The Ultimate Guide to Funding Your Small Business

Even those small business owners and aspiring entrepreneurs with the most impressive business plans can find themselves sabotaged by a lack of funding. A lack of capital can put an end to the plans of a small business to expand or prevent a startup from ever getting off the ground. For those small businesses unable or unwilling to solicit investors, small business personal financing can be a formidable challenge.

Fortunately, when it comes to personally funding a small business, there are other funding options available for small business owners, even for those just starting a business. In addition to looking to small business loans from sources such as banks, online lenders and the Small Business Administration (SBA), business owners can also use a personal loan to start a business or to expand an existing one.

How Do You Finance a Small Business?

In addition to business loans from banks, online lenders and the SBA, there are a variety of other ways to finance a small business. Most startup businesses, in fact, are simply financed through personal savings. But, to do so safely, the business owner should have saved living expenses for at least a year. Credit cards, outside investors, government and corporate grant and loan programs and crowdfunding can also be effective vehicles when it comes to funding a business. But it can be difficult to qualify for a loan for a new business. It’s natural for entrepreneurs to wonder “Is it hard to get a startup business loan?” For these individuals, a personal loan for a small business may be their best option.

According to the SBA, starting a small, home-based business costs at least $3,000. These businesses are normally owner-operated with no employees and have minimal startup costs. A home-based franchise can cost between $1,000 to $5,000 to start. This should not be confused with retail franchises that cost much more. One way to secure these startup costs can be with a personal loan for small business owners. Existing business can also secure funding with a personal loan, but does it make sense to use a personal loan either for a startup or an existing business?

Is It Easier to Get a Business Loan or a Personal Loan?

Using a personal loan for small business can be an easy and effective way for business owners to access the revenue they need should they not have enough revenue or time in operation as an active business. Personal loans for business tend to have lower interest rates than many other business loans (5.99% to 35% APR) and often don’t require collateral.

Terms of the loan can range from three to five years. They are also normally easier to qualify for as approval can come within one day. Another advantage of personal loans for small business is that they generally have more flexibility in terms of what the funds can be used for. In contrast, other types of business loans can have a narrow window of expenses that the loan can be used for.

On the downside, loan amounts are typically limited to less than $50,000. Personal loans for small business owners mix personal and business finances, which can expose a business owner’s personal assets to risk. The loan also becomes part of the personal credit history of the small business owner. This prevents the business from building a reputable credit score, which could hinder the ability of the business to secure a business loan in the future.

When to Use a Personal Loan for Small Business

Certain situations may dictate that the benefits of a personal loan for small business outweigh the risk. Brand new startups, for instance, that cannot qualify for a traditional business loan may find a personal loan to be their best – but not their only – option.

Banks tend to charge higher interest rates for business loans with smaller amounts. As such, the lower interest rates of a personal loan for small business may be more attractive for a business that is looking to borrow less than $50,000. The fact that personal loans are less likely to require collateral is another reason that small business owners may opt for a personal loan for their business, especially given the fact that a lack of collateral is a reason that many business loan applications are denied by banks.

When Is a Business Loan a Better Option?

Established businesses that have excellent revenue and assets will most likely find a business loan to be a better option. This is especially true if a business knows exactly how it will use the funds from the loan to guarantee future success. While it can be difficult to qualify for a bank loan, an SBA loan or a long-term loan from an online lender can be a good choice.

Of course, since personal loans for business are capped at $50,000, businesses needing a larger loan will have to look into dedicated business loans. Online lenders can offer more funding, although interest rates through these lenders tend to be higher. For businesses looking for a large amount of capital, SBA loans can provide up to $5 million, along with low interest rates.

A third scenario in which a business loan is preferable over a personal loan is if a business has a specific need. Personal loans come in the form of either a line of credit or term loan, while business loans can offer more flexibility. For instance, business loans can be used to buy property or specific pieces of equipment that a business may need to grow or to become more efficient.

Who Can Qualify for a Personal Loan for Business?

Some of the factors that lenders look to determine if business owners can qualify for a personal loan for their business are personal credit score, annual income, debt-to-income ratio and net worth. These same factors also influence the interest rate the business owner will pay.

