an entrepreneur’s networking skills. If their ideas and projects capture the interest of wealthy folks, they have a larger chance of getting some money to make it all happen.
The investment should be structured like a loan known as a ‘convertible note.’ This is when a loan does have interest, but it changes into stock when the time is right such as when the company gets the attention of some venture capitalists when they’re more established. The benefits of this happening are:
- A simpler method that incurs fewer legal expenses than a regular investment in exchange for equity
- There’s no need to negotiate on the worth of the company
In short, angel investors need to believe in the owner of the company or organization as much as the projects and ventures they’re interested in. If one doesn’t personally know an angel investor, they can always try out certain sites for angel investing. One of the most well-known examples for this is AngelList.
When to Consider
If an entrepreneur needs a decent amount of investment and is fine with losing some equity, they should consider an angel investor. However, it’s highly recommended that one read up on how to best raise capital through the use of angel investors.
10. Venture Capital
This is usually given by venture capitalists, which is a proper organization or company of investors. VCs would give companies a huge amount of money and ask for a certain portion of equity in return. However, one should keep in mind that they would ask for quite a big role in the business itself.
When pitching to VCs, one should have a properly thought-out plan for their business. They should also have projected financial aspects of the company before the pitching begins.
VCs demand some of the ownership of any business they invest in. In fact, most of them would require the majority of the business transferred into their hands. This means that you must prepare to give at least a tenth, third, or even more of your venture to VCs.
VCs are on the lookout for a great deal of return on any money they invest. This return should ideally be ten to fifteen times the investment itself and must happen within five years. All this is not usually possible for young businesses; hence, they should not be searching for VC investment.
Companies that provide VC investment are able to do so because they have investors of their own. Since they have to pay off those investors, their rate of return and control is not negotiable. With the high level of command they get in any business, VCs are able to make the most and speedily capitalize on their investment.
When to Consider
As with angel investors, a company looking for VC investors should not mind giving up some control. They should also be ready to expand quickly since this is the aim of most VCs. They do this by investing a whole lot into the business’ needs as well as making it a serious market player.