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From Zero to Millions: Financing Your New Business

By Laura Rowley, Yahoo!Finance columnist, and author of Money & Happiness

I really enjoyed hearing the amazing stories of successful entrepreneurs who went from zero to millions on Donny Deutsch’s show last night. A number of viewers have emailed me asking about

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the ideas and websites I mentioned on the program, so here’s a rundown:

It doesn’t take money to make money, it takes passion and discipline. Not having money is sometimes an advantage – it gets you focused on sales, on bringing cash into the business. There are thousands of examples of people who started multi-million-dollar businesses with little or no start-up capital – from Madam C.J. Walker, who built a fortune in hair-care products in the early 1900s to Fred Deluca, the founder of Subway, who started with $1,000. Financially, there a several avenues to help fund your start-up:


Self-funding

-Eliminate any non-essential spending (food, clothing and shelter – move home if you have to) and put your savings and current income into the business. For budgeting tips, see www.moneyandhappiness.com.

-Borrow against the house: Home equity loans are a little harder to get than they used to be, but the interest rates are still lower than credit cards (for people with good credit, around 7 percent).

-Credit cards: If you added up the credit limits on all your credit cards combined, how much cash could you access? Keep in mind this will lower your FICO credit score, and you may be paying between 15 and 30 percent interest.

-Borrowing against the money in your 401(k). This may be a strategy for someone who works full time and is launching their business on the side. Many plans allow participants to borrow up to 50 percent of their account balance to a maximum of $50,000, and return the money over five years with interest. The rate is usually prime plus one percent.

But your employer may have restrictions on what you can use the money for. And if you get laid off or quit, you typically have to repay the loan in 60 to 90 days. If you can’t pay it back in that time frame, the government considers it a distribution and (if you’re under age 59-1/2) hits you with a 10 percent penalty, as well as income taxes. (Let’s say you take out a $20,000 loan; if you’re in the 25 percent tax bracket, some 35 percent of the loan amount would be vaporized. So your $20,000 would become $13,000. So plan accordingly!)

Loans from Family and Friends:

Although these are folks who trust you, you want to legally formalize the loan with everything from the terms to the timing. Talk about your family members’ expectations upfront, outlining the worst case scenarios: What happens if you default on the loan? Clarify that the money they lend to your business doesn’t give them a vote in how you run it.

-Get a Promissory note, and set up a repayment schedule. Signed by the investor and the entrepreneur, the note must include the dollar amount, interest rate and term of the loan. You may want to consult a financial advisor to ensure the promissory note is written properly.

-Online Family Lending Use a lending network designed for inter-family loans, such as CircleLending.com. Tools at that site will help you and your relative come to terms on the length of the loan and the interest rate, and calculate the monthly payment amount. For $99, CircleLending issues a legally binding promissory note and a repayment schedule. For $9 per payment, the company will set up automatic repayments using electronic funds transfer.

-Peer-to-peer Lending: Several websites now make it much easier to find an investor who will back your business. Check out prosper.com, lendingclub.com and zopa.com.

Lending Club’s founder financed his first company with personal loans and high-interest credit cards. He eventually sold the business to Oracle. That experience inspired his new company. Lending Club, which launched on Facebook in May 2007 and on its own site last September, uses technology to match borrowers to lenders willing to offer unsecured loans of $500 to $25,000 with three-year, fully amortizing terms.

The distinctive angle here: The search technology looks for social connections between the borrower and the lender – maybe you went to the same college, or worked at the same company in the past. On its first 100 days on Facebook, the company facilitated $1 million in loans, at an average interest rate of 12.6 percent.

Potential borrowers are weighed on the same criteria a bank would use: a FICO score of at least 640 and a debt-to-income ratio of 25 percent or less, excluding mortgages. Late payments are reported to credit bureaus.

Prosper.com is the largest person-to-person lender, with 430,000 members lending $91 million to each other in the first year. The borrower profiles are extensive, including the repayment history of other Prosper loans and endorsements from friends who have bid on the loan.

Other Loans

-SBA Loans: the U.S. Small Business Administration makes loans through local banks and agencies; you can use these loans to buy equipment, inventory, furniture, supplies and more.

-Line-of-credit loans: These short-term loans let you access a specified amount of money that’s deposited into your business checking account on an as-needed basis. You pay interest on the amount that’s loaned to you. Line-of-credit loans can be used to buy inventory and pay operating costs for working capital, among other things, but not to buy real estate or equipment.

-A Revolving Line of Credit: A lender offers a certain amount of money to a borrower; as the person repays it, they can borrow it again.

-Angel Investors: This is where to turn when you have gone through your own funds and exhausted investment possibilities with family and friends. These are high net worth investors who are willing to invest their own money in your business. I can discuss what they typically look for. Start with the Angel Capital Education Foundation at angelcapitaleducation.org., which has a listing of angel groups.

Good luck going from zero to millions!

- Laura