Financing Options for New Businesses

Coming up with the money to start a new business is a challenge, but it is not impossible. There are many options, some of which you may not have even considered. In addition to traditional lenders, you can seek money from friends and relatives, look for lenders through the SBA, or even borrow against your retirement accounts.

Friends and family
Borrowing money from friends and relatives makes many people uncomfortable, but it's a sacrifice some are willing to make to start their new businesses. If you have friends and family willing to help you, approach them as you would any potential investor. Present a professional loan request with supporting materials such as a business plan and earnings projections, just as you would to a commercial lender. If you go forward with a loan from a friend or family member, draft a contract that outlines the terms and conditions of the loan and the obligations of both parties.

Borrowing from yourself
If you have a 401(k) plan, you may be able to borrow against the money you have been contributing. About 90 percent of 401(k) plans allow loans. If your plan allows you to borrow against it, you can get a maximum of $50,000 but not more than 50 percent of the total amount in your account.

There are several benefits of 401(k) loans:

• Fast approval. Since you are essentially borrowing your own money, the approval process is more or less a formality.
• Attractive interest rate. Most 401(k) loans' interest rates are fixed at the prime rate for the duration of the loan.
• No restriction on how you use the funds. Unlike loans from conventional sources, you can use the money for whatever purposes you see fit.

When you make loan payments, the funds, minus the interest, return to your 401(k) account. One downside is that payments must be made on schedule and the loan must be satisfied within the designated time frame or you may be subject to paying taxes on the money and a 10 percent penalty fee.

The SBA
If you are starting a business from scratch, the Small Business Administration (SBA) is a great place to turn for financial assistance. While the SBA does not grant loans, they do guarantee them. The SBA guarantee substantially lowers a lender's risk, making them more apt to grant a loan.

The SBA's Prequalification Loan program is designed to assist low income borrowers, disabled business owners, new and emerging businesses, veterans, exporters, rural, and specialized industries. It uses intermediary organizations to assist prospective borrowers in putting together their applications and directs them to approved lenders. This service is known as loan packaging.

Commercial lenders and consultants charge for loan packaging, but the SBA does it for free for qualified borrowers. Once the loan package is ready, your intermediary submits it to the SBA for consideration. If your application is approved, the SBA will issue a prequalification letter on your behalf. The prequalification letter indicates that the SBA will guarantee the loan made by a lender under specific terms and conditions.

Traditional lenders
Banks and other lenders like to see substantiation of past earnings, an established business credit history, and positive personal credit. When just starting your business, it can be difficult to demonstrate your business plan's viability and potential to earn. Many lenders will still take a chance on you if you can show them a strong business plan, good personal financial statements, and a solid credit rating.

Proving the financial health of your company — or of your business plan — requires an understanding of your business's cash flow (projected or current). Our plain-English guide to cash flow management tools explains which numbers you'll need to watch, and it also recommends programs that can help you analyze those numbers.