If you find yourself needing financial help to keep your small business afloat, and you’re not in a position to get additional funds from more traditional sources such as commercial loans or equity investors, there may be other alternatives. Here’s a brief review of a few of those options.
It may seem obvious, but if your business isn’t your full-time occupation and you’re still working as an employee in some other job, then consider whether there’s extra money in your salary that you can apply to your business. Similarly, if you have personal savings, consider using that money to help move your business forward. (By the way, personal savings here doesn’t mean money in retirement accounts—which are discussed below.) And, if you happen to be the beneficiary of a trust fund, you might also consider using money from that fund to help your business.
A key advantage of using money from salary or savings is that these sources generally don’t involve other people, which eliminates the need for negotiations and written agreements, even if it means you bear all the risk. A trust fund likely will require working with a trustee, who will be bound by the terms of the trust; however, the trustee may have the discretion to provide money for your business, and, in contrast to other types of loans and credit, you may have no obligation to pay it back.
If you own your own home, you may be able to use home equity to obtain a loan. For example, if your home is worth $250,000 and you currently owe $100,000 on a mortgage, you have $150,000 of equity in your home. If you needed $50,000 for your business, you might well be able to obtain a home equity loan for that amount. You may also find that the interest rate on a home equity loan is lower than it would be for some other sources of funds.
A note of caution: because of recent instability in the housing market, you should be careful about determining the value of your home and adding any real estate-related debt.
There are various kinds of retirement accounts, such as employer-based 401(k) plans and Individual Retirement Accounts (IRAs). Depending on the type of plan you have, you may be able to either borrow or simply withdraw funds; the consequences of a loan or withdrawal, however, will vary from plan to plan.
Some 401(k) plans may allow you to borrow up to half of the amount of money you have in the plan for a business loan. If you’re thinking of going this route, make sure you learn about any other conditions for the loan, such as the interest rate and the date by which you’ll have to pay it back. Keep in mind that any interest paid actually goes back into the plan.
An IRA, too, can be a source of money for your business; however, for tax reasons, an IRA is a less desirable option than a 401(k). In short, if you’re not at least 59 1/2 years old, withdrawals from an IRA will incur a tax penalty.
People can and do use credit cards to fund various ventures. Credit cards can be useful for short-term expenses—with the emphasis here on “short-term.” While some credit card companies may offer low initial interest rates, if you are not able to pay off your balance within, for example, six months, you may suddenly find yourself looking at annual rates of 18% or more—and instead of resolving a short-term cashflow problem, you may make a difficult situation worse. (You may have heard stories about people who “maxed out” a series of credit cards in order to establish what ultimately became successful businesses; be aware that you are probably much less likely to hear about the many other people who tried the same thing, but failed, and were never able to pay off their balances.)
Similar advice applies to buying from companies on credit. You may be given the opportunity to delay paying off what you owe for several months, or to make no-interest installment payments for a certain period of time. However, before signing off on such an arrangement, you should find out what happens if you miss a payment or a payoff deadline. Also, although it may be more difficult now to obtain credit, you can help yourself to get this kind of credit if you can show that your business has a good credit record and is otherwise on a reasonably stable footing.
For certain business expenses, notably equipment, you can often save money in the shorter term by leasing rather than buying. This approach won’t directly provide you with outside cash to spend elsewhere, but it will allow you to use more of the cash you already have for other purposes. Also, some leases allow you to buy the leased equipment after a set period of time. While ultimately more expensive than buying outright, leasing may help your business through a rough patch.
Historically, it has also been possible for some businesses to set up a line of credit with a bank. While that may have become more difficult in recent years, it can be a less expensive approach than a standard loan. With a contractual line of credit, a bank will guarantee a certain amount of funds will be available when you need it; you will pay a fee up front, but you will not have to pay interest on money you currently are not using.
It isn’t necessarily easy to go to private individuals and ask for money. However, depending on your specific situation, you may know people who have money and may be willing to lend it to you. As necessary, you might explain ways in which this type of loan can benefit the lender. For example, you might offer to pay back the lender with interest, or offer other material incentives. The potential advantages to you include possibly lower interest rates and potentially greater flexibility in paying back what you’ve borrowed.
Of course, relying on friends and family involves special risks. If your business ultimately fails, and you are unable to pay back what you’ve borrowed, you can damage important personal relationships. Consequently, you should carefully think through who you ask and how you might protect them from excessive losses—and, by extension, protect your relationship. One key step is to document the transaction so both you and the person lending you the money have something to refer to if questions ever arise.
As a final piece of advice, make sure that you always keep at least some money on hand. Admittedly, if you’re concerned about alternative funding sources, you probably are facing some degree of financial problems. However, unless you’re in the most desperate circumstances, it’s important to try to hold something in reserve, in case a bad situation turns even worse.
There are other potential sources of money for your business beyond what’s listed here, including many that are covered in other Nolo articles and books. Apart from articles on bank loans and equity funding, raising money from family and friends, documenting money you receive, and more information on alternative lenders, consider the following books: