How to Finance Your Start-Up Without Tapping Home Equity ...

By EMILY MALTBY

With home values still depressed?and likely to remain so in the coming year?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 source.

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:

Peer Lending

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 Credit

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.

SBA loans

Many young start-ups face significant barriers securing bank financing because they don?t have a substantial track record of growth. But there are small signs that the credit crunch is easing, as lending standards become more flexible and as some borrowers become more willing and able to take on debt, according to recent data including one January survey of senior loan officers by the Federal Reserve.

Outstanding loans to small businesses have fallen each quarter since 2009, according to the most recent data from the Federal Deposit Insurance Corporation, in an analysis of loans of less than $1 million. They totaled slightly less than $600 billion at the end of September 2011, 5% less than the year earlier.

One role of the U.S. Small Business Administration is to help banks make loans to riskier small businesses, while offering better terms such as a longer payback period. SBA loans are provided by traditional lenders, but a portion of each loan is backed by the government in the case the business owner defaults. Still, SBA loan recipients must adhere to the underwriting standards of the bank, which may include using personal property as collateral.

SBA lending hit a record in the government?s last fiscal year. But the jump was, in part, attributed to the larger loan amounts the agency agreed to back. Since October 2010, SBA lenders have been able to offer loans as large at $5 million, which are more profitable than the smaller loans start-ups typically request. (See this October 2011 story.)

In general, smaller firms have more success with these loans once they are established and ready for expansion capital.

Angel Investors

Some small businesses have had success seeking angel financing ? a segment that?s showing a revival of sorts. Most angel investors, of course, will wind up with an equity stake in your firm.

Some 39% of the $8.9 billion in total angel investments in the first half of 2011 went into seed and start-up ventures, up from 26% of $8.5 billion in total investments over the same period a year earlier, according to the University of New Hampshire?s Center for Venture Research.

It can be tricky to weed out the tire-kickers, says Paul Kedrosky, senior fellow at the Kauffman Foundation. Many individuals are angels ?in name only? and not likely to make investments as eagerly as professional investors, he notes.

Individual angels are increasingly coming together to invest as groups. That spreads risk among the group?s members. But it could create headaches for business owners who have to deal with a number of angels rather than just one or two investors.

Personal Credit and Savings

More than 70% of small businesses were launched using personal savings or assets, according to Elizabeth A. Duke, a governor on the Federal Reserve Board, who, last April, disclosed preliminary data from the Federal Reserve?s upcoming Survey of Consumer Finances.

Personal credit cards, as well as friends and family have grown in popularity during the downturn, and will likely remain an important avenue for entrepreneurs even after the economy rebounds.

Some entrepreneurs obtain business credit cards, which carry fluctuating?and often higher?interest rates while lacking consumer card protections. Delinquencies on business cards can also damage your personal credit score.

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