The ideal funding scenario when starting your own business is that someone decides to give you all the money you need as seed capital. Not only will it be interest-free, you don’t even have to repay the money too.
Now, that might bring a chuckle of laughter. But there really are startups who hit the jackpot this way. But if you think that lady luck is shining on you and staking your plans on angel investors, you are setting yourself up badly.
With the modern systems that businesses exploit, more and more types of businesses do not need huge startup funds to get going. However, those are the minority.
If you are making the first step to being an entrepreneur and cannot find people to invest in you, you have 2 options. Dig into your savings or get a loan. Taking into account that most people don’t even have enough savings to last half a year without income, the natural route you will usually end up with is to find some form of credit. These are the 5 most common and easily accessible funds to t0 start your business.
1) Credit cards
The most obvious option is to borrow from your credit cards. We use them everyday, yet sometimes we don’t realize that they are really borrowing facilities instead of just a transaction tool.
The best part with borrowing from your credit cards is that you already have them approved. You can draw out your funds conveniently at ATMs and wait for the bills to arrive. You might even have multiple cards that allow you to borrow accumulated amounts totaling hundreds of thousands.
Saying that, it is also important to acknowledge the dangers of credit cards. Not only do they have the highest interest rates known to mankind, they can also create an unhealthy psychological effect on your borrowing behavior.
However, if you are confident that you will be able to turnover your capital quickly and make a profit that exceeds the interest rates, it could be a good option. You get 30 days without interest anyway.
2) Personal loans
Credit cards might not be suitable for individuals who easily lose track of numbers. If that is the case, then a personal could be a better choice.
Personal loans give you a lump sum and require you to make monthly fixed repayments on it. This prevents you from spending more than what you wanted to borrow, and also enables you to budget with more certainty and you can forecast what’s the exact amount you have to spend on repayment expenses.
Interest rates on personal loans are usually much cheaper. The drawback is that unlike credit cards that give you 30 days interest free and allows you to repay at anytime, personal loans need you to commit to take up the loan for a specified tenor. You will then have to pay the full amount and full interest within that time frame. Redemption will often come with hefty penalties.
This means that even when you have enough funds to repay the loan, you won’t be able to do it without incurring penalty charges.
3) Business loans
Business loans are a little more tricky. What an irony that they are actually meant for businesses.
Interest rates for business loans are higher than personal loans and lower than credit cards. They are structured like personal loans in that a lump sum is disbursed into you account, and you repay by installments. The business will be liable instead of the individual. Sometimes, lenders will demand personal guarantees to lock down the business owner.
The problem is that being a startup, you will find it a huge challenge to convince bank to approve a loan. There is no income statement for credit analysts to forecast, no cash flow statements to just the financial health, and no balance sheet to assess assets. You will really be up against it.
There are many types of credit facilities meant for businesses. There are invoice financing, letter of credit, hire purchase, working capital loans, etc. They are meant to fund specific functions of companies. For a start, just go with business loans until you have a good understanding of what you business needs.
4) Line of credit
A business line of credit is something like an overdraft account for the business.
It works like a current account where the floor balance is not $0, but a negative number. This means that you can use the current account for your business operating activities as usual. But even when your balance hits zero, your check will clear and take the balance in to a negative number. The limit will depend on the lender.
You will then only pay interest for the amount of funds that crossed that red line. Because of the nature of such facilities, you usually have to pay a facility fee to get it. You can also expect to pay high interest pro-rated on a daily basis.
It is most suitable for businesses which are already stable, but want a buffer of cash readily available in case of emergencies and market turmoil. You are really paying for a backup plan. If you are not at that stage, this is not suitable for you.
5) Home equity loans
The cheapest forms of loans are those that are secured with collateral. And the most valuable security you have is your house. Real estate have long been the holy grail of asset classes when it comes to bank classifications. And because such loans are secured with a valuable asset like a house, the risk is lower to the lender. Thus, they are more comfortable in charging low interest to borrowers.
Your can also use your house to obtain a cheaper and bigger line of credit (HELOC). Home equity loans are very popular choices among homeowners who have a huge amount of equity in their houses.
The drawback is that you are now pledging your house as a collateral. Should your business fail and you default, you might face foreclosure. So do put that into perspective before moving forward.