Funding a startup can require thinking outside the box. Often you’ll need to utilize more than one source of financing to get your new business off the ground. Should you take out startup business loans? Raise money? Use your savings? We’ll discuss everything from SBA loans to angel investors to Rollovers for Business Startups (ROBS).
A ROBS might be the best kept secret in startup funding. They enable you to access your retirement savings to fund your business without the normal early withdrawal penalties and taxes. You can get a free consultation with a ROBS expert by reaching out to Guidant.
Startup Business Loans: All Options
|Startup Financing||Good For|
|Rollover for Business Startups (ROBS)||Those with $50k or more of retirement savings to invest.|
|Home Equity Loan or Line of Credit||Borrowers with 20-30% or more equity in their personal home.|
|Personal Loan||Borrowers wanting to use personal credit profile to secure a loan.|
|Business Credit Cards||Everyone needing a credit line to fund small expenses.|
|Equipment Financing||Borrowers needing to buy large equipment with long shelf lives.|
|SBA Loan||Small Business Administration (SBA) loans have long repayment terms, low interest rates, and are regulated by the government.|
|Microloan||Borrowers falling in specific groups, like veterans, women, or minorities.|
|Friends & Family||Borrowers who know wealthy individuals interested in investing.|
|Crowdfunding||Those with a strong brand or dedicated customer following.|
|Angel Investors||Those needing a large chunk of money to scale.|
|Venture Capital||Those ready to scale their business immediately.|
Each startup business loan option falls into one of three categories: using your own assets, traditional borrowing, or fundraising from friends, family, or investors. We’ll go into more detail about each one below, providing an overview, the typical costs, and a summary of each option.
Here are the 11 best startup business loan options:
1. Rollover for Business Startups – ROBS
Rollover As Business Startups (ROBS) allow you to invest funds from your retirement account into your new business without paying early withdrawal penalties or income taxes. However, a ROBS is not a loan against your retirement account. It is also not a way of cashing out your retirement account. There are no loan payments, and the business takes on no debt.
Around $5,000 in setup fees and ~$1,500/annually in monitoring fees.
A ROBS is a way to use your 401k or IRA to fund your business. With the right professional help, you can tap into your retirement accounts to fund your new business without incurring any early withdrawal penalties or taxes. Essentially, you’re buying stock in your company with funds from your 401K / IRA and holding that stock inside your retirement account.
To make use of a Rollover for Business Startups (ROBS) your company must be set up as a “C” corporation. If your company is successful and starts making payments to shareholders, your 401K would receive a portion of those funds based on its ownership percentage.
You must also be a legitimate employee of your business. There is no set standard for what this means, but a conservative approach is that you work in the business for 1,000 hours annually. That makes a ROBS ideal for actively managed businesses, but not necessarily a good option for people pursuing absentee businesses like some real estate investment companies.
Additionally, a ROBS is flexible and can be used in conjunction with almost every startup funding option on this list. The funds from a ROBS can even serve as a downpayment for a startup business loan or an SBA loan. You can learn more in our Ultimate Guide to ROBS Financing.
For more information on Rollover for Business Startups financing, or to get started today, fill out this form for a free consultation with a ROBS specialist. Our recommended ROBS provider, Guidant, will help you set up your ROBS correctly, and you can typically be funded within about 3 weeks.
2. Home Equity Line of Credit (HEL, HELOC)
If you’re a homeowner with some equity in your home, you may be able to get a low-rate home equity loan (HEL) or home equity line of credit (HELOC) to fund your startup. A HEL gives you a lump sum immediately, while a HELOC can be drawn against as you need funds. With a HELOC you pay interest only on the balance you currently owe.
2-5% in closing costs + 3-6% annual interest rate. Interest rates and upfront costs are generally lower for HELOCs compared to HELs.
In order to get a HEL or HELOC, you typically need to have 20%+ equity in your home. A HEL gives you a lump sum, which acts like a second mortgage, and a HELOC works like a line of credit, that works like a credit card. Let’s take a look below at who each option might be right for.
Lump sum (HEL)
A HEL might be right for you if you need a large amount of money for up front businesses expenses that are essential to your business. You’ll immediately be making payments on the full loan.
Line of credit (HELOC)
If you do not have an immediate use for all of the funds right away, then a HELOC may save you on interest. With a HELOC, you can draw funds as you need them and you only have to pay interest on your current balance, which can save you a lot of money.
While a HEL or HELOC can provide your startup business with capital at a lower interest rate than many other kinds of startup financing, keep in mind that each will use your home as collateral. This reduces the ways you could collateralize other potential loans in the future.
Both a HEL and a HELOC require good credit and sufficient equity in your property. If you’re interested in learning more, read our full article on Home Equity Loans.
