The Wallstreet Journal
How to Finance Your Start-Up Without Tapping Home Equity
By EMILY MALTBY
With home values still depressedâ€”and likely to remain so in the coming yearâ€”many people who plan to start businesses won’t be able to leverage their personal properties to raise capital they need.
There are several alternatives, however, some newer than others. Some 39% of business owners with less than $5 million in annual revenues said a bank loan would be the best way to raise capital in 2012, according to a survey of 2,851 owners of small businesses conducted by Pepperdine University in early January. Other top prospects were personal savings (36%), friends and family (19%), and credit cards (17%), according to the survey.
By contrast, only 11% said home equity would be the best capital
Despite significant funding challenges, including depressed home prices and a tight overall credit market, entrepreneurship rates have risen from 2006 through 2010, according to the Ewing Marion Kauffman Foundation, a small-business research group in Kansas City, Mo.
The foundation has an annual Index of Entrepreneurial Activity but hasn’t yet measured the rate of new business creation during 2011, it says.
Here’s a look at some of your choices:
A small but fast-growing segment of business owners have tapped relatively new capital sources that operate through websites.
Peer-to-peer loan sites, such as Prosper.com and LendingClub.com, allow lending directly between individuals. Interest rates depend on the borrower’s credit history. Only 4% of business owners surveyed in the Pepperdine study say this would be the most promising method of securing funds this year.
Crowdfunding, available on Kickstarter.com, IndieGoGo.com and other such sites, links fundraisers to a large pool of small-dollar contributors. The sites charge fees for the service, typically less than 10% of the capital raised.
Last September, Sung-Yoon Kang got a $5,000 loan through Prosper.com at a 27% interest rate and his wife, Dawn Kang, got a $3,000 loan from LendingClub.com at a 7.9% interest rate. The couple turned to peer lending after
realizing they wouldn’t qualify for a traditional bank loan.
The Kangs, who don’t own a home, used the funds to purchase a food truck. They hope to launch the business Ka’Chi Inc., of West Chester, Pa., in the near future.
Asset-based lending and factoring got attention when banks slashed credit lines in the 2008 financial collapse. Total asset-based credit commitments grew 5% in the last year, according to a November 2011 survey by the Commercial
Finance Association. This type of financing has been dominated by the retail and garments industries, but has spread to other business sectors that have accounts receivable or other assets, according to Brian Cove, chief operating officer at the association, a New York-based trade group.
Asset-based lenders extend loans that are backed by marketable securities, equipment, inventory, accounts receivable and other business assets.
Factors operate on a similar model, purchasing accounts receivables from a business in exchange for an advanced funding amount for each invoice. The Pepperdine study shows 5% of business owners believe factoring is the best way to raise capital.
Interest on the loans can top 20%. Rohit Arora, chief executive of Biz2Credit, a small-business lending broker based in New York, says he believes the interest rates and other related costs may come down as a result of increased competition among lenders.
David Godwin turned to factoring when he started ContinuityX Inc. last year. Within four months of launching, the technology services company, based in Metamora, Ill., had secured a $500,000 credit line from Forest Capital LLC, allowing Mr. Godwin to hire 14 employees and purchase new equipment.
“It jump-started our business,” says Mr. Godwin, who did not use his home equity but did tap personal savings and friends and family to cover other initial costs.
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