The Pros and Cons of Three Ways to Finance Your New Start-Up

Unfortunately, due to initial government closure mandates and ongoing social distancing restrictions, many businesses have been forced to close permanently. As a result, the pandemic has opened up a whole new world of entrepreneurship.

Have you become unemployed or underemployed due to COVID-19? Do you have a hobby, skill, or idea that you would like to monetize?

It is entirely possible to start your own business today. Once you’ve settled on your idea and how to implement it, you just need to find an initial funding source to get it up and going. First, figure out how much money you need to get started. Then, explore the pros and cons of the following three very different funding sources for entrepreneurs looking to start a small business, from the office of David Offen, Esq., a busy Philadelphia bankruptcy lawyer.

1.   Conventional Business Loans

Conventional business loans from the bank, often backed by the Small Business Administration, are available for entrepreneurs with good business credit. However, new businesses created by entrepreneurs with no experience will find it difficult to qualify for a conventional business loan. Any entrepreneur regardless of experience must craft and present a strong business plan to convince a lender that you and your business are a good risk.

Pros: low interest; favorable terms; can be refinanced; builds business credit as you pay off the loan.

Cons: difficult to qualify for if a new business or a business owner with no experience or business credit; will often require a personal guarantee by the business owner.

2.   Crowdfunding

Individuals with little business experience but great ideas are increasingly turning to online crowdfunding sources to realize those ideas. With the right spin and social media exposure, projects can be pre-paid entirely by individual investors or donors through a virtual crowdfunding campaign.

First, you will need to source a manufacturer for your product, then calculate the cost of manufacturing and mailing your product at different amounts (for example, 100 pieces, 500 pieces, 1000 pieces, 5000 pieces). Ideally, you will be able to price your product for an amount that can fund continuing production or over-production so that future sales will fund more production and profit.

Next, you must have a prototype manufactured. Be sure your prototype is of the quality you can expect from your first production run because your prototype is going to feature prominently in your crowdfunding campaign.

Finally, you will have to publish your campaign on one of the many online crowdfunding platforms. Each site provides tips and tricks on how to make your product more appealing and your campaign more successful. Detailed photographs of the prototype and a video of the prototype being used work well. Ideally, your donors pledge to your campaign, it is fully funded, and you manufacture and send out your product.

Pros: Anyone with internet access can set up a crowdfunding campaign; crowdfunding sites provide tutorials on how to set up your campaign and market your product; there is a no-risk option you can select that if the campaign is not fully funded, the project will not go forward, and investors/donors receive a refund.

Cons: You must be comfortable with social media and able to commit the time to get your campaign noticed; if you select the option that the project will go forward even if not fully funded by donors, you may have to pay to complete the project and deliver your product to your investors.

3.   Mortgage on Your Home or Charge Credit Cards

These are the easiest yet most risky way to fund your project initially. Are they a good idea? The answer is, it depends.

Using Credit Cards for Quick Cash

If you have good credit, you probably have some lower-interest credit cards you can tap, and this is the fastest way to obtain cash. The thing is, the low interest for a credit card is somewhere around 12% and most have credit cards with much higher interest rates. Do you have the means to pay the monthly payment on that debt other than your new business?

Pros: Quick cash, appropriate for small projects when you have a steady income stream to pay the debt down without having to wait for proceeds from your new business venture. Most appropriate if you need only a couple of thousand dollars quickly.

Cons: If you cannot afford more than the minimum monthly payments on your credit card debt, it will quickly spiral out of control due to the exorbitant interest. You must be able to pay off this debt quickly.

Mortgaging Your Home to Fund Your Start-up

If you’ve been paying on your mortgage a while, it is likely you have some equity built up. It may have occurred to you to tap into that equity to fund your new business project. While not as quick a process as using a credit card, you can get a second mortgage or open a home equity line of credit (HELOC) to liquidate some of that equity. The interest rate will be much, much lower than the interest rate of any credit card.

Pros: You can tap into the equity you’ve built up in your and get much more cash than you would by using a credit card, and the interest rate will be very low comparatively.

Cons: If you do not have a steady income stream and ability to pay this additional debt each month, you risk defaulting on the second mortgage or HELOC, putting your home at risk of foreclosure due to business debt.

If your business is up and running, you have enough income to pay the debt each month, and you need a quick couple of thousand dollars, credit cards or a HELOC may be realistic temporary sources of financing. However, if your business is operational and you find you are periodically looking for more cash, consider whether you are optimizing your cash conversion cycle. There are free small business tools online that might help. The pandemic has unexpectedly opened up myriad entrepreneurship opportunities. Good luck with yours