What is next? I know you’re sitting on the edge of your seat and we’re almost through with the 16 most common ways to raise capital for your small business. We just covered Peer Loans or P2P lending and HELOC’s so today we’re going to cover ROBs, equipment financing, and Merchant Cash Advances or MCA’s for short. None of these options are “unsecured” like an unsecured business line of credit or some other form of unsecured business credit, however, they are all good options for the right situation. Small business loans today are tough so let yourself get the basic education you need to get the solution that’s best for your situation. Here we go…
11. Cashing out or borrowing from retirement funds. This is another popular way to fund a business, startups and new franchise units in particular. The problem with cashing out is fairly obvious: If you cash out your retirement funds, they don’t continue to appreciate in value, and you don’t have any money on which to retire! You’re taking a huge gamble that your business will be a smash success and you’ll be able to replenish those funds later.
Borrowing money out of a 401(k) or IRA to fund your business is possibly even worse. The IRS calls these transactions Rollovers as Business Startups, or ROBS transactions. ROBS work like this: You incorporate your business and create a 401(k) plan for the startup. Then you transfer funds from an existing retirement account to this new retirement plan. Then, you borrow out the money from your company plan to spend on business growth — tax free.
Does that sound a little fishy to you? Then you won’t be surprised to learn the IRS has taken a dim view of ROBS. Though companies that help structure ROBS transactions swear by their validity and ROBS transactions are common — 4,000 were set up in 2009 — the IRS has warned it is actively reviewing these transactions and may decide many or all of them are illegal.
If that happens, all the money entrepreneurs have borrowed out of their retirement plans will have to be paid back in, plus interest and penalties. Moral of the story: Be very, very cautious about borrowing out of your retirement plans. Experts recommend simply cashing them out and paying the tax and early withdrawal penalty up-front if you must use that money for business purposes. Then you know you won’t run afoul of the IRS later.
12. Equipment financing. If the money you need is for the purchase of a piece of business equipment such as company trucks, know there are specialized equipment lenders that can help. Rates for an equipment loan can range from bank-rate to high cost, depending on the individual applicant’s credit and the type of equipment.
Not all banks do equipment lending, and the ones that do will often require a down payment — and won’t offer a leasing option. For these reasons and many others, small business owners normally prefer non-bank equipment financing. Most banks don’t want to end up repossessing a construction crane and having to market and sell it – that’s not their business.
I often recommend small business owners consider leasing equipment rather than taking on long-term debt with a loan for an asset that may not have much resale value down the line. Leasing preserves your cash flow, as it doesn’t require a down payment and usually little or no money “out of pocket.”
In fact, I recently took my own advice on this and leased a new phone system rather than taking out a loan. I could have obtained a lower rate if I had gotten a bank loan. However, I would have needed a down payment, we would not have been able to lease the equipment, we would have missed out on valuable tax benefits, and the bank loan would have showed up on my personal credit report.
There are tax advantages to leasing, too, as you can write off the payments as a business expense. With a loan, you could possibly write off only the interest portion. Also, a bank loan hits your credit rating as a debt, where a properly structured business lease doesn’t.
13. Merchant Cash Advance (also known as merchant financing or an MCA).
The merchant cash advance industry is growing constantly because the banks are unable to properly meet the needs of the American entrepreneurs. As an example, it can be very difficult for restaurant owners, seasonal businesses or franchisees, which use credit card processing heavily, to get loans from the traditional business financing institutions.
Why is that happening? The answer is simple: the banks will require tangible assets as collateral for their well guarded cash most of the time. This means that even the owner of a very profitable restaurant will have a hard time trying to get a traditional bank loan because he or she can’t use perishable foods or used cooking appliances as a guarantee.
Another example: a franchisee that used all his money purchasing his very first franchise and is now interested in purchasing the second one will have a hard time trying to get a loan from a bank, but he won’t have any problem applying for merchant financing.
For industries where much of the business comes through credit-card charges, merchant financing allows you to get a loan against those future sales. As mentioned before, businesses that are shut out of factoring, such as restaurants, often use this borrowing method. Unlike factoring, merchant financing is a loan, but it’s one for a sale that hasn’t happened yet.
Basically, the cash provider will give the merchant an upfront cash advance, while the merchant agrees to repay the money by giving the business financing company a percentage of the sales until the balance is zero.
One advantage of an MCA is that usually there isn’t a lot of documentation required – the acceptance is based primarily on your monthly credit-card sales history. Credit scores and company finances aren’t much of a factor, so your credit does not have to be good. You’ll need a track record of usually at least a year in business and at least a few thousand a month in credit-card charges.
Most business owners choose MCA’s because this allows them to have access to cash quickly; under normal circumstances, the money can be available in one or two weeks. And unlike a traditional bank loan, where you have to pay a fixed rate no matter if your business is prospering or not, with merchant financing you will only have to pay a percentage from the daily sales.
This means that if the business isn’t working that well, the payment will be smaller; on the other hand, if the business is thriving, the owner will be able to repay the loan much faster.
An “average” merchant financing loan would be around $30,000 and would be paid back over six months at a factor of 1.3 to 1.4. This means you pay back 30%-40% more than you borrowed over a six- or nine-month period of time. It might look a bit too expensive, but let’s not forget that the lender is taking on a lot of risk, because it is betting on your company’s success.
In addition to this, if those funds are used to build the business and increase revenue, or even to help you go through tougher times without shutting down your business, merchant financing really is a lifesaver, especially if you don’t have other lower-cost borrowing options.
It’s important to note that in recent years some variations of MCA’s have hit the market. They are mainly bank-statement driven and are usually slightly better priced than MCA’s. They also do not require businesses to accept credit cards (unlike MCA’s). Much like MCA’s, however, they are looking for cash-flow and not high credit scores.
Tune in next week for some more common methods for acquiring the capital you need for your business. We realize that everyone wants unsecured business lines of credit because there’s no collateral, good rates, etc. but this is not the only form of business credit that can help you grow your business. Knowledge is power and if you understand these different options you’ll be able to confidently make the right decisions for your business. Keep livin’ the dream!
and I think it’s worthy of a discussion.
at plan be static. A big part of any website and SEO (Search Engine Optimization) plan will involve targeting certain “keywords.” Keywords are the words and phrases that you know are being used in search to find companies like yours offering products and services like yours. For example, we recently targeted “unsecured business credit” as a keyword phrase. Go ahead a check out that search on Google and tell us how we’re doing.
