What’s shocking is how often entrepreneurs forgo the cheapest, most readily available loans in favor of high-interest credit cards and personal loans.
One of the biggest challenges every entrepreneur faces is finding the capital to fund his or her vision. If you’re one of the lucky few to land a major VC investment, congratulations! You’re part of the mere .05 percent of startups that have successfully navigated the venture capital route.
For the vast majority of startup founders, however, the road to funding is a stressful and arduous one. In fact, only about half of all startups — according to the National Association of Small Business — survive to their fourth year, and one of their biggest reasons for failure? You guessed it: running out of cash.
Still, every startup needs capital, and there are dozens of ways to get it. What’s shocking, though, is how often entrepreneurs forgo the cheapest, most readily available money in favor of high-interest credit cards and personal loans. Indeed, home equity is an option that’s consistently overlooked by the startup community; just 7 percent of all small business owners who apply for loans or lines of credit do so by tapping into a home equity line of credit, and only 6 percent go for a mortgage refinance, according to a recent report from the Fed.
To be clear, the home equity option isn’t for everyone, and as with all loans and lines of credit, there are strict repayment terms that carry some financial risk. But founders in a position to carefully consider and mitigate that risk may find that tapping their home equity is one of the easiest and most affordable sources of funding for a startup.
In fact, I speak from personal experience. Here are the details:
HELOC (Home Equity Line of Credit)
My partner, Bill Osborne, and I started Nations Lending in 2003 with $35,000 from a home equity line of credit and an $18,000 personal loan from my mother. Nations Lending now originates nearly $2 billion in loan volume annually with the help of nearly 700 employees. Without that original home equity line of credit, we wouldn’t have grown into what we are today.
A home equity line of credit is exactly what it sounds like. If your home has increased in value, you’re able to borrow against the value increase, or some portion of it, like a credit card. But unlike its plastic cousin, HELOCs come with a substantially lower interest rate than any business credit card out there. With a HELOC, small business owners don’t have to take the money they qualify for all at once, either. Rather, they can draw on it as it’s needed.
This is one of the things that makes HELOCs ideal for funding a small business, because it’s hard to predict today what your capital needs will be a month from now. As an added bonus, some of the interest payments may be tax deductible.
In 2003, our company couldn’t show a small business lender or the Small Business Administration the $50,000 to $150,000 in annual revenue that we needed to qualify for a loan. That HELOC proved to be our proverbial lifeline; in unlocking that $35,000 in home equity, we got the money we needed in a matter of days to continue growing the business.
This is not to say small business loans are a bad choice, of course. But they simply aren’t for everyone, especially because many entrepreneurs won’t meet revenue requirements and the loan itself could take months to materialize.
Case study: Scott Raybuck, serial entrepreneur and founder and CEO of Zuri, a CBD supply company in Ohio, knows the advantages of a HELOC quite well. He tapped $300,000 in the form of a home equity line of credit, along with other substantial savings, to start his company Zuri.
“Most people don’t think that way –it’s more traditional to keep personal finance and business finance separate,” Raybuck told me. “I think it simply boils down to the nomenclature of the loan or line of credit — the fact that it’s called ‘home’ equity. People think they have to use the funds for something home- or family-related. That’s not the case.”
A home equity line could be a great option for entrepreneurs. Just make sure you understand the terms and the risk.
While the home equity line of credit is the superior product for funding small businesses, entrepreneurs need to also be aware of the more ubiquitous cash-out refinance option. This basically turns your home’s equity into a one-time loan, which you start paying back in the form of a new mortgage payment.
Let’s face it, if you’re starting your business at a young age, maybe you haven’t owned your home long enough for the equity to grow for a HELOC. That’s where a cash-out refinance comes in because it can still beat most small business loans and credit cards in terms of interest rate and repayment terms.
In a cash-out refinance, a homeowner gets a brand new mortgage to pay off the old one, while at the same time withdrawing accumulated equity in cash. The difference between the two mortgages is given to the homeowner in cash. Translation? I’m talking money to fund your entrepreneurial dreams, typically available at a significantly lower interest rate than your average 15 percent to 20 percent business credit card.
Case study: In an interview with MortgageLoan.com, Sam Craven, owner of Senna House Buyers in Houston, Texas, discussed how he used his home to get the ball rolling on a business that’s since done close to 300 real estate deals.
“It was an easy process,” Craven told the website. “They lent me 80 percent of my home’s value and that was enough seed money to get the ball rolling. I would highly recommend people unlock the dead equity that is sitting in their home to chase their dreams.”
Every day, small business owners come to the shocking revelation that the amount of capital they thought they’d need to get up and running is insufficient. When this happens, home equity can be the gamechanger they desperately need.
But before making a decision, you have to understand all your funding options and weigh them carefully against one another. Speak with your lender and/or attorney to make the best decision for you and your business.
Read More: Entrepreneur