David Lerner Associates: Loans are a Primary Financing Sources for a Business
There are many sources of financing available to a business owner. Consider all options carefully before making any decisions. The following list of loan sources should provide some ideas.
Debt sources
A. The business owner. He or she can establish a debtor/creditor relationship with the business. The owner then becomes the creditor (the lender), and the business is the debtor (the borrower). There are several sources of funds to tap into:
Retirement fund: Contact the retirement plan administrator to see if this is a viable option. Keep in mind that the extent of the funds available for borrowing will be limited by the amount of money invested in the plan.
Life insurance: If there is an accumulated cash value in a life insurance policy, it might be possible to borrow against it. Moreover, the older the policy, the more likely it will carry a lower interest rate than other types of loans.
Credit card: With a good credit rating it is possible to borrow money using credit cards. Though credit cards are a source of quick cash, they’re likely to have a high interest rate. Heavy credit card borrowing should be used only in financial emergencies.
Home equity financing: A home equity loan or line of credit is a good source of funds, but the downside of this type of borrowing is the risk of losing the home in the event of default.
Liquidate retirement plan: This is another option, but cashing in an individual retirement account can be very expensive. The withdrawal will be included as taxable income (except to the extent attributable to nondeductible contributions), and there may be an assessed 10 percent penalty for early withdrawal if the plan holder is younger than 59½ years old. However, a qualified distribution from a Roth IRA is not taxable.
B. Friends and family. The advantage of borrowing from friends and family is that terms can be more favorable than with strangers. The disadvantage, however, is the potential strain on the relationship. Friends and family can be easily alienated if their expectations go unmet or if they do not get their money back, especially if they were barely able to provide the funds in the first place. Keep the relationship formal to avoid any misunderstandings, and choose the relatives or friends from whom you borrow carefully.
C. Banks. Like most lenders, banks are conservative when it comes to lending money. The bank will not risk its depositors' money unless the bank is reasonably certain that it will get repaid. For that reason, banks are not inclined to lend to new businesses with little or no collateral. If and when the bank lends to a new business, it usually requires a large equity investment by the business owners (anywhere from 25 to 50 percent), depending on the business. Therefore, a bank may not be a good idea for a long-term, unsecured loan for a new business.
D. SBA. The SBA is a federal program that provides technical assistance (in the form of management counseling and informative seminars), and financial assistance (direct loans, loan guarantees, and tax relief). Though the SBA offers direct loans in specific circumstances, the SBA primarily acts as a guarantor of long-term loans for qualified business owners. The primary lender is a traditional financial institution. In this capacity, the SBA usually guarantees 70 to 90 percent of a loan, typically for those in business for more than one year. For more information on these and other loan programs, contact your local SBA office, the SBA Answer Desk at
(800) 827-5722, or the SBA's website at www.sba.gov.
E. Small Business Investment Companies (SBICs). SBICs are privately owned organizations licensed by the SBA. Like the SBA, SBICs provide entrepreneurs with technical or financial assistance (loans or stock purchases). Similarly, "specialized" SBICs offer assistance to those
entrepreneurs considered socially or economically disadvantaged. Funds are limited, however, and both types of SBICs are, like other investors, selective in the type of businesses in which they invest. For more information, contact your local SBA office or the Small Business Investor Alliance at (202) 628-5055.
F. Economic Development Administration (EDA). This federal agency, an extension of the U.S. Department of Commerce, provides assistance to economically deprived areas of the country. The EDA typically provides financial assistance to businesses that locate within such areas. For more information, call the EDA at (202) 482-2900, or visit the Administration's web site at www.eda.gov.
G. Credit Unions. A credit union is a type of financial institution created by a particular group to provide financial assistance to its members. Many companies or labor unions, for example, have credit unions that offer low-interest loans to their employees.
It’s wise to investigate all possible sources of loans, and choose the one that best fits the circumstances.
IMPORTANT DISCLOSURES
Material contained in this article is provided for information purposes only and is not intended to be used in connection with the evaluation of any investments offered by David Lerner Associates, Inc. This material does not constitute an offer or recommendation to buy or sell securities and should not be considered in connection with the purchase or sale of securities.
To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances.
These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable– we cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice.
Some of this material has been provided by Broadridge Investor Communications Solutions, Inc.
David Lerner Associates does not provide tax or legal advice. The information presented here is not specific to any individual's personal circumstances. Member FINRA & SIPC.