Caution for Small Business Owners Using a Home as Collateral
Friday, February 15th, 2013
Recent data from the Pepperdine Private Capital Market Project revealed that 88% of privately-held businesses with revenues less than $5 million want to execute growth strategies, but they typically have lower levels of necessary resources, such as the people or finances, to grow compared to privately-held businesses with higher revenues.
Eager to grow, but lacking the means, many small-businesses owners have turned to friends and family for funding. Pepperdine Private Capital Market Project research from Q1 2012, shows that 71% of businesses with less than $5 million in revenue were successful in securing funding from friends and family – the No. 1 source from among 17 lending categories.
Now some business owners may be tempted to use their homes as collateral. With the recent spike in home prices this option may seem even more appealing.
In mid-January, real estate firm DataQuick reported that home prices nationwide increased 7.4% year-over-year and in Southern California the median home price rose 19.6% in December over the same month last year to hit $323,000. San Bernardino and Riverside counties posted the strongest year-over-year increases, up 20.0% and 19.1%, respectively, indicating that the once hard-hit Inland Empire is now recovering.
Certainly, there will be some businesses that are able to take advantage of the increase in home prices to grow their operations. This should bode well for states like California where the concentration of small businesses is higher. However, before home owners get too optimistic here are a few things to consider:
• Many banks are still hesitant to fund via home equity lines. While there will be some increased access to funding, it will not nearly be in line with what we saw pre-financial crisis.
• Even as access to home equity loans increases it may not be the best decision to use home equity as collateral. Many entrepreneurs forego a job to start their venture and piling on additional financial risk in the way of home equity further increases their risk profile. But, entrepreneurs don’t see “risk” as clearly as those sitting on the sidelines. This optimism leads to many successes, but even more failures and disappointments.
• If you operate your business out of your residence, your home or personal assets may be considered collateral for a loan. However, in the event of inadequacy of collateral, the Small Business Administration will generally not decline a loan if it is the only unfavorable factor.
Whether or not small business owners use their home equity as collateral is a personal decision and will vary from situation to situation. In order for business owners to increase their prospect of securing capital they should make sure they know about the different types of private capital (i.e. angel funding vs venture capital vs private equity) that are available. While these sources of capital are not for everyone, raising small business owner’s knowledge of capital classes will help them make informed and effective decisions.
Business owners should also have a well-written business plan as well as personal experience or solid mentorship in the industry they are entering. Part of this business plan should include understanding the criteria that are needed to attain financing from different sources. This will help streamline the process by eliminating the funding sources that are not attainable or not the best fit for business owners.