Here you will find definitions and key terms regarding funding your business.
The NIACC JPEC has several funding programs ranging from NanoLoans to Venture Capital providing capital of $1,000 to over $200,000.
Financing with Debt versus Equity. Debt, like loans or notes, represents claims on the assets of the company. Whoever holds the loan or note does not have direct say in the management of the company, but is one of the first to be paid off if something goes wrong. When the loan or note is paid off, their participation ends. Equity, on the other hand, is selling someone part of the company. It may be a semi-permanent arrangement, like selling shares, or a temporary one, like using angel investors or venture capitalists. In general, entrepreneurs prefer debt financing over equity financing because the effective interest rate is usually lower and there is no dilution of control. The following gives an overview of the most popular financing programs.
Pre-Launch (Early Stage) Financing. Sometimes you need money to determine if you have a business- develop prototypes, complete research, etc. That money can be difficult to find. You may need to:
- Sell Assets. If you own things, you can sell them. It’s that simple. Jewelry, rugs, pool tables, boats, time-shares, second properties–the list goes on. Most people’s largest assets are their homes and cars. Homes are covered later. Here’s what you can do with automobiles.
If you drive a nice, late-model car, you can sell it and lease a cheap one without a down payment. This might net you $15,000 to $20,000 and leave you with a small monthly lease payment.
- Borrow Against Your Home. This is the oldest trick in the book. It’s also one of the best because you can exert almost total control over the process. Here’s how it works: Say you need $50,000, your home is worth $250,000 and you owe the bank $100,000 on your mortgage. You can borrow against the equity, in this case $150,000.
Of course, once the loan kicks in, you’ll have monthly payments. If you’re starting a new business, it’s a wise idea to set aside some of the proceeds from the home equity loan to help make these payments until the business can pay you a steady salary.
Another way to get money out of your home but maintain a lower monthly payment is to refinance the mortgage with a new one.
- Borrow Against Insurance Policies. If you want to know where all your money goes, look at your insurance payments. Each month you probably pay for health insurance, life insurance, disability insurance, auto insurance and perhaps homeowner’s insurance. Unfortunately, you can only borrow against whole life policies, but most have some cash value after three years. Simply write your agent or insurance company, saying you want a policy loan. Most companies will lend up to 90 percent of the cash value, and your policy stays intact as long as you keep paying the premiums as they come due. However, if you die with a policy loan outstanding, the benefits might be diminished, although that varies by policy. But the good news is that loans against your insurance policy are fairly reasonable, since the rates charged are tied to the key money-market rate.
- Financing with Friends and Family. This is usually the first place a business person looks for money- hopefully before (and instead of) maxing out the credit cards. Typically, sympathetic friends and family will make you a loan at or near the prime lending rate. Friends and family make loans because they know YOU. Coincidentally, this is also sometimes the same reason they don’t loan money.
However, investments with friends and family can turn out bad when things don’t go as planned. The situation can be even worse than with professional investors because friends and family react to bad news as much with emotion as with logic. Take the following steps to protect everyone:
- Get an agreement in writing. This will eliminate all conversations that start with, “You never said that.” Execute a promissory note that states the amount and the interest; have it signed and witnessed or notarized.
- Emphasize debt (loans) rather than equity (ownership). You don’t want friends and family in your company forever. Before you know it, they start telling you how to run the place. Make it a loan, and pay it back as fast as you can.
- Put some cash flow on their investment. If someone says, “Here’s $50,000–try not to lose it, and pay it back as soon as you can,” that’s great. But consider paying some nominal interest at regular intervals so that you and they have a reality check. And it’s better to pay this quarterly rather than monthly. This way, when things are teetering, your lender won’t immediately know it.
- Borrow Against Your Investments. If you’re starting your business part time while keeping your full-time job, a potentially stable investment is borrowing against your employer’s 401(k) retirement plan. It’s common for such plans to let you borrow a percentage of your money that doesn’t exceed $50,000. The interest rate is usually reasonable, with a specified repayment schedule. The downside of borrowing from your 401(k) is that if you lose your job, the loan must be repaid quickly, often within 30 days. To see if this is an option, consult your plan’s documentation.
You may also want to consider using the funds in your IRA. Within the laws governing IRAs, you can actually withdraw money from an IRA as long as you replace it within 60 days. This is not a loan, so you don’t pay interest; rather, this is a withdrawal that you’re allowed to keep for 60 days. A highly organized person could possibly juggle funds among several IRAs. But if you’re one day late–for any reason–you’ll be hit with a 10 percent premature withdrawal fee, and the money you haven’t returned becomes taxable.
- Credit Cards. Credit cards are quick and easy. In a perverse way, they are also cheap. That is, a minimum payment of $50 per month can hold down a whole lot of debt. Of course, if you only make the minimum payment and with a high interest rate, your balance continues to grow, and if the business fails, you have to pay.
- NIACC JPEC NanoLoan Program. NanoLoans are targeted to early stage entrepreneurs whose business concept is not yet bankable. These business concepts cannot meet the minimum qualifications to gain access to traditional credit, including NIACC’s USDA Revolving Loan Fund. An entrepreneur with a pre-bankable business concept can borrow up to $2,500 at attractive terms to complete development of their business concept. Contact the NIACC JPEC for more information.
NanoLoans are a financial innovation which originated in developing countries where it has successfully enabled extremely impoverished people (mostly women) to engage in self-employment projects that allow them to generate an income and, in many cases, begin to build wealth and exit poverty. Due to the success of NanoLoans, many in the traditional banking industry have begun to realize that these borrowers should more correctly be categorized as pre-bankable; thus, NanoLoans are increasingly gaining credibility in the mainstream finance industry. Although almost everyone in larger development organizations discounted the likelihood of success of NanoLoans when it was begun in its modern incarnation as pilot projects with ACCION and Muhammad Yunus in the mid-1970s, the United Nations declared 2005 the International Year of Microcredit. Mr. Yunus was awarded the Nobel Prize in 2006.
Other Programs. The previously mentioned programs represent the most commonly used. There are many others that are narrower in scope. For personal help call (641) 422-4384 for an appointment.