If your business is struggling to make it to the next level or has some cash flow issues, injecting some of your own cash can help solve your problems. You don’t have to go through a complicated loan process or wonder if your credit is good enough.
But lending money to your business isn’t as simple as writing a check. It’s essential that you do it the right way and consider what might happen if your business can’t pay you back. Here are five things to think about before acting as a creditor to your own company.
1. Know the difference between a loan and an investment
Investing your own money into your business is common among small business owners. Your investment would be considered owner’s equity, and neither you nor the business will have to worry about explaining the transaction.
What’s more, you can withdraw the cash at any time without any tax implications. At the same time, you may lose some or all of your equity if your business fails.
With a loan to your business, it may require more paperwork, and you may have to work with a tax professional to do it right. But you can also write up the loan agreement to protect your personal interests.
2. Make it official
Without the proper paperwork, it can be difficult to explain what happened to the IRS in the event of an audit, or to future investors and lenders who might question the loan.
As such, it’s generally a good idea to draw up a contract, potentially with the help of an attorney, to make sure the loan and its terms are official. In other words, treat the transaction like any creditor would, despite your standing as the business owner. It needs to be clear that the loan is a binding agreement.
3. Learn about tax implications
Depending on how your business is structured, it could affect you when you file your taxes for the year. For example, a loan could increase your basis in the company.
An increased basis could increase how much you’re personally liable if the company goes under or affect your ability to take losses from the business.
Also, you may need to claim interest, paid or unpaid, as income on your tax return. As a result, it’s crucial that you speak with a tax professional before drawing up the loan to find out exactly how it will affect your taxes and whether you should limit how much you loan your business.
4. Consider making it secured
Whether or not you’re certain things will work out, it may be worth requiring collateral on the loan, such as some of your business’ inventory or equipment.
That way, if your company can’t pay you back or it fails, you can lay claim to some of the company’s assets to get some or all of your money back.
5. Think about other loan options
Lending money to your business can get complicated fast. So, if your business has been around for a while or you have a decent personal credit history, it may be worth looking into other funding options first.
For example, a business credit card can help you cover some of your operating expenses as you work through cash flow problems. Some cards even offer an introductory 0% APR promotion, allowing you to finance a large expense over time interest-free.
Another option is a small business loan. While these have been historically difficult to get if your business is new or you don’t have a lot of revenue, many online lenders offer loans to business owners who don’t meet the standard requirements.
Alternatively, U.S. Small Business Administration (SBA) loans could be a good option if you have good personal credit and don’t need the money soon.
The bottom line
There are several ways to get capital for your business, and lending your own money to your company is just one of them.
But offering your business a loan can get you into trouble if you don’t do it correctly, and it could end up costing you more money in taxes than if you were to classify it as an investment.
It’s also crucial to make sure you consider all of your options to get capital from others before you decide to lend your own money. While it’s not ideal to pay high interest rates on a business credit card or loan, it can be worth it to avoid the headache of making sure you do it right.
This article was originally written on October 26, 2018 and updated on February 1, 2021.