When an entrepreneur decides to begin the process of starting his/her own business,
one of the first steps taken is to
look for funding. Creating a new business can be a stressful ordeal; however,
raising the necessary business capital is part of this crucial process and one that
should be thought about thoroughly before deciding on an option. During the funding
entrepreneur will discover that some options are more secure than others.
It is important to make sure that the chosen method of securing capital is the most
Home equity loans
One way in which an entrepreneur can
raise capital for their new business is through a home equity loan (HEL).
Some conditions must be met in order to qualify for an HEL. For example, the borrower
must have collateral in order to secure a loan, a solid credit and cash flow history,
and positive financial projections for the new business, amongst other requirements.
In a home equity loan, the borrower uses the equity in their home in exchange for
a secured loan plus interest. When a borrower fails to repay the loan amount with
its accrued interest rates, the ownership of the property gets automatically transferred
to the financial institution that provided the loan.
Qualified applicants can usually obtain the money immediately; however, home equity
loans can be very risky, especially for new businesses. If a
new business does not
perform well, then the borrower will be at risk for losing both their business and
home. In addition, lack of repayment will eventually lead to a poor credit rating,
which is often difficult to repair, especially if a borrower defaults on his/her
Insurance policy loans
Many people with life insurance policies have a cash value to their plan. Often
entrepreneurs are tempted to borrow against their own life insurance plans
because of the prospect of obtaining immediate cash for their new business at low
interest rates. The rate of charged interest is highly dependent upon when the insurance
policy was initially purchased. Usually older insurance policies have the benefit
of offering low interest rates when borrowing against their plans.
To qualify, the owner of the policy must be the one to borrow against their policy.
In addition, they can borrow no more than 90% of their insurance policy’s cash value.
As enticing as this may sound, the prospective
business owner should be very weary
of these types of loans.
One downside of borrowing against one’s own life insurance policy is the reduced
amount of benefits in the occurrence of an eventual death. Not only will this loan
diminish the amount of the whole policy but loss of interest will occur as well.
If premium payments are not made on time, a “lapse” of policy may result, and the
borrower may lose his/her life insurance coverage. Lack of payments can also result
in IRS problems.
Retirement plan loans
A business owner can also choose to borrow against their retirement plan(s) to benefit
startups. Retirement plans such as a 401k or an IRA may be the solution for
many business owners since it is another way to obtain immediate cash. However,
retirement plan loans carry plenty of risks, including the chance of the borrower
defaulting on their loans. In addition, the defaulted loans and economic hardship
withdrawals are both taxed as income and pose a 10% penalty if the borrower is less
than 59 ½ years old. Obviously, the danger involved with this practice can be drastic,
entrepreneur needs to make sure that their new business will be a potentially
successful idea in order to prevent the repercussions of non-repayment.
Looking for funding to raise
capital for a new business can be very stressful. It is not only important to explore
all options when raising capital but to also consider which option has the most
benefit for an entrepreneur’s business venture and way of life. Home equity loans
may seem like an excellent alternative; however, if the business fails, then the
entrepreneur may end up losing both their business and home. Insurance policy loans
may also be tempting, but non-payment can result in the borrower losing value to
their plan and in severe cases, they may even end up losing their entire life insurance
policy. If an
entrepreneur decides to take a loan against their retirement plan,
they will be charged a 10% penalty if they are not of retirement age, and they may
even be at risk for default if payments are not made. The most important thing to
consider before choosing a funding option is to make sure that a company has the
prospect of being successful. If a company is successful, then repayments can be
made, and the entrepreneur will not be at risk for losing everything.