5 Ways to Finance Your New Small Business

Small Business, Starting a Business
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5 Ways to Finance Your Small Business Start-up

By Dave Rowan

Learn more about Dave on NerdWallet’s Ask an Advisor

So you’re thinking about starting your own business — congratulations! If you’re like I was when I was opening my first business, you’re experiencing a range of emotions, from exhilarated to terrified, on an hourly basis within any given day.

It’s certainly a wild ride and, of course, not all businesses are successful. In fact, according to the U.S. Small Business Administration, more than 30% fail within the first two years, half fail within five years, and a full two-thirds fail within 10 years.

Why? Money. Many entrepreneurs simply run out. So how can you prevent cash-flow issues from crippling your new venture? Here are five ways to finance your new small business to help make sure that by the year 2026, it’s not only surviving, but thriving.

>> MORE: How to calculate cash flow

1. Have money in the bank (lots of it)

How long it will take your business to turn a profit depends on a number of factors, including:

  • The type of business. For example, opening a traditional brick-and-mortar store has far higher startup expenses than starting an online consulting business.
  • How quickly you attract customers. Where I live, for instance, new restaurants that serve great food at reasonable prices are often quickly filled to capacity. But if you’re opening a new business-coaching practice, it might take you a considerable amount of time to establish a reputation and find clients.
  • Your margins. Let’s go back to the example above: Your new restaurant may be full, but your profit margin may be thin, netting you only 2% to 6% of sales. Consulting businesses, on the other hand, can command margins well in excess of 30% of sales.

If you don’t have any other sources of income, consider saving enough to be financially self-sustaining for the first three years of your new business. This means that if your take-home pay is $8,000 per month and you want to maintain that level of income, you’d want to have about $300,000 in the bank before you quit your day job.

This level of savings might seem pretty intimidating. If you can’t hit that number, you can probably still open your business, but you’ll need to consider some of the techniques listed below. And be cautious. I’ve seen too many people quit their jobs to open a business and not only fail, but consume most or all of their retirement savings in the process, resulting in financial ruin.

2. Keep your day job

More and more entrepreneurs are starting a business while continuing to work full- or part-time. This has become increasingly easy to do in the last several decades given email and other helpful productivity advancements. Now you can even hire a virtual assistant to help run your business while you work your 9-to-5. This keeps much-needed cash flowing in the door while you build your venture. Consider hanging onto your day job until you’ve been in business for two or more years and have replaced at least 25% of your salary with the profits.

3. Open a home equity line of credit

The last thing you want to do is run up significant credit card debt to finance your business. Instead, consider a home equity line of credit for much-needed financing. People typically use HELOCs for home improvements or help with funding a child’s education, but there aren’t any restrictions on how you use the money. This means it can provide a cash infusion for your business while you’re in startup mode.

A HELOC usually has a 20 to 25 year term with two phases: the draw period and the repayment period. During the draw period, which typically lasts 10 to 15 years, you can use money from your HELOC and you’ll only pay interest on the amount borrowed. Then, during the repayment period, which lasts for the remaining 10 to 15 years, you’ll need to repay the money along with additional interest. Interest rates are relatively low — but they’re usually variable, which means they can increase or decrease — and all interest you pay is tax-deductible.

Two points of caution: First, a HELOC shouldn’t be your only source of business funding. Because it uses your house as collateral, it should only be used in combination with the other financing methods described here. If it is your only source of money and you run into trouble with repayment, you could be forced out of your home. Second, establish your HELOC before you quit that day job. Lenders will want proof of income, and you’ll have a much easier time qualifying before you decide to take the leap.

4. Find fruitful part-time work

Let’s say you’ve been in business for some time now and are turning a profit, but you’re also burning through your savings at a faster rate than you anticipated. It might be time to supplement your income with a part-time job.

If the success of your small business is important to you and you can definitely see a path forward, you might need the additional income to pay the bills in the meantime. Whether you wait tables at a high-end restaurant or become a driver for a ridesharing service like Uber, part-time work can help you make serious coin to plow back into your venture.

5. Consider peer-to-peer lending

The first four tips can help when you’re considering starting and starting a business. Once you’ve been in business for a few years, you might want to consider peer-to-peer lending as a financing option. Peer-to-peer lending can be a good option for small-business owners because they can get approved and funded more quickly than if they applied for small-business financing from a bank or other traditional lender. Peer-to-peer loans charge higher interest rates than HELOCs do, but they’re still a better option than maxing out a credit card.

But peer-to-peer lenders want to see that you’ve been in business for a while and are generating substantial revenue — often $75,000 or more annually — before sending money your way. So tuck this final method into your memory bank until you’ve been in business long enough to meet the requirements.

Get to work

As you get started on your new venture, think about which strategies you’ll use to finance your business in addition to your business plans, marketing and sales concerns. Doing so will give you more confidence, room to make mistakes along the way and the best chance to be among the minority of small-business owners who proudly celebrate their 10th year in business.

Dave Rowan is a certified financial planner and the founder of Rowan Financial