About 48 percent of businesses use some form of debt financing during their initial year of operation. The sources most frequently used are personal credit card debt (30.2 percent), personal bank loans (18 percent), business credit card debt (14.6 percent), and loans from friends and family (10.1 percent).^[1] Note that the majority of debt financing is not in the form of a bank loan. Instead, business owners rely on more personal sources of debt financing to supplement their start-up needs.

The majority of debt financing is not in the form of a bank loan. Instead, business owners must rely on more personal sources of debt financing to supplement their start-up needs.

There are two major advantages to debt financing opposed to equity funding, which will be discussed in Truth 25, “Equity funding.” The first is that none of the ownership of the business is surrendered—a major advantage for most business owners. The second is that interest payments on a loan (in most cases) are tax deductible, in contrast to dividend payments made to investors, which aren’t. There are two major disadvantages to debt financing. The first is that debt must be repaid. Cash is typically tight during a start-up’s first few months and sometimes for a year or more. The second is that lenders often impose strict conditions on loans and insist on ample collateral to fully protect their investment. This often requires that a business owner’s personal assets be collateralized as a condition of the loan.

Commercial banks are not a practical source of financing for most new businesses.^[2] This sentiment isn’t a knock against banks; it’s just that banks are risk adverse, and financing start-ups is a risky business. That’s not to say that you can’t get a home equity loan to fund part or all of your start-up needs. It’s just that most banks won’t normally assume the risk of loaning money directly to a business with an unproven track record. They would rather loan money to an individual who has equity in a home to pledge as collateral.

When banks do loan money to start-ups, the money is often loaned through the Small Business Administration (SBA) Guaranteed Loan Program. This program is a realistic alternative for many start-ups and offers reduced interest rates and longer repayment terms than conventional loans. The SBA does not have money to lend but makes it easier for business owners to obtain loans from banks by guaranteeing the loans. The most notable SBA program available to small businesses is the 7(A) Loan Guaranty Program. The loans are for small businesses that are not able to obtain loans on reasonable terms through normal lending channels. Almost all small businesses are eligible to apply for an SBA guaranteed loan. The SBA can guarantee as much as 85 percent on loans up to $150,000 and 75 percent on loans over $150,000. In most cases, the maximum guarantee is $1.5 million. A guaranteed loan can be used for working capital to start a new business or expand an existing one. It can also be used for real estate purchases, renovation, construction, or equipment purchases. The best way to learn more about the SBA Guaranteed Loan Program and determine if you are eligible is to meet with a participating lender.

One channel for borrowing funds that is getting quite a bit of attention is Prosper.com, a peer-to-peer lending network.

There are a variety of other avenues that business owners can pursue to borrow money. Getting loans from friends and family, as discussed in Truth 23, “Personal loans, loans from friends and family, and bootstrapping,” is a popular choice. Credit card debt, although easy to obtain, should be used sparingly. One channel for borrowing funds that is getting quite a bit of attention is Prosper.com, a peer-to-peer lending network. Prosper is an online auction Web site that matches people who want to borrow money with people who are willing to make loans. Most of the loans made via Prosper are fairly small ($25,000) but might be sufficient to meet a new business’s needs.^[3] There are also organizations that lend money to specific demographic groups. For example, Count Me In, an advocacy group for female business owners, provides loans of $500 to $10,000 to women starting or growing a business.^[4] An organization that is aligned with Count Me In and American Express, named Make Mine a Million $ Business, lends up to $50,000 to female-owned start-ups that have been in business for at least two years and have $250,000 or more in annual revenue.^[5]

Some lenders specialize in microfinancing, which are very small loans. For example, Accion USA gives $500 credit-builder loans to people with no credit history.^[6] While $500 might not sound like much, it could be enough to open a home-based business such as an eBay Store or to get started in a direct sales organization.