If you’re already a successful business owner or have just received a generous inheritance, you’ll have no trouble financing a new venture. Not only do you have cash, but banks are probably lining up to loan you money. You’ve already got it, so you don’t need it, but that’s exactly when financial institutions (and people) are anxious to give it to you.
But what about the rest of America’s aspiring entrepreneurs? There are plenty of smart, ambitious and hardworking folks who need to secure financing to build or buy a business. Traditional small business financing—such as the Small Business Administration (SBA) loan programs—can be very difficult to secure, so if you’ve gone down that road and been denied, you are not alone.
I am here to tell you that there is still opportunity ahead: There are other ways to fund your business—some of which you may not even have heard about yet—and one of them will be right for you. So, to make your search a little easier, here are my top three alternative options for funding a business:
1. Portfolio loans
Many entrepreneurs fund a business by selling securities they personally own and then investing the cash they earn from the sale into their business.
What those entrepreneurs may not realize is that there’s an option to use a portion of a portfolio to invest in a small business or franchise without selling the underlying securities. A portfolio loan allows you to leverage the value of your portfolio assets into a revolving line of credit with a loan-to-ratio value (a lending risk assessment that lenders use) between 65 percent and 90 percent.
These loans can offer fair interest rates and a longer amortization timeframe, and generally they move from application to approval in just a few weeks. In addition to attractive terms, entrepreneurs can continue to reap the rewards of appreciation as their stocks increase in value.
What to watch out for:
Unlicensed and unregulated lenders are what you need to avoid. The Financial Industry Regulatory Authority strongly recommends using their FINRA BrokerCheck tool to verify the licensing status and background of promoters, lenders and anyone else involved in the transaction.
And if the value of the portfolio declines and the borrower has drawn down the entire line, the borrower may have to bring in outside capital, or sell securities, to maintain the appropriate loan-to-ratio value.
2. Rollovers as business startups
Rollovers as business start-ups (ROBS) are also known as 401(k) rollovers, and they’re becoming more and more popular.
Some estimate that 30 percent of new franchises each year are funded through this arrangement. ROBS allow you to invest up to 100 percent of your existing retirement assets into a business or franchise by migrating your retirement funds into a new account that then operates as a stakeholder in your business.
Migrating the funds this way allows entrepreneurs to avoid paying taxes and penalties for withdrawing funds from their retirement account early; simply emptying all or a portion of your retirement account before turning 59 ½ incurs sizable penalties and regular income taxes. ROBS began fairly recently, with the Employment Retirement Income Security Act of 1974 (ERISA), which was designed to encourage investments in small business.
What to watch out for:
In order for ROBS to work smoothly and avoid IRS penalties, the arrangement must be set up to exacting standards. Unless you’re extremely well-versed in tax or ERISA law, you should seek the the help of a qualified professional to initially form and provide ongoing administration for the plan. Put simply: Hire a firm that specializes in these types of transactions.
3. Unsecured credit
Another method of funding a new business is through an unsecured line of credit. (The traditional version of this method—using a secured line of credit—is to use your home or other business’s assets as collateral.)
If your personal credit is strong, an unsecured line of credit can be a good way to get your hands on up to $125,000 in startup capital. It’s called “unsecured” because the lender does not require you to pledge personal assets as collateral. Many entrepreneurs prefer not to pledge their personal assets while in start-up phase because a successful outcome is uncertain.
For a new business, your application will most likely include a business plan and up to three years of earnings projections. Be prepared to explain exactly what you’ll use the money for, so the lender will feel confident that you’ll be able to pay it back.
What to watch out for:
There are many unsecured programs available with varying interest rates and origination fees.
Shop around for the best program but do not apply until you’re certain of the direction you want to proceed—too many hard inquiries into your credit history in a short period of time can damage your credit score and decrease the likelihood that you’ll be approved for a loan with favorable terms. If you have any negative reports (like late payments) on your credit history, make sure you resolve them before seeking an unsecured loan.
If you’ve got ambition and drive but lack the liquid funds to purchase your slice of the American Dream, one of these alternative funding options may be the right choice for you. Just remember to investigate business opportunities and financing options diligently.