3. Personal Loan from a Peer-to-Peer Site
Peer-to-peer (P2P) lending is borrowing money through an online service that matches you directly with individuals and institutions. The online technology empowers you to quickly reach a lot of investors you would likely be unable to otherwise. Lending Club is the largest P2P site that connects borrowers to investors in a matter of minutes.
1-6% origination fee (taken out of upfront lump sum) plus 5-26% interest rate
Historically, P2P sites such as Lending Club have focused on providing 1 to 5 year personal loans for the purposes of paying off credit cards or consolidating debt. However personal loans can also be used for business purposes. Recently, P2P lenders like Lending Club have also started to offer small business loans, but these are usually reserved for more established businesses.
To qualify for a P2P loan through Lending Club, your credit score should be above 650 (you can check your score for free here).
If your credit score is below 650, consider a lender like LoanMe. They have high interest rates but they will approve business loans when others won’t, and they offer personal loans up to $50,000. Get prequalified in minutes with LoanMe.
- Don’t even bother with these loans if you don’t have a 650+ credit rating
(Check your personal credit score for free.)
- While these loans may be for a business purpose, you’re the one that is borrowing and on the hook for the loan. If you don’t pay the loan back, your credit rating will be affected, and you could lose personal assets.
- Depending on your credit rating and the length of the loan, the interest rate is probably going to be in the range of 12–25% per year, or about what you would pay borrowing with a credit card.
- Unlike a credit card, this a lump-sum. You’ll have access to all of the cash in a bank account but also be paying interest on the full amount right away.
If a personal loan is right for you, then you can prequalify online for up to $40k with Lending Club within just a few minutes.
4. Small Business Credit Cards
Both Personal and Business credit cards can be a relatively cost effective way of financing your startup. Many come with 0% APR introductory periods and valuable cashback or rewards programs. This can be a good savings for your business if you use credit cards regularly.
16% Average Annual Interest Rate + Annual fee of $50-$100 fee for some cards
Small business credit cards aren’t an ideal way to fund large capital investments in your small business startup, but they can be an essential tool for cash flow management. You can cover expenses with your small business credit card while waiting for payments from your customers, preserving cash and earning rewards at the same time. The National Small Business Association found that 37% of small businesses used credit cards to finance their business operations.
Benefits of a Small Business Credit Card:
- Many credit cards offer promotional introductory rates of 0%.
- Only pay interest on the balance you’re carrying at the end of the billing cycle.
- Cashback and rewards programs let you earn money for your business just by charging purchases to your card.
- Employee cards that allow you to restrict what the card can be used for (gas, office supplies, etc.) mean more independence for trusted employees, less busy-work approving purchases for you, and more rewards or cashback.
With APRs that typically range from 10 – 30%, credit cards are a very affordable means of short term borrowing for small businesses. Their one downside is that they’re particularly sensitive to your credit score, and if your score is damaged the credit limit can be lowered or the credit line closed.
For more insight on how credit cards should be used to help finance your small business, read our in depth guide here. If you’re ready to apply for a business credit card, review our top small business credit cards.
5. Equipment Financing
Equipment financing can be used to purchase equipment, vehicles, or machinery. Financing can be obtained through equipment dealers, banks, and online providers. Equipment financing can help startups preserve their cash for other needs.
APR starts at 5%.
Equipment financing can be a great option for startups where equipment or machinery will play a major role, like in a trucking company. Financing equipment, rather than paying for it all at once, allows you to keep more cash available for other business expenses.
Since equipment financing is collateralized by the equipment itself, it is typically easier for startups to get approved for than unsecured small business startup loans. Whether you’re looking to buy a skid steer or salon chairs, equipment financing might be right for you.
Equipment financing can be structured as a loan or an equipment lease. They all work similarly, but mostly differ with how the ownership of the equipment works at the end of the financing term. Here are the three most common methods of these financing options.
With an equipment loan the purchased equipment is owned by you. The loan allows you to spread out the payments over 1 – 5 years.
Fair Market Value (FMV) Leases
This is what most people think of when they think about an equipment lease. You make monthly rental payments in exchange for the use of the equipment. At the end of the lease term you can purchase the equipment at its fair market value, extend the lease, or return the equipment.
$1 Buyout Leases
Under a $1 buyout lease you make monthly rental payments to use the equipment. At the end of the lease term you have the option to purchase the equipment for $1. This is a good lease option if you’re fairly certain you will want to purchase the equipment at the end of the lease.
Under an equipment leasing agreement you typically get to use the equipment for 2 – 5 years while paying interest rates of 6 – 16%. Check out our equipment lease calculator to help you determine which leasing option might be right for your business.
