Financing options for a small business are usually debt-based or equity-based.
Choosing between equity-based or debt-based financing may hinge on choosing between the risk of debt repayment and the loss of control from selling equity in a company.
Use of rewards-based crowdfunding, grant proceeds, or a Home Equity Agreement (HEA) may offer new approaches to financing a small business.
A Home Equity Agreement may be a good choice for business owners to access capital without having a traditional loan repayment structure or selling equity in their company.
According to the U.S. Census Bureau, Americans started 4.3 million businesses in 2020, a 24% increase from 2019. While this may be an exciting time to start a company, many business owners may have questions about financing those dreams. Now more than ever, small-business financing is accessible to a broader audience through new platforms and products. Here are three options you might not yet know about.
For small-business owners, financing options usually come in two forms: debt-based or equity-based.
Debt-based financing involves receiving funds that require repayment under a wide range of possible structures. Generally, debt financing repayment will include payments of interest and principal, use of collateral, and a personal guaranty. Lending options for small-business owners usually come from banks and credit unions that offer both short- and long-term loan products. Examples are:
Home equity loan
Home equity line of credit (HELOC)
Business line of credit
Working capital loan
Equity-based financing options, in comparison, are those where you sell an ownership interest in the business to an investor in exchange for capital. Depending on the nature of the business, investors may include close friends and family, or they could be institutional (e.g., venture capital firms, angel investors and other accredited investors).
When starting a small business, understanding the difference between debt and equity financing is essential.
Choosing between a debt and equity financing structure for a small business will depend on risk tolerance and financial position. Both options offer value propositions with unique characteristics.
Debt-based financing, for example, allows owners to maintain control over their business because they do not sell any of their equity. The trade-off for maintaining control is the increased risk that comes with debt, in addition to potential cash-flow issues from repayment obligations. While equity-based financing does not carry the same risk of added debt, it may mean giving up some business control and sharing in profits.
Aside from traditional loans and capital raising, business owners may access financing through one of the following newer options.
Many online platforms now allow small businesses and entrepreneurs to obtain short-term funding to launch new projects. Known as crowdfunding, this gives businesses a way to garner attention and test a product’s viability – see if people find it worthwhile.
The funding can be either rewards-based or equity-based, depending on the platform. Entrepreneurs can create campaigns through their chosen platform and receive money, in exchange for either rewards to donors or shares in a company with an equity-based arrangement. The potential rewards could include merchandise items, access to new products or anything else a donor may find valuable.
Two main benefits of crowdfunding are the ability to raise money quickly, and the opportunity to expand the reach of your business. Like choosing between debt- or equity-based financing, choosing a reward or equity crowdfunding source will depend on business objectives. Business owners should be mindful of state and federal securities regulations that may apply when exploring equity-based funding.
Another option for funding a small business may be to obtain a grant. Unlike a loan or equity financing, a grant is an award of funding to a person or business that does not require repayment or sale of equity. Instead, the grant is more like a gift, which can be especially helpful for a start-up business looking for initial funding. For this reason, grants are also highly competitive and may be hard to obtain.
Third-party organizations such as nonprofits and government groups (local, state, and federal) offer grants to businesses and entrepreneurs for designated purposes. The process of qualifying for a grant usually requires submitting an application and might be contingent on other requirements for eligibility. These criteria will usually connect to the purpose or mission of the organization offering the grant. The purpose could have to do with the ownership of the business, the stated industry, the use of grant funds or any other number of initiatives.
Another possibility for small-business owners looking for capital to start or continue their entrepreneurial dreams is to use a home equity agreement. Through a company like Unlock, you can sell a percentage of your home’s future value under the terms of an HEA. In exchange, you will receive cash proceeds that you can use to capitalize on your business. To qualify, applicants must generally meet the following criteria:
Own a residential (non-commercial) property
Have a minimum FICO score of 500
Have a qualifying amount of equity in the home
How Long Do You Have to Meet Obligations With an HEA?
Standard home equity agreements have 10-year terms. This provides homeowners with some flexibility for meeting their obligations under the agreement. One option is to sell the home within those 10 years, and repay Unlock’s ownership percentage from the sale proceeds. Another option is to buy out Unlock’s equity interest in advance. The process for doing so generally requires an independent appraisal to evaluate the home’s fair market value and determine the amount you owe based on the terms of the home equity agreement.
What is the Advantage of an HEA Compared to Other Financing Options?
One benefit is that there is no traditional repayment of interest and principal, as is the case with a standard loan. Another is that you do not need to relinquish shares or ownership in the business, because the equity comes from the home. However, homeowners must be mindful of their outstanding obligations under the agreement as they navigate other financial decisions during that 10-year term of the equity agreement.
If you are a homeowner comparing small-business financing options, consider the value of an HEA as an alternative to traditional financing or capital raising. You can enter a few details through Unlock’s online form to see your eligibility.
Contact Unlock today for questions about using a home equity agreement to finance your small business.