Starting a business is an expensive endeavor that is not for the faint of heart. Very few entrepreneurs have the capital or credit to pull out $25,000 to seed a new idea, much less the hundreds of thousands of dollars that some types of business may cost just to get started. Most potential entrepreneurs do not have access to the first $5,000 or $10,000 need to launch. Featured here are four alternative strategies to fund the initial launch or expand a small business.
It is important to start with some context-setting about capital. There are many types and sources of capital, often falling into debt or equity categories where debt is a form of a loan and equity is an exchange of ownership or shares in a business. Alternatively, individuals with financial capacity may source funds from their savings or retirement accounts. Each of these sources requires some financial means, the right type of business or a network of high-net-worth individuals that the average person just does not possess. As each type of creative capital source is discussed, so too will the pros and cons of such choices be considered.
CREDIT CARDS
Credit cards are a double edge source of capital. For many people, credit cards are more a tool of a disaster than strategy, but more recently, a cross-cut of people have figured out the right recipe to run their businesses with credit cards in ways that net savings and free up cash flow. Depending upon the type of business and revenue model, two types of credit cards might be useful.
Zero percent APR introductory rate credit cards from major brands are a more recent phenomenon that an entrepreneur can utilize these offers to reduce their cash need at launch with a decent credit history. If, for instance, the startup founder could secure a $10,000 credit card with 0% for 12 months, then they could purchase and pay for significant startup costs with no penalty for the first year. With lower startup costs and a moderate payback time frame, an entrepreneur could leverage this tool to reduce risk.
Alternatively, airline or travel points-based credit cards can be a tool to efficiently operate a business that requires moderate cash flow each month with an ability to pay the bill off each month consistently. For instance, if purchasing $10,000 worth of equipment to complete a job that pays the bills efficiently, an entrepreneur can use a credit card to ‘float’ the cash needs each month without dipping into savings or other cash and get the benefit of credit card points. Over time those points may convert to cash, airline miles, or additional value for the business owner.
Now, the cons: Credit interest rates combined with high balances can create more financial woes than the benefits they contain. Generally speaking, one should not use a credit card for purchases unless they have a realistic plan for paying it off either with revenue or savings as a backup.
EQUIPMENT FINANCING
There are many hidden costs in the launch or growth of a business. Furniture, fixtures and equipment are common line items that are not properly considered. Ranging from office furniture to specialty equipment, these assets are sometimes one of the easiest items to finance through the organizations that sell them. Inquire with vendors about the possibility of doing a low or no interest finance deal. When that isn’t possible, looking into leasing, rent or purchasing pre-owned can save thousands of dollars of cash needed for other purposes.
Be warned, however, that this may not work for everyone, and there are occasionally hidden fees or costs such as service agreements, transaction fees or high-interest rates. Ask the hard questions at the beginning and read the fine print. A good philosophy is to remember that if it seems too good of a deal, it is.
HOME EQUITY
Sometimes the money you need is there, but it may be locked up in an existing asset. The most common situation is home equity and banks have gotten savvy to the idea of borrowing against your home for personal purchases, home renovations, or in this case, to fund your business. Home Equity Loans and Home Equity Lines of Credit are two such forms. There are a few basic rules, the details described on bank websites and third-party lending sites, but most importantly, the home being borrowed against needs to have no more than 80% debt to asset value AFTER the loan is made. For example, if your home is worth $300,000 and you want to borrow $25,000 then your payoff should be less than $225,000.
There are two main cons to this model. The first is that you will take on an additional payment and pay interest on that loan. The second, and most important con, is that if you do not pay this loan, the lien is on your personal home and the bank can foreclose. It is of the utmost importance to ensure you have a clear understanding of how you will pay back this second loan. Overall, using this source is one of the more commonly used options for entrepreneurs who don’t have large sums lying around.
Alternatively, a cash-out refinance accomplishes a similar goal but two positives and one negative compared to home equity loans. Hopefully, a refinance will save you money on your interest rate and put the cash in your hand without a separate loan payment (although your mortgage payment may go up). The most important con for a cash-out refinance is the fees associated with ‘closing the loan’ that can be a few thousand dollars or more depending upon the financial institution.
PRE-SELLING & CROWDFUNDING
Modern practices and trends in entrepreneurship suggest that building awareness and engaging prospective customers prior to launching your business, primarily as a tool for business model validation, are crucial and essential to the success of a venture. Not all business models and products fit the traditional Lean Startup Methodology approach that this embodies, but for many, there are creative options to accomplish this without changing your concept.
Pre-selling may be accomplished in various ways, but the most common is engaging a user or customer with the features and benefits of your business solution and working toward their commitment to purchase, pre-order or place a down payment in exchange for early access. This method provides an opportunity for customers to play a foundational role in ensuring the solution is viable. In many cases, it requires that the entrepreneur only has to demonstrate at a basic level the nature and features of the product.
On the other side of this capital source is the ever-popular crowdfunding campaign, which has become far more available over the past decade due to the success of platforms such as Kickstarter and IndieGoGo. In this model, typically, a product-based solution is positioned as ‘coming soon’ and can only be built with customers purchasing or donating to the building costs in exchange for small gifts. These gifts range from something as simple as a sticker or mug up to the product’s discounted purchasing. In very high capital commitments, there may be experiences given such as dinner with the founders or a tour of a facility.
The cons of each of these are small but present. Most importantly, pre-selling and crowdfunding are sometimes just not an option for the type of business you may start. Also, the crowdfunding space is highly competitive and requires a significant amount of effort to engage a body of potential customers. Also, in recent years, well-funded organizations have turned to these platforms and can make it difficult for smaller and newer concepts to get the attention of potential funders.
Starting and growing a business requires capital and cash, even in small doses, and many entrepreneurs do not have access to traditional capital sources. There are many creative sources of capital; remember, entrepreneurs, are well known for their creativity in solving this problem. One of the best ways to find new sources is to listen and network with other entrepreneurs so that you can hear how they solved this important challenge.
Jeremy Vickers, Ph.D., serves as Associate Vice President of External Affairs at Baylor University where he leads institutional events, community relations, and external affairs. He is passionate about innovation and entrepreneurship and channels that passion to serve organizations where he can support both growth and change. Jeremy lives in Waco, TX with his wife Jackie and four children.