Smarter Finance USA can finance your equipment as a loan or a lease. They are able to provide financing of up to $100,000. Borrowers will need 650+ credit scores (check yours here for free), no bankruptcies, foreclosures, or repossessions, and at least a 10% down payment.
6. SBA Loans for Startup Businesses
The Small Business Administration (SBA) is primarily known for their loan guarantee programs. Two SBA programs that are more startup friendly are the Community Advantage Program and the Microloan Program. Both programs target new or underserved businesses.
Annual interest rates of around 6 – 9 %
SBA loans can be difficult to qualify for. You’ll often need to have a credit score of 680+ and be able to pledge some collateral for the loan (real estate is preferred). There are a wide variety of SBA loans available but the two programs most likely to help provide startup business loans are the Community Advantage Program and the Microloan Program.
The Community Advantage program lets your startup borrow up to $250,000. The Microloan program provides loans up to $50,000. The SBA is not the lender, as they just guarantee the loan. The lender is an SBA-approved intermediary, such as a CDC (community development corporation), or a non-profit institution.
Generally, these loans are available to partially self-financed startups (the SBA likes to see that the owner invests at least 30% of their own money in the business) and startups where the owners have prior experience in the industry and in management. The primary benefit of an SBA loan is the low interest rate and long repayment term that it offers, making your monthly payments lower than they would be with other loan options.
Technically, SBA 7a loans are also available to startup small businesses, however these are made by traditional lenders who have very restrictive qualifications and underwriting standards. We recommend applying with a local lender who knows you and your community the best (Here is a step by step analysis of how to apply). SBA loans require strong credit scores, typically above 680 (Check your score for free.).
Additionally, as a startup your SBA lender will expect that you present a well prepared business plan. We recommend using business plan software, which provides you with great looking templates, guides you through the process so you don’t miss anything important, and provides you with lots of examples. Our preferred business plan software is LivePlan and offers a 60-day money back guarantee.
7. Microloans from a Nonprofit Lender
For startup business owners who don’t have great credit, sufficient collateral, or a lot of other options, a nonprofit lender can be just the resource you need. These lenders have specific criteria they use when looking for borrowers. You will have to find one that matches who you are or what your business is (such as a lender looking for restaurants).
Annual interest rates range from 8 – 22%
Accion is a nationwide nonprofit lender that provides microloans for startups. In most states, you can borrow up to $10,000 for a new startup, or up to $50,000 for an existing business. Kiva is another nonprofit that will lend up to $10,000 in startup funding.
These are not grants or free money. Accion will only lend to startup business owners that have sufficient cash flow to make loan payments. Accordingly, you should be prepared to show a source of income independent of the business (e.g. a full-time job or spousal income) if your business isn’t generating enough income yet. Having a cosigner with strong income and credit score can also help.
TIP: If your credit score is too low to get traditional business financing (under 640), consider working with a company to repair and build it. You can read our review of the best repair companies here. Ignoring a low credit score can hold your business back for many years. To learn more about improving your business’s credit score read our in-depth article here.
You can borrow up to $50,000 from Accion, with interest rates as low as 8%. Visit them to see how much you qualify for by filling out a fast online application.
8. Borrow from Friends & Family
Family members and friends who like your business idea may be willing to lend you startup funding. Usually those loans have very favorable rates and repayment terms.
In December the required minimum interest rate on short term loans (less than 3 years) was .55% and on long term loans (up to 9 years) was 1.68%.
These rates come from the IRS index of Applicable Federal Rates that updates on a monthly basis. This index gives us the minimum interest rates the IRS expects on all loans. Even if your friend does not want to receive a return on their money it is important for you to pay interest on what you receive. If you don’t then the IRS may see the money as a gift and tax you for it.
Friends and family can be a great source for getting startup funding. There are generally two ways to do this:
- Selling them a share of your business
- Taking their money as a loan
Unless your friends and family are sophisticated investors, taking money as a loan is generally cleaner than selling them a share of the business for 3 reasons:
- Even small equity owners might believe that they have the right to have a major say in the strategy and operations of the business. You may not want to be constantly getting business advice from your uncle.
- The founders of a new business tend to place unrealistic valuations on the business. To avoid giving friends and family a “bad” deal, a loan that pays a good interest rate might be the fairest approach.
- Owners of a business may be required to be part of the application for (and guarantee) any future financing.
Borrowing from family and friends used to be a little fly-by-night. If you were smart you’d have an attorney draw up clear paperwork, but most folks would just wing it themselves. These half-documented arrangements could lead to reporting and legal problems, but also could stymie your fundraising efforts (it just didn’t look professional).
Crowdfunding capital through large amounts of people is usually handled through an online platform. Entrepreneurs looking to crowdfund capital for their business generally give equity or some type of reward in exchange for the funds.
