How to Lend Money to Your Own Business

How to Lend Money to Your Own Business

How to Lend Money to Your Own Business

If your business is struggling to grow or is going through cash flow issues, injecting some of your own cash from your personal finances can help ease your concerns. Small businesses, entrepreneurs, and startups could avoid having to go through a complicated loan process (while wondering if their credit is good enough to qualify).

However, lending money to your business isn’t as simple as writing a check. You’ll need to follow the right procedures, as well as consider what might happen if your business can’t pay you back. In this article, we’ll discuss what to know before you lend money to your own business, the pros and cons, and what to think about before borrowing from friends and family.

How to Provide a Personal Loan to Your Own Business

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 would generally have to worry about explaining the transaction.

What’s more, you can withdraw the cash at any time — without any tax consequences. 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’s 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. 

Other common ways of funding your business include:

The type of funding you can qualify for depends on your business structure — whether you’re a limited liability company, sole proprietorship, or corporation. A business with any structure can apply for a business credit card, which 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.

Qualifying for small business loans and lines of credit may require being an LLC or corporation. 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 immediately.

For more on qualifying for better funding options, learn how to establish business credit in this guide from Nav.

The Pros and Cons of Lending Money to Your Business

Considerations When Borrowing Money for Your Business From Friends or Family

Getting loan money for your business from friends or family can be a sensitive and complex matter. While it might seem like a convenient option, it’s important to approach it with care to protect your relationships and financial interests. 

Here are some considerations to make when you’re thinking of borrowing money from friends or family to fund your business:

Open communication

  • Start by having a candid and transparent conversation with your friends or family. Clearly explain your business idea, business plan, financial needs, and how you intend to use the borrowed funds.
  • Discuss the terms of the loan, or whether it’s a gift. Make sure everyone is on the same page regarding expectations. 
  • Keep the person agreeing to lend money updated on your business’s progress, especially if there are changes that could impact the loan or repayment plan. Regular communication can foster trust and goodwill.
  • Consult with a lawyer, certified public accountant (CPA), or financial advisor to ensure that the loan agreement is legally sound and protects both parties’ interests. This can help prevent misunderstandings and disputes in the future.

Interest rates and terms

  • Decide whether or not you’ll charge interest on the loan. Charging interest can be important for tax purposes and to compensate the lender for the opportunity cost of their money.
  • Establish a clear repayment plan with specific due dates and consider what happens in case of a missed payment.

Loan documentation

  • Draft a formal loan agreement that includes all the terms and conditions of the loan. Include details such as the loan amount, interest rate (if applicable), repayment schedule, consequences of default, and any collateral, if applicable.
  • Both parties should sign and date the agreement to make it legally binding.

Business plan and projections

  • Provide a well-thought-out business plan and financial projections to demonstrate your ability to repay the loan. This can instill confidence in your ability to manage the borrowed funds effectively.

Consider the impact on relationships

  • Understand that mixing business with personal relationships can be risky. Be prepared for potential strain on your relationship with the lender, especially if the business encounters difficulties or you struggle with repayment.
  • Figure out how much influence the person will have over business decisions ahead of time.

Collateral and guarantees

  • If possible, offer collateral or personal guarantees to secure the loan. This can help mitigate the lender’s risk and potentially lead to more favorable terms.

Alternative funding sources

  • Explore other financing options before turning to friends or family. This includes traditional loans, grants, investors, or crowdfunding. Having multiple options can help you negotiate better terms.

Exit strategy

  • Consider how you will repay the loan if your business does exceptionally well. Discuss whether early repayment is possible without penalties.
  • Remember that borrowing money from friends or family can have both financial and personal implications, so it’s essential to treat it as a serious financial transaction. 

FAQ’s on Businesses Borrowing From Personal Funds

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