Applicants will need to submit documents and information such as their driver’s license, credit score, bank account number, pay stubs and W-2 forms and personal tax returns.

In addition to banks or online lenders, business owners could also venture into the loan marketplace and use a service that can quickly connect the business owner with a number of potential options.

Home Equity Loan for Small Business

When it comes to considering a personal loan for business purposes, a common question is “Can you use home equity for a business loan?” While the answer is yes, a home equity loan used for business purposes comes with a fair amount of risk. This risk is multiplied substantially in cases where an entrepreneur is using a home equity loan or home equity line of credit (HELOC) to start a business.

That’s because it can be very difficult for a small business to succeed, and a home equity loan typically uses the home as collateral. Thus, if the business fails, the entrepreneur’s home can be in jeopardy.

According to the Business Employment Dynamics report of Bureau of Labor Statistics, 20% of businesses with employees fail in their first year, and 33% fail in year two. Only about 50% survive for five years. As a result, it’s recommended that a home equity loan or HELOC should be considered only by those who’ve paid down a significant portion of their mortgage.

Home Equity Loan vs. HELOC

Both home equity loans and HELOCs are second mortgages on a home. For entrepreneurs trying to decide whether to use a home equity loan or to use a HELOC for small business, it’s important to understand the difference between the two. Most home equity loans and HELOCs allow up to 85% of the value of a home, minus the outstanding mortgage balance. Since the home is used as collateral, interest rates are typically low.

Home equity loans normally come with a fixed interest rate and fixed monthly payment. The loan is paid back over a range anywhere from five to 30 years. The loan amount can be used however the business owner sees fit, and some home equity loans don’t have any fees.

Unfortunately for business owners who may be wondering if the interest paid on a home equity loan for business is tax deductible, the answer is no. Interest paid on a home equity loan is only tax deductible if the loan is used for home renovations.

The question of whether there is a minimum amount for a home equity loan, depends on the lender. But it’s not worth the time of lenders to make small loans. The lowest available amount on the market is $10,000. Some lenders have a minimum of amount of $25,000; the minimum for others can range from $35,000 to $150,000. For those wondering if it’s hard to qualify for a home equity loan, there are a few minimum basic requirements that must be met, such as:

  • A credit score of 620 or higher, with a score of 700 and above likely to qualify for the best rates;
  • Twenty percent equity in the home, which means a maximum loan-to-value ratio of 80%;
  • A debt-to-income ratio of 43% or less;
  • And a documented ability to repay the loan.

HELOCs, on the other hand, works much like a credit card. A HELOC allows borrowing against the available credit in a home, with the home used as collateral for the line of credit. As the outstanding balance is repaid, the amount of available credit is restored.

Some entrepreneurs may ask, “How do I start a home equity line of credit for a business?” The same lenders who offer home equity loans can also offer HELOCs. The basic requirements such as credit score, debt-to-income ratio and the like also apply to HELOCs.

Can I Use a Small Business Loan to Pay Personal Debt?

While mounting personal debt may make it tempting to use funds from a business loan to pay personal expenses, it’s not advisable and, in many cases, not permitted. Businesses that are set up as corporations, LLCs and partnerships are separate and distinct legal entities. As such, the funds provided by the loan belong to the company and not the owner. Now, business owners can pay themselves a steady salary out of the company account. However, money cannot be removed to pay personal expenses.

The same applies to company credit cards. Charging personal items on company credit cards blurs the line between personal and business expenses and can potentially make the business owner personally liable for money owed by the business.

Some business owners also make the mistake of using cash from a business line of credit to pay for personal expenses. Such a move exposes the business owner to additional tax liability. That’s because using the business line of credit for personal expenses can allow the Internal Revenue Service (IRS) to reclassify the line of credit as personal. As a result, the interest charges associated with the line of credit would no longer be tax deductible.

Can a Business Give a Personal Loan?

It’s not uncommon for business owners to borrow from their business. But the IRS has the power to re-classify the loan as a dividend or distribution. This makes the funds withdrawn taxable to the recipient and potentially not tax-deductible to the recipient.

