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Intestinal Fortitude 101: Funding Your Business with Your Credit Cards, IRAs, and Home Equity Loans

Those of you who’ve been following my blog over the past 10 weeks or so (or at least the 3 of you who are still awake and haven’t yet slit your wrists) know that I’ve been discussing how to finance a new or existing business. I’ve been spending a lot of time on this topic for 3 reasons:

  1. it’s one of the most important issues business owners face,
  2. it’s a topic about which I receive a significant number of questions, and
  3. it’s worth understanding the legal and business ramifications of the various methods of financing a business.

Alas, every journey must eventually come to an end, as must this one. With that in mind, let me briefly discuss 3 additional financing sources that I haven’t yet talked about to tie up our financing miniseries: using credit cards, funds from your IRA, or home equity loans.

  • HOME EQUITY LOANS:  The advantage of taking out a Home Equity Loan is that you’ll pay a relatively low rate of interest and get a long term loan. Disadvantages? The obvious one is deciding whether you believe in your business enough to risk your house (have you done a business plan and some basic financial projections?). The less obvious one (but perhaps more problematic one) is that your spouse will have to co-sign the loan (I’m assuming that if you’re married, you hold title to your house jointly with your spouse). Is your spouse willing to be liable for the debts of your business if things don’t work out? More important, what happens if the two of you get divorced? In the absence of an up-front written agreement with your spouse dealing with this issue, it’s not going to be pretty. If you go this route, talk to me first.

 

  • CREDIT CARDS: Again, are you confident enough in your business plan to risk your personal credit and the inevitable lawsuits and collection efforts should the business fail? If so, there are a number of advantages to using credit cards, including the lack of a need to put up security, the lack of spousal involvement, and the possibility of very low “teaser” rates (which are worth shopping around for). Once the teaser expires, it’s possible to roll the balance over to another card with another low “teaser” rate.

Disadvantages? The risk, of course. Also, credit card financing is and should be short term due to the inevitable interest rate hikes once the teaser period expires. Plus, you will almost certainly have to personally guarantee the card.

Finally, remember all the ink I spilled a couple of months ago blogging about the limited liability gained via incorporating, and the various transgressions that could give rise to a loss of that limited liability? Funding a business using your personal credit cards implicates some of those issues (specifically, segregation of funds issues). Call me so we can discuss if you’re thinking of going this route.

 

  • IRAs: This is the financing technique that I find to be simultaneously both the most appealing and the most terrifying.   So here’s your question: Should you take money out of your IRA to finance your new business?

For me, the 2 most important threshold issues related to IRA financing are these: (1) how much of your IRA you’ll be tapping, and (2) your age. Here’s a long but important sentence: If the remaining funds in your IRA (after you pull out whatever you’re going to pull out to fund your company) would be sufficiently small such that living on those funds would have a significant adverse effect on your quality of life at retirement, AND you’re over the age of, say, 45 or so, I’d have a serious heart to heart with both your spouse and your accountant (not necessarily in that order) before pulling the money out. I also personally believe (and you can take this for whatever you think it’s worth) that it’s best to be ultraconservative and assume that the funds remaining (if any) in your IRA after you tap it to finance your business will be all that you’ll have left for retirement. In other words, assume that the remaining funds will NOT grow significantly between now and your retirement (and could possibly decrease), and that you WON’T be able to contribute any additional funds to your IRA between now and retirement.

However, once you decide to take the plunge, you’ve actually got several advantages over virtually any of the other financing techniques I’ve been discussing in my financing miniseries.  Debt financing (banks, SBA, home equity, credit cards, etc.) can put a serious strain on your business’s cash flow – not to mention your personal financial situation, since you’re likely giving personal guarantees or security for the loans.  Venture capital financing can result in the loss of control over your own company and your eventual personal obsolescence. And financing using the 3Fs can result in family discord, estrangement, disappointment, and broken relationships. But utilizing IRA financing eliminates all of these pitfalls. And, you can avoid early withdrawal penalties and taxes if you employ an IRS approved financing plan.

So, how does it all work? First, you’ll form your new company (and, of course, you’ll form the right kind of entity because you’ve read my blogs on corporate formation). Second, your new company will set up a “qualified retirement plan” in accordance with IRS regulations. (You’ll need an experienced and reputable benefits firm to do this for you. I can help with recommendations, if necessary). Third, you’ll roll over the desired amount of your personal IRA funds into the company’s new “qualified retirement plan.” Last, your company’s newly-established “qualified retirement plan,” fresh with funds from your personal IRA, will use those funds to buy stock in your new company. Your company is now funded with equity from the stock sale (rather than cash flow -draining debt), and the “qualified retirement plan” owns all (or some) of your new company.

The following goes without saying (but since I’m anal retentive AND a lawyer, I’ll say it anyway):  I strongly recommend that you work with an experienced corporate attorney when setting up the new company and when consummating the stock purchase by the qualified retirement plan. Someone like me, perhaps. These are sophisticated corporate transactions and need to be treated as such.

Next up: ever think about what would happen to your company if your business partner died? What if he decided to sell his interest in the company to a third party?  Or suppose she decides to just stop working (can she do that)? If you haven’t thought through these issues, you should. Succession Planning is on deck.

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