Small Business Financing – using your home as collateral

Mostly there is no other option for small business financing than to put up the family home as collateral. There are of course risks to this and here are some examples on how it has worked and how it hasn’t. Reported in the New York Times, the article shows readers what can happen. It’s a difficult decision… even for established businesses that need a (hopefully) short term boost. Here’s what has happened to 2 business owners:

In March 2008, about nine months after he bought a steel-processing business, Precision Steel Services in Warren, Mich., for some $750,000, Shailesh Kumar went to two banks in search of a $350,000 loan.

He wanted to expand the business and pay off a $290,000 debt he had with the seller, replacing an 8 percent, seven-year debt with a 6.5 percent, 20-year loan. “It would have made a huge difference in terms of cash flow and growth capital,” Mr. Kumar said.

But both lenders he was negotiating with demanded that Mr. Kumar put up equity in his own home as collateral. Mr. Kumar hesitated, and then as 2008 wore on, he watched the value of his home fall to $330,000 from $425,000, wiping out all of his equity. Eventually, the banks broke off negotiations. With no cash on hand and revenue down by some 60 percent during the first half of 2009, Mr. Kumar closed Precision Steel in July 2009.

Zalmi Duchman, 31, took a $100,000 home equity loan on his Surfside, Fla., condo and in 2006 used $5,000 of it to start the Fresh Diet, a gourmet meal-delivery service. (He used the rest for living expenses while building the business.)

About 18 months later he took out an additional $200,000 to match with a $900,000 S.B.A. loan that he used to buy a competitor with operations in Miami and New York. “I don’t think I would have gotten the S.B.A. loan without my condo,” said Mr. Duchman, who expects the Fresh Diet to bring in $30 million in revenue this year. “I wouldn’t have grown the way I did.”

Under pinning the whole problem of using a home as collateral is the lack of alternatives. Lets face it, banks and other lending institutions cannot loan without security. Some businesses succeed and some fail. Without the courage of entrepreneurs taking risks with small business finance then what does the future hold? How else can the ‘small guy’ raise finance?

….Some worry about the impact this inability to raise capital and start businesses and hire employees might have on the economy; others wonder whether it ever makes sense to demand this level of commitment from entrepreneurs…..

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