ABA Family Legal Guide

Forming and Operating a Small Business

Starting a Business

Financing a Business

Can I just finance the business myself?

It may be possible for you to finance the business yourself. There are a number of alternatives for personal contributions:

Savings

This source is obviously very simple and easy, since it's your money, but how many of us have enough salted away to open much more than a lemonade stand? And if you do have substantial savings, the question is whether all your savings should be invested. Remember, you may have other personal or family needs requiring your savings.

Paid-up Life Insurance

The surrender or cash value of a life insurance policy is the equity you've built up over the years through the premiums you pay. This is what the insurance company would pay you if you canceled the policy. You could do that and use the proceeds for your business, but then you'd have no life insurance, perhaps at a time when your family is relying more than ever on you. A better option is to borrow against this amount from the company. Rates are low, and the loan is easy to arrange (after all, it's your money). Repayment plans can also be flexible. This is a good option.

Borrowing Against Your Retirement Plan

This is an option only if you continue to work for your employer while starting up your business, and only if you've built up equity (in retirementese, vested benefits) in your 401(k) or similar plan. If you have, borrowing against this equity is relatively easy (once again, it's your money), rates are low, and the repayment period can be as long as five years. Best of all, you're repaying yourself. Depending on the terms of your plan, however, you may face another problem: The money can't be two places at once. While you're using it for your business, it may not be growing in your retirement plan, and you may be shortchanging your sunset years. Your benefits person at work can explain how such a loan operates under your plan, and he or she can tell you how such a loan can be arranged.

Home Equity Loans

This is a third way to borrow against your own money. A home equity loan is, in essence, a second mortgage. Rates are usually higher than first mortgages, since there is greater risk for the lender. You usually can deduct the interest you pay on your federal income tax returns. The downside is that you have to go through most of the paperwork and much of the expense and delay of a first mortgage, including paying mortgage-recording taxes in some states, and your home is at risk if you can't pay the loan back. You can find more information on this kind of loan in chapter 5, "Home Ownership."

Borrowing Against the Value of Your Stocks and Bonds

If you're fortunate enough to have such investments, this is one more way of borrowing against your own money. Instead of selling stocks or bonds and incurring taxes (and maybe missing out on some big gains), you can use them as collateral for a loan from your brokerage firm. As with home equity loans, you can't get the full amount of their current value (too much risk), but once again, rates are low and repayment flexible. This is an alternative worth considering, but remember that if the stocks fall in value you could be in for a rude shock, since you will be obligated to deposit additional funds with the broker or pay back part of the loan to keep the loan-to-value ratio appropriate.

Credit Card Debt

Every once in a while you read about a now-successful entrepreneur who rolled the dice and maxed out her credit card to get the business going. That can happen, but all in all this is not as attractive a route as the other alternatives we've listed. Credit card rates are often very high, so you'll pay a lot in interest if you can't pay off the balance quickly.