Business owners who are part of an LLC can borrow money from their company if the LLC is treated as a corporation. Of course, any other partners would have to approve the loan. If it’s treated as a pass-through entity for tax purposes, there’s no need to characterize the withdrawal as a loan since the cash can be taken out as a draw.

How Can I Get a Business Loan with No Money?

With a low bank balance and without positive cash flow, getting a small business loan can be a tall order. Loans are paid back through automatic withdrawals on a regular basis. Banks and other lending institutions must be sure that money will be there for them. And without positive cash flow, a low bank balance isn’t going to improve.

The good news is that there are three options that can provide financing despite limited cash flow or a low bank balance:

  • Business Credit Cards. Using a business credit card to meet regular expenses can be a good way to stretch the finances of a small businesses. This is especially true of cards that feature a cash-back option, and if the business pays its balance on time and in full every month. This will help boost the credit score of the business.
  • Equipment Financing. Under the terms of an equipment loan, up to 100% of the equipment being purchased can be financed with the equipment itself used as collateral.
  • Invoice Financing. An invoice financing company can front 80 to 90% of the amount of unpaid invoices to a business. It uses the unpaid invoices of a business as collateral. The business receives the balance of the invoice, minus a fee from the invoice financing company, when the invoice is finally paid.

Grants

Grants can be another source of funding for small businesses. Such grants are available both through the public and private sectors and are available for both start-ups and existing businesses. But while a myriad of grant opportunities exists for a wide variety of reasons, researching and applying for them can be a laborious process. A few of the reasons and resources for grants are below.

  1. Coronavirus Small Business Grants. The current pandemic has created a number of small-business grant opportunities, as part of the Economic Aid to Hard-Hit Small Businesses, Non-Profits and Venues Act. Here is a current sampling of these options.

    The Targeted Economic Injury Disaster Loan Advance is one of these programs. Under the terms of this program, the SBA offers EIDL advances of up to $10,000 to small businesses in low-income areas that have suffered a significant drop in revenue due to COVID. The advance functions like a grant, given that it doesn’t have to be repaid. The SBA is currently contacting eligible businesses, but more information can be found at SBA.gov.

    Applications for the Restaurant Revitalization Fund opened on May 3. The RRF allowed restaurants and other food establishments that have lost revenue during the pandemic to apply for up to $10 million in funding. Establishments owned by women, veterans and socially and economically disadvantaged individuals were given priority during the first 21 days in which applications were accepted. The $28.6 billion fund was set up for restaurants impacted financially by the pandemic. However, out of 370,000 applications, only 105,000 restaurants received funding.

    The Shuttered Venues Operator Grant program opened on April 8 and has a pool of $15 billion from which to compensate movie theatre operators, playhouses, concert halls and other eligible venues that had to be shuttered because of COVID. A business must have been operating on February 29, 2020 in order to qualify.

    II Federal Small Business Grants. Federal grants can be an excellent source of revenue for small-business owners who may be looking to expand their operations. A good place to start investigating what grants may be applicable to a small business is grants.gov, which is a comprehensive database of grants available through various government agencies.

    In addition, two other programs — the Small Business Innovation Research and Small Business Technology Transfer programs – are designed to help in the development of research and technological research and scientific innovation. Through these two programs, small businesses can connect with federal grants and contracts from 12 government agencies.

    III. State and Regional Small Business Grants. The U.S. Department of Commerce operates agencies in every state that helps small businesses find financing such as state and regional grants, secure locations and employees. These state agencies can be found through the economic development directory.

    IV. Corporate Small Business Grants. Many corporations and company also award grants to non-profits and small businesses. FedEx, for example, runs a small business grant competition that annually awards $250,000 to 12 businesses. Eligible entrants must be based in the United States, must have been in operation for at least six months and have less than 100 employees.

    Members of the National Association for the Self-Employed (NASE) can apply for monthly small-business grants of up to $4,000. The dependents of members can also apply for an annual $3,000 college scholarship. Grants are awarded throughout the year, with completed applications reviewed quarterly in April, July, October and January.



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