5-10% of total money raised + offered incentives/rewards (gifts, share of business, etc)
There are many different ways to crowdfund. Some startups just rely on the strength of their business or campaign, believing that their product will inspire contributors. Others offer rewards or incentives to supporters in exchange for their investments.
There are still other options that actually offer shares of the business to supporters in exchange for their investments. Let’s look at the 2 main crowdfunding methods – reward based and equity based.
Reward Based Crowdfunding
The reward based crowdfunding strategy is very popular on Kickstarter. It works by offering a product or service as a reward to people who give a certain amount of dollars to your business. The funds must be for a specific purpose (like manufacturing a new product) and that purpose must be given at the beginning of the campaign.
This option might be for you if you do not have any revenue and are just looking to launch your product for the first time. It’s also a good option on high-margin products or services. It not only can give you the needed funds to build your product, but it can also introduce you to new customers. Many entrepreneurs use this type of crowdfunding to initiate pre-sales of new products and gain exposure.
Equity Based Crowdfunding
Equity based crowdfunding is relatively new in many ways, and online platforms are still being established. There are three types of equity financing.
- Equity I: This option must be done privately through accredited investors. Entrepreneurs using this type of crowdfunding get access to the fewest number of potential investors but also have to deal with the fewest amount of legal regulations.
- Equity II: This option allows you to publically advertise your crowdfund opportunity, but you can still only accept money from accredited investors.
- Equity III: This option allows you to publically advertise your crowdfunding needs and goals, and you can accept funds from just about anyone. This option is heavily regulated by the SEC to protect the interests of inexperienced investors.
Being able to reach just about anyone through an equity crowdfunding campaign requires you to abide by many laws and regulations. This is because many of the investors looking to work with you will be inexperienced investors and the laws are in place to protect their interests. Learn more about crowdfunding.
10. Angel Investors
Angel investors are usually wealthy individuals who give your business money debt-free in exchange for an ownership stake. An angel investor invests as much in you as the business owner as they do in the business’s products or growth opportunity. Angel investors generally give less money than VC’s, but they also are less likely to take an active role in your business.
A percentage of the ownership of your business.
Angel Investors are individuals who are generally wealthy and like to invest in early-stage start ups, generally contributing between $25,000-$1,000,000 per investment. Here are the major differences between Angel investors and VC’s:
- Angel investors are generally not looking for as great of a rate of return on their investment as Venture Capitalists.
- Many of them like to help advise business operations, but generally do not take control of making decisions.
- Angel Investors are typically looking to invest less than $1,000,000.
Tips for Raising Money from Angel Investors
- Raising money from angel investors is all about networking
- If possible, structure the investment as a convertible note. A convertible note is a loan that pays interest, but converts into stock under certain conditions, like if venture capitalists invest in the company later. There are 2 big benefits of a convertible note:
- They are simpler and therefore require less legal fees than a typical equity investment.
- They eliminate the need to decide on how much the company is worth with the angel investor (that will be determined by the valuation of the next investment in the company).
- In many cases, angel investors are people you know who are just as much about investing in you as investing in your idea. However, if you do not have friends with deep pockets, you can also advertise your business on angel investing sites such as Angel List and New York Angel.
11. Venture Capital
Venture Capitalists are generally a group of investors that make up a company or investment firm. VCs give you money debt-free in exchange for a percentage of equity in the business, but they are also likely to take a more hands-on role in your business. It’s important to contractually establish upfront how much control they will have in the company. A well prepared business plan with financial projections is a must when pitching to a venture capital firm.
You have to give up a percentage of the ownership of your business.
Venture capitalists are basically investors who are looking for a very high rate of return for their money, generally around 10-15 times initial investment within a 5 year period. Most new businesses cannot guarantee such a high rate of return, which is why they are often not a good match for venture capital funding.
VC firms generally have other investors who give them money to invest into these startup businesses. Because VC’s must answer to their own investors, they are more likely to take an active management role in your business. This ensures they can help steer the ship, maximizing the opportunity for a quick return on their investment.
For those who think that their start up might be right for venture capital, here are some good resources:
- How To Raise Money From Angel Investors And Venture Capitalists By Marshall Brain
- Raising Money From A VC by Mark Suster
Bottom Line: Startup Business Loans
Finding financing when you’re starting a business can be difficult, but the eleven options we’ve discussed above should work for most small businesses. If you’re looking to get financing to purchase an existing business or to fund a franchise, startup business loans might not be your only option.
The best kept secret in startup financing is a Rollover for Business Startups. If you have $50K+ in your retirement account, it is the fastest way to fund your startup (funding in about 3 weeks). You won’t have to pay any early withdrawal penalties or taxes on the money you rollover. Request a free consultation with Guidant today to get started.