In the world of entrepreneurs, paying for business expenses with personal funds is like eating the forbidden fruit. The rule is to maintain a clear divide between business and personal finances. There are extraordinary benefits of building business credit. Business owners can also have crucial consequences for relying on personal assets. Newbies sometimes don’t have a choice.
Banks don’t throw around money like they used to. Funding options for startups may be limited without the right financial profile or backing. That’s why we wanted to explore the option of paying for business expenses with personal funds. We’ll discuss if it’s really as bad as its reputation. You will also learn when personal funds for business is appropriate and what other options you may have.
When Should You Invest Personal Funds in a Business?
When we talk about financing a business with personal funds, most think of money from a savings account. That’s not always the case. Your option could be a personal savings, emergency funds or maybe your investment or retirement assets. It could also be the cash value from a life insurance policy, taking out a second home mortgage or rainy day savings for purchasing the best car insurance.
When we get down to actions more drastic than withdrawing a few grand from your savings account for business funding, it has to make sense. Paying for business expenses with personal funds could make sense when
- The amount of the loan is small
- The interest rate on a personal loan is better than one for a business loan
- Your return on investment for your personal funds is potentially greater by investing in the business
- You can’t get approved for business funding
Amount of Funds the Business Needs
Before taking any funds from your personal assets, you need to know how much money your business needs. There are ways to determine your business financing need like your business plan and financial projections. Make a list of expected expenses for your business like rent or building costs, supplies, equipment, labor costs, etc.
If you’re starting on a shoestring budget, $10,000 may cover your needs. More detailed businesses could need up to $100,000 plus in funds. How much you can dedicate to your business makes a difference in whether you should use personal funds or not. You may also choose to contribute a portion of the investment from personal assets. Partners may contribute the rest or it could be a loan that requires personal contribution like an SBA loan.
Personal Loan vs. Business Loan Interest Rate
Suppose you have solid personal credit history and a decent score in the mid to high 600s. You may not have enough business history to achieve similar credit results. In that case, personal loans may be more accessible and at a better interest rate. That results in you saving money over time. You should also be prepared with a plan to repay the loan. If you don’t know how you will manage the loan, it’s not the option for you.
Return on Investment (ROI)
Just like with expenses, planning for you business will give you insight into the return on investment (ROI) you expect to see. Knowing that information will help you compare and contrast. If your money is sitting in a savings account, you’re most likely collecting more dust money from annual percentage yield. Investment accounts are another story. Review the type of vehicle you’re using in paying for business expenses with personal funds. Dumping the money into your business may give you a better future payoff.
Paying for Business Expenses with Personal Funds is Your Only Option
Gaining access to business financing without a business credit score is tough. If your personal credit is a bit flawed, your options become even more narrow. Using some form of personal funding may be your only option to make your business dreams come true. If you have money put away for a rainy day, retirement, or a dream deferred it’s time to decide if it’s worth the risk.
Pros and Cons of Using Personal Funds to Start and Grow Your Business
Even when being strategic, there are still advantages and disadvantages to using personal funds for business ventures.
- Save money on fees and interest
- Delay debt financing
- No stipulations on how to use funds
- No monthly loan payments
- Business tax benefits
- Could put your personal credit history and score at risk
- Prolongs process of separating business and personal credit
- Could mean depletion of future collateral
- Puts future livelihood at risk
- Possible tax or early withdrawal penalties for investments
How to Handle Tax Deductions When You’ve Used Personal Funds to Pay Expenses
When tax season comes around, following the rule is critical to keep your business and yourself out of trouble. The IRS has specific rules on how to write off business activities and what type qualify. There are two different ways to deduct business expenses. Each business deduction type may apply to personal assets you use to operate.
Tax rules state businesses must capitalize some expenses instead of deducting them. Those capital expenses include startup costs, assets, and improvements. If you’ve used personal assets to start or expand your business, you would include that amount of funding in your capitalization.
Deduction of personal money you invest in the business depends on the amount. With personal loans, you’re only allowed to deduct the interest amount. Let’s say you put 80% of the loan proceeds into the business but use the other 20% toward personal items. In that case, you can only deduct 80% of the loan interest on your tax return. If you use all of the loan for the business, 100% of the interest would be your deduction.
Other Options for Funding Your Business
Not everyone has $25,000-$50,000 sitting around not working for you. Conservative investors will want to protect retirement funds you’ve worked so hard to accumulate. All isn’t lost when it comes to hunting down business money. If you find paying for business expenses with personal funds isn’t the right move for you, try these other funding options.
- Traditional Loan
- SBA Loan
- Purchase Order Financing
- Accounts Receivables Financing
- Peer-to-Peer Lending
- Equipment financing
Before making any solid decisions about your business funding, you should get advice from a credit expert like LenCred. A good credit expert can evaluate your situation to recommend the best channels to get startup funds or working capital while building business credit. They can also advise you on how and where to apply for business loans and credit cards.