Putting Personal Money Into a Business in 4 Steps
Tom has 15 years of experience helping small businesses evaluate financing and banking options. He shares this expertise in Fit Small Business’s financing and banking content.
This article is part of a larger series on Business Financing.
Using personal money in your business can address funding needs but can also create unnecessary risk and potential tax consequences if not done correctly. Here are the four steps to follow when using personal funds in your business:
1. Establish a Business Checking Account
One of the most important things a small business owner should do is separate business and personal monies. A business checking account provides a level of protection for your personal assets. Additionally, establishing a legal entity for your business provides additional protection.
If you don’t have a business checking account, Bluevine is one option to consider. A fully online bank, it offers customizable bill pay, charges no overdraft fees, has no minimum balance requirements, and pays 2.0% APY on qualified balances up to $100,000. Its application process is quick as well.
2. Determine the Source of Personal Funds
There are several ways you can use personal money to fund your business. Each of these paths has varying levels of complexity and potential risk, as you’re utilizing your personal assets. When deciding on the best funding option, it helps to make a list of your assets, liabilities, income, likely investors, and your current credit score. You can use our assets and liabilities worksheet to assist. Once you complete the list, evaluate it to determine which option is best for putting personal money into your business.
Rollover for Business Startups
A rollover for business startups (ROBS) allows you to fund your business through your retirement savings without the penalties and taxes that accompany an early withdrawal. It’s a good way for you to use your own money to either start, buy, or recapitalize a business. A ROBS isn’t a loan, which means you don’t need to make a monthly payment.
Typically, you’ll need at least $50,000 saved up in a qualified retirement account to make a ROBS worthwhile, and you should remember that your retirement funds are at risk. Prior to setting up a ROBS, you should be aware of all the tax and legal implications involved. An experienced ROBS provider, such as Guidant, can offer expert advice to help you make an informed decision.
Credit Cards
Using credit cards can be a relatively quick and inexpensive way to get funding. As it may be hard for a startup to get a business credit card initially, you can use a personal credit card for business. Just make sure that you don’t mix personal expenses with business expenses on any credit card that you utilize. Credit cards have relatively low interest rates, allow you to build credit, and offer promotional or rewards programs to qualified borrowers. We recommend checking out our articles on small business credit cards to help you find the best one for your business.
Home Equity Loans
Home equity loans (HEL) and lines of credit are options that work well for business owners who are short on cash but have significant equity in their personal real estate. Both typically offer some of the lowest interest rates of any financing option, with funding often available within a few weeks. Using the equity in your home can be risky, as your house is put up as collateral for the loan. If your business doesn’t succeed, you’ll still need to make payments on borrowed funds.
Personal Loans
Most traditional lenders won’t give loans to new businesses, which leads many business owners to rely on personal loans instead. Funds can be accessed relatively quickly, and no collateral is required for an unsecured personal loan. Business owners with good credit should qualify; however, loan limits tend to be small.
Loans From Family and Friends
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. While borrowing from friends and family may be a tempting option, it’s really 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.
Cash Savings
If you have money set aside in a savings account or investment portfolio, you can finance your business without any debt. This can be done 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.
3. Transfer Personal Funds Into Your Business
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 making an investment in the future success of the business 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. Make sure you keep fully documented proper records of this transaction so your balance sheet and taxes are accurate.
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 on a consistent basis. These bookkeeping tips are helpful for ensuring that your business finances are managed and tracked properly.
We recommend QuickBooks Online as the best choice for small business accounting software because of its strong feature set, including the ability to create classes and locations for tracking income and expenses. In our case study analysis, QuickBooks Online also excelled in inventory accounting, bank account management, invoicing, bill management, and reporting.
What To Consider When Putting Personal Money Into Your Business
While the process of putting personal money into your business isn’t difficult, you can make costly mistakes that could hurt your personal finances overall. It’s a good idea to seek expert advice before using personal money so you don’t hurt your finances or increase your taxes later.
Evaluate the 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. If you haven’t done so already, we recommend developing a robust business plan that includes details on how much money you will need to fund your business and the sources of those funds.
If you have sufficient personal assets to fund your business and also have a reserve for emergency expenses that may arise, using personal assets makes sense.
Which Legal Business Structure Is Right
A business can be organized as one of multiple 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. Note that 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, some type of corporate structure will be needed should you choose to get a small business loan.
Consult a certified public accountant (CPA) or Attorney for Your Best Option: Talking to an accountant or attorney about the best option for your business’s legal structure is a good idea. Both will offer you advice on the potential implications of changing the business structure.
Tax Considerations
There are additional things to keep in mind with using personal money in your business. Neither recording the transaction as equity nor as 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 business may receive when the business pays you interest on the loan or you sell your ownership interest in the business.
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. However, if you lend money to your business from your own savings, the interest that’s deducted on your business return or Schedule C, if you’re a sole proprietor, must be reported as income on your personal tax return, so there’s no personal tax benefit.
Making an Equity Contribution
If you make a contribution to your business as an investment, then you just need to make sure 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 on your personal tax return as income.
Bottom Line
Many entrepreneurs rely on personal funds to finance their businesses as they start up, but when doing so, it’s important to weigh the risks. It’s equally important to follow accounting best practices. Learning how to invest in a business isn’t complicated, but you need to do it correctly to prevent complications, so consulting a legal or tax professional as needed is a good idea.
