Borrowing from your business without borrowing from your future

Your business

Is there a better way to borrow without disrupting your long-term goals?


Most entrepreneurs recognize that success is a byproduct of calculated risk and that building a successful small business requires a certain amount of agility. But they also realize it requires a lot of capital to retain that agility and seize strategic opportunities.

According to Endurance International Group, more than half (57 percent) of U.S.-based small business owners planning to make investments in their businesses this year – ranging from product development to investing in real estate –by, some will dig into their personal savings to fund those strategic opportunities.

It’s not uncommon; Inc. Magazine’s The State of Small Business survey from 2015 found that over the past five years, 46 percent of entrepreneurs had tapped into their personal savings to fund their business.

But is there a better way to borrow without disrupting your long-term goals?

“We tend to find the families we work with try to shy away from accessing their personal wealth because they have so much other stuff going on – private investments, taxes, trusts, estate planning,” says Michael Occhiuto, financial advisor and senior vice president at RBC Wealth Management’s Midtown New York office. “I view tapping into their personal wealth as a last resort if they ever come on dire straights and need help solidifying the business.”

His colleague, Scott Edwards, financial advisor and managing director at RBC Wealth Management’s Midtown New York office says he agrees, pointing out that pulling money out of a personal investment vehicle can be a slippery slope.

“If you miss just one year of investment return, even (in a conservative portfolio) at five percent it can really derail your portfolio in the long term,” says Edwards. “If you’re running a business, you’re usually going to need money for more than one year.”

Instead, says Edwards, an entrepreneur can leverage the business and its assets to tap into funds for further growth. Here are some ways small business owners can borrow from their business without disrupting their long-term goals.

Unsecured line of credit

“Unsecured lines of credit are coming back, they’ve been dead since 2008,” says Edwards. “(With unsecured LOCs) lenders basically look at the individual borrower, go over their liquidity profile and extend a line of credit just based on who they are,” he says.

Since no asset is acting as collateral and the LOC is borrowed against the possibility of future business returns, these sorts of credit vehicles can be highly risky for lenders and often come with higher interest rates.

At quick glance, an unsecured loan may seem like a better option for a business but given that they are only given to well established, reputable businesses, a secured line of credit is more likely the route for small businesses starting out.

Asset-based loans or lines of credits

As the name suggests, asset-based loans are structured around assets – typically accounts receivables and inventory, explains Dean Deutz, vice president of wealth initiatives and senior manager of the Wealth Solutions Group at RBC Wealth Management in Minneapolis. Asset-based loans can equate to around 70 or 80 per cent of a business’ eligible receivables and 50 per cent of finished inventory.

The credit grantor establishes a lien against an asset that belongs to the borrower and if the business owner defaults on repaying the loan or line of credit, the lender has a right to seize the collateral and liquidate it.

“The reality is there’s a lot of businesses with assets that are either not strong enough or mature enough to fund the loan and the owners end up doing personal guarantees,” says Deutz.

Unfortunately, as businesses transition from the startup phase to standing on their own legs, sometimes owners forget their personal guarantee is still attached..

“You have to continually review your (loan or line of credit) on a periodic basis,” adds Deutz. “We see business owners not doing a periodic review of their debt and personal guarantees and they miss an opportunity to refinance or remove their personal guarantee from a business loan. The worst case is when they don’t do a review and the business fails for some reason and their personal assets are at risk.”

Skip these woes by reviewing and where possible, re-financing.

Securities-based lending

Securities-based lending is the process of pledging a portfolio of, say, blue chip equities or municipal bonds, as collateral to back up a loan of around 50 to 60 per cent of those assets’ value. Loan-to-value rates can go lower for concentrated stock positions and higher for bond portfolios.

“You’re not selling those stocks you’re just borrowing against them so the stocks can still grow in your portfolio,” says Edwards. This also lets the investor avoid a taxable event.

“In terms of payback, you don’t have a schedule where you need to pay back the principal every month or every quarter – you’re just responsible for the accrued interest every month,” adds Occhiuto. “So the balance will actually grow over the length of the loan unless you decide to pay some of that down.”

While securities-based lending can provide liquidity for certain business or personal opportunities, there are some risks involved. Securities-based lending can come with restrictions on how one uses account proceeds. There’s also the risk that an entrepreneur might have to provide additional funds or securities if their existing securities start slipping in value. Failing to do so, the bank can sell any assets in the collateral account at its discretion, seriously impacting a longer-term strategy.

“Look at the amount of market cycles we’ve been through since 2005… the amount of volatility,” says Edwards. “You really have to focus on the market cycles and the macro level of things, the overall environment.”

He says he uses the same advice for entrepreneurs who find themselves nearing retirement with portfolios predominantly stacked with shares of their own company.

“We have a CEO of a publicly-traded bio tech company whose own stock trades at $20 a share and he owns 1.5 million shares,” says Occhiuto. “When we sit down and go over his estate plan, asset allocation and how he’s diversified and protecting his personal wealth, he’s got a big problem on his hands because 98 per cent of his net worth is tied up in the company.”

The wealth management advisor says they’ve been working with him to help him diversify,but like all entrepreneurs who’ve built a company from the ground up; it can be a tough sell.

“You never want to have all your eggs in one basket, this may be your baby but at the end of the day you’re going to want to retire at some point and you want to have some security,” he adds. “No one knows what tomorrow is going to bring so you want to be diversified… so that you can run your business and sleep at night knowing you’re going to be financially secure.”

RBC Wealth Management, a division of RBC Capital Markets, LLC, registered investment adviser and Member NYSE/FINRA/SIPC.

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