How To Finance Your Home Based Business Start Up

Ok so you’ve got a great idea for a home based business start up. You’ve got the vision, enthusiasm, and a plan. So how do you plan on funding your home based business start up? We’ll look at several options for raising the capital necessary to get started.

You may have already allocated some of your own money to start a business from home. That’s important when going to others for financing. Putting your money where your mouth is shows you have skin in the game and that you are committed to the venture.

If you are willing to risk your own resources, that goes a long way towards demonstrating your commitment. If you don’t believe in your own business, why should an investor?

Self Financing – savings, assets, investments, home equity (tax deductible up to $100K), credit card, 401 (k) loan (typically up to 50%).

If you’re not self financing your idea for from home business, make sure you have a good business plan before you pursue financing from investors or banks. Even if you are counting on funding from family, having a plan to present to them demonstrates you have a plan to succeed.

Family & Friends
Borrowing from family and friends can be tricky as you risk jeopardizing the relationship. There’s the potential of causing friction. I really don’t recommend it because mixing money and family (or friends) many times do not end well. With business relationships that don’t work out, you don’t have to deal with a lot of emotional baggage. You just part ways and move on. With family and good friends that’s difficult to do. It’s a little uncomfortable when you see Uncle Joe at the family reunion who invested $10,000 in your business that failed. Unless they’re really insistent on helping you - or enthusiastic and understanding, I wouldn’t pursue it. Especially if it’s not money they can afford to lose. I would feel awful knowing the money I lost on a business venture was part of a relatives retirement fund.

That doesn’t mean you can’t depend on family and friends for emotional support or advice. They can also be helpful with referrals and recommendations – helping you get the word out on your new business. Sometimes networking can be more valuable than money. And you don’t have to deal with the potential emotional stress if there are financial issues down the road.

If you do borrow from family or friends, it’s good practice to get everything in writing with a loan agreement. Document all the terms of the loan – payments, length, interest, due date, secured or unsecured, etc.

Tax Considerations
When borrowing from family for a home based business start up, a lending agreement is important as it protects the lender from potential federal taxes. If the IRS considers it a gift, the lender is liable to federal gift taxes. Without documentation of a loan from a family member or friend, the IRS considers the loan a gift which is subject to taxes if it’s over $13,000.

For family or friends who do lend you start up money, you may want to make them a shareholder. That way its considered an investment with different tax treatment if the business fails. Consult with an accountant for guidance on these issues as they can quickly become complicated.

For those who do invest in your home business, make sure you keep them abreast of your progress. They obviously have a vested interest in the business and want to know how it’s doing.

Private Investors
Investors will typically expect an equity stake in your home based business start up - or part ownership - for the funding they provide. This would be a share of your company or shares of stock. They would basically become a partner. Some investors want some involvement or control in how the company is managed. So you can see there are compromises in obtaining funding from investors in that you usually have to give up some control of the business.

Venture capital funding investors used to be quite plentiful. But these days its very difficult to find a venture capital firm willing to fund a home based business start up.

Angel investors invest in entrepreneurial opportunities and usually have fewer strings attached than venture capitalists do. They are usually not investing other peoples money like the venture investments, but their own money. Angel investors can be other professionals, customers, vendors, employees, even other entrepreneurs.

Home Based Business Start Up Loans
Before pursuing a loan for your home based business start up, make sure you have developed a good business plan. You’ll need that to convince a lender that you are a good risk and demonstrate you’ve put a lot of thought and effort in planning your business plan.

There is such a wide variety of business loans available. They can be line-of-credit, traditional installment, secured or unsecured. Probably the most beneficial loan for a small home based business start up is the line-of-credit. This is very helpful in times of low cash flow or emergencies. It’s also useful for purchasing supplies and inventory. These are usually short term loans that may be linked to the business checking account so the funds can be easily accessed.

Installment loans are longer term loans paid back with fixed payments over years. It may be intended for a specific purpose such as purchasing large equipment. The full amount of the loan is received up front.

A secured loan is one where an asset is used as collateral. It typically carries a lower interest rate than the unsecured loan but is viewed as lower risk. The collateral acts to minimize the lenders risk in the event of a loan default. The collateral can then be sold to satisfy the loan balance.

An unsecured loan has no collateral. The lender considers the borrower a low risk. New businesses have a difficult time qualifying for an unsecured loan. Interest rates may be higher than a secured loan.

Regardless of the type of loan, the lender will check your personal credit history. This gives them an idea of your trustworthiness and ability to meet your obligations. Credit history is also an indicator of the borrowers character. Some lenders may also conduct background checks for criminal history and work experience.

Small Business Administration Loans
Another potential source for home based business start up financing is the U. S. Small Business Administration or SBA. (http://www.sba.gov/category/navigation-structure/loans-grants/small-business-loans/sba-loan-programs) This is a federal government agency dedicated to encouraging small businesses. The SBA requirements for loans are typically not as stringent as banks or other lending institutions. They also lend smaller amounts than some banks wish to both with.

The SBA doesn’t actually make loans itself. It just backs the loans to entrepreneurs with a promise to repay the bank if you default. The application for SBA backed loans is actually made through participating banks. The application goes through an initial approval at the bank which then submits it to the SBA. Approval typically takes less than a month.

The most important criteria for obtaining an SBA loan is the ability to repay with income from the business. The SBA also considers the borrowers credit history, experience, personal investment, and collateral.

The SBA has a variety of loan programs:

  • MicroLoan program for small loans up to $35,000.
  • CAPLine loans for revolving amounts up to $2 million.
  • SBAExpress program for amounts less then $350,000 and quick processing.
  • Pre-Qualification program for loans up to $250,000 in disadvantaged or underserved situations.
  • SBA 7(a) program is the most flexible loan. It guarantees up to $2 million The term can be as long as 25 years to repay for real estate equipment and 10 years for working capital.
  • SBA 8(a) program is a set-aside for socially and economically disadvantaged businesses intended to help minority businesses start. Those qualifying for the program must leave after 9 years.

The SBA also has a special program for women entrepreneurs called the Women’s Business Ownership (OWBO) program. The OWBO provides training and assistance in obtaining financing and federal contracts for their business.

Summary
There are a variety of funding options for the home business. They all have their advantages and drawbacks. Before pursuing funding make sure you have a solid plan and vision for your business so that you can sell it to others.




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