5 smart ways to raise biz money
By
Susan Schreter
Does it matter how much you borrow or invest in your business? Do funding sources matter?
The short answers: Yes and yes.
First off, investing in your business with your own cash is a form of leverage. If you are able to steadily pay back a loan to your business, your overall risk goes down. Further, you build value in the business, and the returned funds can be put to work in other investments.
Your second option is getting a loan to raise cash during tough times. Entrepreneurs can raise and lower existing debt to match changing business needs this way.
But how much money should you funnel into your own company to keep thriving? And where should the monies come from? Here are five things to consider:
1. Home equity loans and lines of credit.Watch out. Crafty mortgage brokers and banks often host marketing campaigns to entice small business owners. They imply that borrowing from home equity is a perfect, risk-free way to fund "your dream business."
There is enough evidence in today's financial markets to show that slick promotions can easily turn into consumer nightmares. Consider this: Most entrepreneurs forego taking a salary during the startup phase or when their businesses face hard times. So just at the time when an entrepreneur's personal income is falling, their monthly housing costs increase because of high interest and principal payments. It's a risky move that can jeopardize a family's home ownership.
But there are instances when drawing funds from home equity makes sense. Entrepreneurs who run reasonably healthy, revenue-generating businesses, or entrepreneurs who are sitting on top of considerable home equity and don't have other big financial obligations, are good candidates for home equity loans and lines of credit. (Don't forget to read the fine print about the payback terms.)
Also, business owners who have had their bank credit lines pulled, or who have relied on credit cards to improve company cash flow, may be able to stabilize their financial situation by borrowing against home equity, too.
1. Retirement plans.Let me say this plainly. IRA, 401(k), pensions and other retirement savings plans are not intended for self-directed entrepreneurial investments. Just about every week I receive a letter from a distressed business owner who laments, "I put everything into my business." While many retirement plans have liberal policies for borrowing from its assets, a business owner should keep at least one safety net in place. If everything fails, most retirement assets can't be seized by bankruptcy creditors, too.
Still, business owners can reduce high interest business debt or help weather the recession with some extra cash from such retirement plans. But be aware: if you take a permanent withdrawal from most retirement plans before age 59-1/2, you have to pay income tax plus a 10% penalty to the IRS.
In general, I recommend that business owners cap their contributions this way: If you're over age 50, limit the amount of cash invested in your business to 15% of non-retirement savings; people aged 30 to 50 should limit investments to between 25% to 30% of non-retirement savings. Twenty-something entrepreneurs can open their check books wider.
1. Asking for help from others. Once you tap all of your own resources (responsibly), then it's time to consider appealing to independent investors. While many investors prefer to buy an equity stake in promising businesses, some relatives, friends or local colleagues may be very content to lend money at higher interest rates than what they can receive from traditional savings investments.
Sure, asking friends, family or strangers for money may be awkward. But after more than 20 years in the venture capital world, I've found that those who are most determined get the funding. Then they go out and keep talking to potential funding sources until they get what they need to build a stronger, more lucrative company.
1. Your cash contributions and taxesInvesting your personal savings in a business is worth considering, but put in place a risk-adverse investment structure to maximize your operating flexibility. This is not a lack of faith in your business. Rather, it is positive confirmation that you can be a shrewd business person who can get the most out of every dollar invested in a company.
I like to remind business owners that not all cash contributions have to be invested in a company as equity. After all, if you already own 100% of a business, investing more hard cash into it won't buy you any greater ownership.
The most common mistake entrepreneurs make when structuring business debt is trying to turn one or more cash contributions into a bona fide loan months or years after the fact.
The proper way to document a loan is to develop a formal loan agreement and sign it the same day that funds are deposited into the company's bank account. This agreement should specify the interest rate, general terms of repayment and if any of the company's assets are pledged as security for the loan. Filing a simple Uniform Commercial Code ("UCC") lien with your state can help document your loan to the business, too. A UCC can legally establish you as a creditor with certain preferred rights to loan collateral such as computers and other office equipment.
The loan and accruing interest payments should be faithfully recorded on the company's books, too. To help maintain the contribution as debt rather than equity, it's wise for the business to pay interest at least every quarter. These interest payments may be deductible for business tax purposes.
I like loan terms that permit entrepreneurs to convert some or all of the outstanding debt into equity at will. This way, entrepreneurs have the flexibility to accommodate commercial lenders or potential investors who may want to see a "cleaner balance sheet" with less debt on the books as a condition for providing more funding to the company.
Susan Schreter is a 20-year veteran of the venture capital, buyout and investment banking community and teaches MBA-level classes in entrepreneurship and sustainable social enterprise development. She is also the founder and managing editor of TakeCommand.org, an online service organization that empowers entrepreneurs to raise and manage money with confidence. Send your questions to Susan@takecommand.org.