by David Nilssen
Entrepreneurship provides phenomenal opportunities that can defy most financial models and calculations. How a deal is financed may be as important as the business itself. There are so many ways to fund a business purchase that accessing the necessary capital should not be a difficult task. Most people simply don’t realize how to do it. Keep in mind, though, that it isn’t possible to buy a business—a good one, that is—with no money down. The following are some common funding options:
Cash – A lot of people have cash available in savings or securities and opt to purchase their new business or franchise that way. The reality though is that I wouldn’t. Having cash on hand is helpful when “life happens.” Just like a business allows you to leverage employees, financing gives one the ability to leverage other peoples money without depleting their personal reserve.
Retirement Funds – It is possible to purchase a business using retirement funds without taking a taxable distribution or incurring penalties. Thousands of people invest their IRA and 401(k) funds into their businesses each year. Using retirement funds new business owners to start with equity and not debt. Making the initial investment with money they already had allows money the new business generates to be reinvested into the business instead of being paid to a bank in the form interest payments. This method also enables individuals to avoid pledging their home or their credit as collateral.
Home Equity Line of Credit (HELOC) – A HELOC allows people to use the equity in their home to qualify for a sizable amount of credit with a relatively low interest rate that they can use when and how they please. The appeal of these loans fluctuate with rates, since terms are typically variable, but this is a good option for people who don’t want to or can’t use cash or retirement funds. As with any financial decision, the costs should be weighed against the benefits. Borrowers should also carefully consider which terms best meet their needs without posing undue financial risk. The main risk associated with a HELOC is that if borrowers fail to pay amounts they have borrowed and the associated interest, they could lose their your home. The cost of a HELOC is the interest paid plus a percentage to originate the loan. With variable interest, borrowers could expect to pay around 8-10 percent during a 20-year loan.
SBA Financing - The Small Business Administration does not lend money for people to buy businesses; they guarantee loans, up to a certain amount, made by lenders for small business acquisitions. In essence, they guarantee the loan for the lender, not the borrower. SBA loans have benefits and drawbacks. They will lend up to two million dollars and have terms of up to 10 years. Both of these can be extended when real estate is involved in the purchase. However, SBA loans typically require about 25 percent as a down payment and they require collateral. The borrower’s financial history, dating back two to three years, is reviewed to make sure they have a strong ability to repay. These loans tend to take at least sixty days to close. They cost about 1 to 3 percent to originate and have interest rates of 10 to 12 percent over 10 years.
Signature Loans – These are expensive, yet appealing in certain circumstances as a method for funding a business. Signature loans are unsecured loans, typically granted for up to $150,000. They are generally granted at rates around the prime rate plus 1 to 3 percent (similar to HELOCs and SBA loans), The cost to originate these loans, however, is fairly high. This type of loan is meant for a borrower who has limited home equity, retirement funds and/or cash. These loans may make sense if the borrower’s earning potential is high and they have other investments they would like to use existing cash or credit for. These loans cost 8 to 10 percent to originate, and have interest rates of 10 to 14 percent over 5 to 8 years.
So which form is best? As an attorney might say, that depends. It’s hard to argue that if a borrower has money in an IRA or 401(k), it makes sense to use equity instead of debt. For borrowers, not having to make payments or put their home or credit on the line is tremendous. HELOCs have the added benefit of being deductible. SBA Loans are a great option for those who don’t have enough retirement funds or home equity. A signature loan is a viable option for those who need fast cash or are using existing funds for other priorities. The bottom line is that each borrower faces different circumstances and should get in touch with a company that will help them evaluate their options and find the loan that is right for them.
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