Starting a business requires capital — often more than you initially planned for. If you burn through your savings too quickly, or expenses begin to mount, where will you obtain additional financing? The answer varies by entrepreneur.
According to the most recent Survey of Small Business Owners put out by the U.S. Census (look for an updated survey next year), these are the primary means for funding startups:
Personal or Family Savings or Assets
Business Loan from a Bank
Business Profits or Assets
Government or Guaranteed Loan
The Most Popular — But Not Necessarily Safest — Means of Funding
The survey showed that 51% of small business owners use their own savings, or the savings of a family member to fund expansion of their companies. If it’s easy enough to replenish the empty savings account, this can be a viable option for funding a business. But what happens if you can’t pay back a family member, or you jeopardize your family’s retirement security?
The survey showed that 24% of business owners use a credit card to pay for business expenses. There are mixed feelings on using credit cards to fund a business. If the interest rate is higher than a traditional business loan, it can be costly for a business to pay it back, and with profits slow to come in over the first few months, it’s easy for a business to rack up serious credit card debt before it can pay it back.
Taking out a home equity loan or second mortgage to start a business is something you should think about carefully before doing, especially if you are reasonably close to paying off your home. You don’t want to add on another 30 years of debt with no plan on how your business will repay the second home equity loan. Plus, you may put your family’s home at risk.
Better Options for Startup Funding
If you’ve got business profits, those are the smartest to use to reinvest in your company. Twenty-nine percent of those surveyed are putting profits back into the company to expand it, rather than taking out costly loans elsewhere. It might mean things will be lean for a while, and growth may take longer because you have less to invest in hiring sales and marketing people, investing in technology, and so on. In the long run, though, you won’t have a business saddled with debt.
Business bank loans can also be an option, best suited for established businesses with a steady-enough revenue stream to commit to a repayment schedule. Almost one-third of small business owners are using traditional business loans, according to the survey. Bank loan rates are usually much more competitive than credit card rates, and they can help your business establish its own credit, independent from your personal credit.
Surprisingly few business owners go the SBA loan route, accounting for less than 3% of businesses.. SBA loans are administered by local lenders in your community – you can find a list of SBA-approved lenders on the SBA.gov website or at your local SBA office. The lender can let you know about traditional loans they offer, as well as SBA loan programs you may qualify for.
Choose Your Funding Wisely
Whichever method you select to help start or grow your business, own the decision. Have a plan for how you will pay yourself, your family member, credit card, or bank back, and a contingency plan for what you’ll do if you can’t pay it back. Calculate what the loan rate will cost you in the long run so you won’t end up paying thousands more than you borrowed.