Putting Personal Money Into a Business in 4 Steps
This article is part of a larger series on Business Financing.
As you start your business, it may be necessary to put some of your personal money into the business to cover startup costs. It’s important to know how this process works to avoid potential tax consequences and unnecessary risks. You’ll need to open a business checking account that will contain your company’s finances, choose a source of personal funds to use, transfer your funds into your business account, and then record the transaction accurately to avoid potential tax issues.
Step 1: Open a Business Checking Account
Before you can put personal money into your business, you need to open a business checking account for your company finances. By doing so, you can separate your business and personal finances, which helps you protect your assets and avoid tax complications.
Both traditional banks and online financial technology (fintech) companies offer some of the best small business checking accounts on the market. Bluevine is a great choice for a small business checking account. It’s largely fee-free, and you can earn 2.0% APY on qualifying balances of $250,000 or less.
Step 2: Determine the Source of Personal Funds
Once you have a business checking account, you need to choose which source of personal funds you’ll use. Each source carries different levels of complexity, along with other pros and cons. Consider each type of funding and choose the one that best fits your financial situation.
A rollover for business startups (ROBS) allows you to use personal retirement funds for your business without the penalties and taxes involved with an early withdrawal. If you have at least $50,000 in your retirement account, a ROBS may be the best option for putting personal money into your business.
It isn’t a startup business loan, so you won’t have monthly payments that can eat into your business cash flow. However, it’s important to remember that your retirement funds are at risk with a ROBS. You’ll need to meet several requirements to qualify, including having your business organized as a C corporation (C-corp).
A ROBS is a very complex transaction, so it’s important to choose a ROBS provider that can help you through the process. Guidant can offer you expert advice to help you make a decision.
ROBS Pros & Cons
|Access your retirement funds tax-free and penalty-free||Risk of losing retirement funds if the business fails|
|No time in business requirement||Must be a C-corp to qualify|
|Allows for debt-free funding of business for higher monthly cash flows||Must maintain annual requirements to avoid taxes and penalties|
A credit card is a quick way to get funding for your business. Because you may not be able to get business credit early on, using a personal credit card for business may be the best option.
Be sure not to mix your personal and business expenses on any card you use. Credit cards are best for smaller purchases that can be paid off in a short period. If you can use a card with a low introductory rate, you may be able to pay off the balance before the rate increases. If you need a large sum of money, you’re better off considering other options on this list with low or no interest charged.
Chase Ink Business Unlimited ® is a great choice if you’re considering a credit card. It is our best small business credit card, thanks to a great introductory bonus and ongoing rewards. If you want more information on that card, our full review of the Chase Ink Business Unlimited card has more details and information on how to apply.
Credit Card Pros & Cons
|Can be a quick way to access funds for your business||Interest rates can be high after introductory rates expire|
|Good for new businesses that don’t have enough business credit yet||Your personal credit is on the line and can be damaged if payments are late|
|Ongoing rewards can help your business save money or earn bonuses||Credit limits are usually very low compared to loans and lines of credit|
If you have available equity in your primary residence, you may be able to take out a home equity loan (HEL) or a home equity line of credit (HELOC) to help fund your business.
While both types of financing use the equity in your home, they have slight differences. Compare the two in the table below.
Lump sum disbursement
Borrow money only as you need it
Fixed interest rate
Variable interest rate based on the prime rate
Cannot borrow money as it is being repaid
As you pay back the money, it can be borrowed again, like a credit card
Fully amortized repayment period of up to 30 years
Usually, a draw period of up to 10 years, followed by a renewal or repayment period
Best for large and one-time expenses where a lump sum of money is needed upfront
Best for smaller, recurring expenses
The interest rate on an HEL or HELOC will be lower than a credit card, with larger amounts of money available depending on the equity in your home. In addition, there is no restriction on how you use the funds.
However, taking out a mortgage to fund your business puts your home at risk if the business fails. Also, to qualify for an HEL or HELOC, you will need strong personal credit, with a FICO score of at least 700 usually required. If you’re interested in an HEL or HELOC, the best place to start your loan search is at the bank that holds the primary mortgage on your home or where you do your personal banking.
HEL and HELOC Pros & Cons
|Less expensive than other financing options||Tied to homeownership|
|Available for startups||Your home is at risk if you default|
|No restrictions on how funds are used||Requires strong personal credit to qualify|
Because new businesses might not be able to get a small business loan, you may have to take out a personal loan to fund your business. You can often receive funds the same day you are approved, and no collateral is required with an unsecured personal loan. However, unsecured loans will have a higher interest rate.
As long as you have a strong personal credit score, you should qualify. Personal loans are often larger than credit card limits but will likely be smaller than HELs or HELOCs. Again, your local bank is a good place to start for personal loans. Otherwise, our buyer’s guide on the best personal loans for business funding can help you find a provider.
Personal Loan Pros & Cons
|Startups can get funding by using personal credit before business credit is established||Personal credit is at risk if the loan isn’t repaid|
|Funding can be received in the same day||Loan amounts can be small|
|Unsecured loans do not require collateral||Tax issues may arise|
Your friends and family may sometimes be willing to lend you money. They can also invest in your business in exchange for an ownership share. However, while borrowing from friends and family may be a tempting option, it’s important to consider the implications this can have on your personal relationships, especially if the business fails. Loans from family and friends should include an agreement with terms and conditions established on repayment of monies borrowed.
