Before you get started looking for the best mix of financing for your business purchase or start up there are certain items that you should consider beforehand.
Clean Your House
Avoid making major purchases such as automobiles, jewelry, home improvements, new memberships or doing anything that could impact your credit rating such as applying for new credit cards, or delaying or missing payments to creditors, or even changing banks.
Clean up Your Credit Score
In the days of “easy money” you could probably qualify with FICO scores much lower than today. It is important to have a credit score as high as possible to qualify for financing. Make sure there are no errors in your credit report that could affect your score.
Start early today it could take longer on the average to obtain your financing
Financing used to be easily obtainable in 30 days and depending upon your situation, may still be feasible in this time. But if your net worth is heavily tied to your home or other real estate, and updated appraisals are necessary to approve your loan, you are going to be in line with a lot of other people, thus causing delays of 30-90 days in your loan processing.
Because there are many different ways to finance a new business, you should be prepared to do some thorough research on the subject to make sure you find the option that will work best for you. Some possibilities for financing a franchise include:
Cash. If you have all the money you need in liquid or semi-liquid assets (cash, stocks, home equity, etc.) to start a business or buy as well as run it to the break-even point, you could self-finance the purchase. You should be sure to weigh the “opportunity cost” of tying up your capital and compare that to the “hard cost” of another type of financing.
Bank Loan. This option works if you have sufficient personal collateral to secure a loan for the amount you need and this collateral is usually in the form of home equity. Banks require collateral and a personal guarantee on most loans because they will want recovery if you default on the loan. This is true whether your business is a corporation or any other type of entity. Besides giving banks a way to recoup a loss, when you have personal collateral on the line it gives the bank some assurance that you will work hard to protect your own investment as well as theirs.
SBA Guaranteed Loan. The most common source of loans are banks, savings and loans or commercial finance companies. There are also companies that can put together different financing packages and market them to competing lenders to obtain the most favorable terms for the borrower. The U.S. Small Business Administration (SBA) has various loan programs available and guarantees SBA loans to help increase lending and mitigate some of the risk for lending institutions. Most loans will require a minimum equity investment of 20% by the borrower. In some cases, signature loans with minimal down payments may be available to borrowers with excellent credit history.
Equity Financing. Equity financing requires that you sell someone an ownership interest in your business in exchange for capital. Investors may be friends, relatives or employees or they may professional investors, generally knows as Venture Capitalists or Angel Investors. Attracting venture capitalists to help you purchase or start a business is difficult, as they are usually more interested in companies with great potential.
Retirement Accounts. The simple way of describing how you can leverage your 401K or IRA into financing your business is that it is similar to a rollover. You simply “rollover” your IRA funds from whatever financial instrument they might currently be invested in into the stock in your new business. You might say you’re investing in yourself and you are using your resources to invest without the early withdrawal and tax penalties that would normally occur if you simply withdrew from your current fund to fund your business. This has become the most popular form of financing during the past decade as there are no monthly interest payments and great potential to rebuild retirement equity in your new business. There are companies that specialize in setting up these plans to meet the requirements set up by the IRS to use these funds without taxes or penalties. Please be aware that having a C Corporation as your business structure is required to use these programs.
Partners, Friends and Relatives. If your friends and relatives have confidence in your entrepreneurial abilities they may be willing to loan you money as you begin your business venture. Private loans are often provided at a low interest rate which can be helpful as you get started. You may also want to look for a partner to help you finance and run a business. This is may be a good idea if you are lacking some business skills or experience. We’ve seen great results when partners complement each other, for example when one is a dynamic cold caller and the other can handle the employees and customer service aspects.
Credit Cards. Because of high interest rates and low credit limits, credit cards are usually not the best place to look for money when financing a business. It may take many months before your new business is making money and the last thing you want to do is hurt your credit rating by borrowing money you can’t easily repay. Plus, the monthly finance charge can add significant costs to your overall investment. A better use for your credit cards would be to save them for emergencies.