Legal Issues for Financing a Wisconsin Small Business
Many, if not most, entrepreneurs need money to start and grow their small business. This article provides an overview of financing options for Wisconsin small businesses and common legal issues that arise with those options.
Gifts from Family and Friends
Traditional banks will generally not lend to a business unless the enterprise has been operating for one or two years. That makes raising money challenging for brand new businesses. One option for those businesses is a gift of money from family or friends. A benefit of a gift is that it does not have to be repaid. Additionally, treating money as a gift rather than as a loan or investment can help preserve personal relationships, which can sour if a business becomes unable to repay a loan or fails, wiping out an investment.
The donor should document a gift to an entrepreneur with a written letter, copies of which both the donor and the entrepreneur should keep. Donors should keep in mind the annual gift-tax exclusion, which is $15,000 for 2021 and changes from time to time. (A donor giving more than $15,000 in cash or assets in a year to any one person must file a gift tax return.)
Business Loans from Individuals
Another option is for small businesses to obtain loans from family, friends, or other individuals. These types of loans generally take the form of a written promissory note.
Promissory notes can be structured in different ways. One option is installment payments, where the borrower makes equal monthly or yearly payments for a certain number of months or years until the loan is paid off. Another option is a lump sum payment, where the borrow pays off the entirety of the loan by a future date.
Promissory notes should generally include a commercially reasonable interest rate (not too high or too low). Additionally, they may be secured or unsecured by collateral, such as the borrower’s house or car.
Promissory notes are not risk free, and many notes fall under securities laws, meaning the notes must either be registered with the Securities and Exchange Commission and Wisconsin Department of Financial Institutions or qualify for an exemption from registration. Entrepreneurs considering loans from individuals are strongly advised to work with a legal clinic or business attorney to ensure the loan is structured properly and any issues with securities laws are addressed.
Business Loans from Commercial Lenders
Another option—one that can avoid issues with securities laws—is a business loan from a commercial lender. As noted, traditional banks will generally not lend to a business unless the enterprise has been operating for one or two years. Fortunately, there are other options:
Wisconsin Women’s Business Initiative Corporation (WWBIC) – WWBIC is Wisconsin’s largest microlender, providing access to fair capital for business startups and expansions. It offers loans ranging from $1,000 to $200,000-plus as well as business classes and other assistance. WWBIC generally requires collateral for its loans and that entrepreneurs sign personal guarantees.
U.S. Small Business Association (SBA) – The SBA does not lend money directly to small business owners. Instead, it backs certain loans made by partnering banks, community development organizations, and micro-lending institutions (such as WWBIC). Entrepreneurs interested in an SBA loan should contact the SBA or consider using its Lender Match program, in which more than 800 lenders participate throughout all 50 states.
Community Development Financial Institutions (CDFIs) – CDFIs are financial institutions with a mission of promoting economic development. They include community development banks, credit unions, and non-profit loan funds. Examples of CDFIs in Wisconsin are the Hmong Wisconsin Chamber of Commerce, WWBIC, Brewery Credit Union, and the Milwaukee Economic Development Corporation. Wisconsin has nearly two dozen CDFIs.
Credit Cards – Some entrepreneurs fund their ventures in part with credit cards. While this is an option, the cons of credit cards often outweigh the benefits. Most credit cards have high interest rates, and it is easy for entrepreneurs to overextend themselves using credit cards.
Crowdfunding
A funding option that continues to grow in popularity is crowdfunding. There are multiple types of crowdfunding:
Lending-Based Crowdfunding – Kiva is the most popular lending-based crowdfunding platform. Through it, a loan is funded by contributions as low as $25 from people all over the world. Of note, the loans have a zero percent interest rate. Entrepreneurs interested in Kiva loan should apply online or contact WWBIC, a partner of Kiva.
Donation-Based Crowdfunding – GoFundMe is the most popular donation-based crowdfunding platform. Through it, individuals make donations to various causes, including small business fundraisers. Entrepreneurs raising funds through a platform such as GoFundMe should be sure to read and comply with fine print (i.e., the fundraising terms). Entrepreneurs should also work with a certified public accountant to properly account for all funds, which may result in taxable income.
Rewards-Based Crowdfunding – A third type of crowdfunding is rewards-based crowdfunding. Popular platforms include Kickstarter and Indiegogo. Through these platforms, individuals “invest” in businesses or projects in exchange for rewards, such as discounted products, t-shirts, or back-stage passes. The investors do not receive any ownership in the business. As with the other types of crowdfunding, entrepreneurs should read the fine print before pursuing rewards crowdfunding. Additionally, entrepreneurs should fairly advertise their products and the potential rewards.
Equity Crowdfunding – This type of crowdfunding is where investors receive actual ownership (e.g., stock) in a business or a right to receive ownership in the future. It occurs through internet portals properly registered with federal or state agencies. It is generally appropriate only for high-growth startups seeking investment and is beyond the scope of this article.
Equity Investment
The final financing option is equity investment, where investors become part owners of a business. The type of equity depends on the business structure. For example, investors in a limited liability company receive LLC interests or units. Investors in a corporation, on the other hand, receive common or preferred stock or use more complex financing vehicles, such as convertible promissory notes or SAFEs (the details for which are beyond the scope of this article).
Equity investment is a complex subject with numerous legal issues to be addressed. As such, the other financing options described above are often better for small businesses to pursue. Entrepreneurs interested in receiving equity investment for a venture are strongly encouraged to contact a legal clinic or experienced business attorney.