Family and Friends Loans Pros & Cons
|Can borrow money even with poor credit||Can get unwanted business advice from family or friends|
|Funding may be available quickly||Potentially unrealistic business valuations and return on investment|
|Flexible loan repayment can be set up||Selling business shares to family or friends may require them to be liable for future financing applications|
If you have money set aside in a savings account or investment portfolio, you can finance your business without any debt. You can do this either as your personal loan to the business or, preferably, an equity contribution. While using personal cash is a low-risk way to fund your business, make sure you maintain enough in your savings account to cover any unexpected personal expenses that may arise.
Personal Savings Pros & Cons
|Should be able to access funds same-day||Putting personal savings at risk in your business|
|No obligation to pay back funds right away||Amount of funds available limited to what you have in savings|
|Flexible loan repayment if it is structured as a loan||Can cause tax issues depending on if it is a loan or an equity contribution|
Step 3: Transfer Personal Funds Into Your Account
Once you put your personal money into your business, you can classify it as either equity or a loan. Most business owners will list this transaction as equity, meaning the funds are a contribution and that the business doesn’t owe you repayment. This transaction means that you’re investing in the business’s future success in return for an increased equity stake.
How you record the transaction will determine the accounting process and how you receive money back from the business later. Ensure you keep fully documented proper records of this transaction, so your balance sheet and taxes are accurate.
Step 4: Record the Transaction Properly in Your Accounting Software
We highly recommend that you have accounting software that tracks your business expenses and that you take steps to update all expenses and revenue consistently. These bookkeeping tips help ensure your business finances are managed and tracked properly.
Our evaluation of the best small business accounting software will help you find the solution that best fits your business needs. QuickBooks Online is an excellent option because of its strong feature set and ability to create classes and locations for tracking income and expenses. In our case study, it excelled in inventory accounting, bank account management, invoicing, bill management, and reporting.
What To Consider When Putting Personal Money Into Your Business
Before deciding on whether to put personal money into your business, you should consult with both a personal and business financial advisor to discuss the pros and cons. While it can be a beneficial way to support your new business financially, it can put your personal credit, savings, or retirement funds at risk.
Risk of Using Personal Assets
While most entrepreneurs believe their business concept will succeed with certainty, nearly half of all new businesses cease to exist within five years. If the business fails, the owner could lose any savings, retirement funds, or other personal assets that they have put into the business. We recommend developing a business plan that includes details on how much money you’ll need to fund your business and the sources of those funds.
Business Legal Structure
A business can be organized as one of many business structures, such as a corporation, limited liability company (LLC), partnership, or sole proprietorship. The advantage of LLCs and corporations is that they protect the business owner from personal liability for the obligations of the business.
It’s more difficult to move personal money into a corporation due to the formalities that need to be followed (such as issuing shares of stock), so an LLC may be a better entity. Regardless, you’ll need a corporate structure should you choose to get a small business loan.
Tax Considerations for Making an Equity Contribution
There are other things to remember when using personal money in your business. Neither recording the transaction as equity nor a personal loan to the business allows you to take your investment as a deduction on your personal taxes. However, there are tax advantages that the company may receive when the company pays you interest on the loan, or you sell your ownership interest in the business.
If you contribute to your business as an investment, then you just need to see to it that the business properly accounts for your money in this way. This is to ensure you’re properly compensated if the business is sold, you cash out your ownership, or the business pays dividends to its owners. Any money you receive due to your ownership will be reported as income on your personal tax return.
Considerations for Structuring Your Investment as a Loan
If you’re lending your business the money, you’ll need to make sure you have the proper paperwork drafted to acknowledge what the business owes you and how the business repays the loan. The business will need to make regular payments, and you’ll have to charge at least a nominal amount of interest to make the transaction legal and to fill out your personal taxes correctly. Any interest payments will show up on your personal taxes as income.
Loans have a tax benefit for the business that a contribution doesn’t provide. Interest on a loan is considered a business expense, which reduces the business’s taxable income. If you’re a sole proprietor and lend money to your business from your savings, the interest deducted on your business return or Schedule C must be reported as income on your personal tax return. In this case, there’s no personal tax benefit.
Pros & Cons of Putting Personal Money Into a Business
|You can access money for your business quickly in most cases, except for ROBS.||Using personal funds for business puts your personal finances and credit at risk.|
|It can allow you to get funding before your business has credit or income to get business financing.||You may be limited by your personal credit and income, or the amount of retirement funds you have.|
|Adding your personal funds to your business makes you even more committed to the success of the business.||There can be tax implications when lending money or buying shares of your business.|
Putting personal money into your business can allow your company to grow while it builds business credit and income. Since startups often cannot get funding, personal funds can help overcome startup financing challenges. Once your business builds its credit and revenue, you can get future financing in the business name. However, using personal funds can put your personal credit and retirement funds at risk. Be sure to consult with your financial advisor to help guide you through the process to reduce risk and eliminate potential tax issues.