More and more business owners are personally financing their businesses. For those looking to self-finance, we—with some backup from small biz experts Stephen Key and Emily Chase Smith—want to share some advantages and disadvantages to keep in mind when asking, “Should I use my own money to fund my business?”
Fund My Business: The Advantages and Disadvantages of Own Funds
Pro: You Will Run a Better Business
“If you’ve got your own money on the line, you’re going to look at your business very differently, both in the beginning when you’re asking yourself how to fund my business, and down the road,” says Stephen Key, author of One Simple Idea for Startups and Entrepreneurs. You’re going to want to really do your due diligence to make sure you can minimize the risk of losing your money. “You’re going to plan differently,” says Key. “It becomes all about planning, all about homework, and all about having a solid business plan.” You will run a smarter and better company as a result. And all the rewards will be yours, not the bank.
Pro: One of the Top Owner’s Funds Benefits – It’s Your Business, Your Way
What’s one of the greatest joys of financing your own business? “You have complete control,” says Smith. “You’re not beholden to anybody but yourself. You don’t have investors looking over your shoulders asking for specific returns. You decide how the money is being used. You decide how fast you’re looking for a return.” This is one of the big reasons so many entrepreneurs—as our survey shows—do decide to go the route of self-financing and have business expenses paid with personal funds. It’s a reason that’s awfully hard to argue with.
These pros and cons should hopefully help guide your decision to either self-finance or go with a commercial loan. Regardless of which source of finance you choose, it’s worth remembering some advice Smith shared with us: “No matter where you get your money from, you have to take a long term perspective and acquire some financial savvy to be a successful business owner.”
Con: The Risk of Personal Debt and Bankruptcy
When we think of small biz owners whose business expenses are paid with personal funds, we tend to think of retirement accounts or savings nest eggs. Using funds in retirement accounts can negatively impact business owners in the short term and in the long term. Tapping into these accounts early means business owners may have to pay a penalty fee, as well as taxes on the amount withdrawn. And using these funds may mean not being able to retire when initially planned.
In addition to using their retirement accounts, many small business owners also use personal credits card or line of credits. That’s where Emily Chase Smith, author of The Financially Savvy Entrepreneur, says many entrepreneurs get in trouble. “A lot of small business owners are taking on debt on the personal side. Let’s say they’re taking on a line of credit for their business with the bank. They have to then personally guarantee that money,” says Smith. What’s the risk of that? “If the business goes under, then the entrepreneur will either spend the next decade paying it off on the personal side or need to file for personal bankruptcy.” Those are two undesirable outcomes you need to be sure you can live with.
Con: Your Money Might Not Be Enough
Strangely, success is one of the worst things that can happen to a self-financed entrepreneur. Say you used $10,000 of savings to start your company and develop a product. Suddenly Target wants to place a gigantic order. You now must have to deliver that order. And you won’t see any money from it until 90 days after delivery. Guess what? You can’t afford to give Target what they want.
Key cautions against business expenses paid with personal funds, “If you’re going to be successful, you’re going to need a lot of capital. The whole dilemma of cash flow comes up real quick,” says Key. A bank loan can give you more financial room for potential success. A dip into your savings could see your quick start meet a quick dead end. Smith drives that point home very clearly: “You could have the world’s best business idea, you can be smart, you can be a serious hustler, but if you run out of cash? Your business is gone. No cash, no business.”
Fund My Business: Alternatives to Business Expenses Paid With Personal Funds
Of course, not every small business owner has the means or the desire to self-fund their business—and, fortunately, there are a number of alternatives. Here are several to consider.
Depending on the type of business you’re starting and your personal and professional background, you may qualify for a bank or credit union loan to fund your startup. Banks generally require a significant amount of proof that you’re a well-qualified borrower, such as seeing a comprehensive business plan, financial projections for up to five years, previous tax returns, and financial statements. They may require you to pledge personal collateral in case the business plan fails.
If you don’t qualify for a traditional bank loan, you may be able to get a business loan guaranteed by the Small Business Administration (SBA). Banks that offer SBA-backed loans can help you determine if you qualify.
From Kickstarter to Indiegogo, online crowdfunding platforms can make it easy to showcase your business plans and solicit financial backing from individuals around the country or world who are excited or passionate about what you’re doing. These are generally financial gifts, meaning you don’t technically have to pay your “backers” back if your business doesn’t succeed.
However, most backers expect something in return for their gift—such as free products or services once the business is off the ground. (And they will likely be upset if you don’t wholeheartedly pursue your business or your plans fail.)
You might be able to find an affluent individual who is passionate about your business concept and wants to help you succeed—such as someone who’s already running a business in your industry or a related industry. An “angel” investor not only can provide startup funding—generally in return for equity in your company—but also may potentially give you valuable business insight and guidance (assuming you need it).
VCs are generally looking to make equity investments in startups that they think will grow significantly and provide them with a healthy return on investment, or ROI, within a certain time frame. The potential drawback, of course, is that they may want to exert some control over your business operations in order to help you achieve the growth they’re looking for.
While self-funding your small business can provide motivation and the pride of building a business without outside help, it’s not the best route for everyone. Make sure to consider all your funding options carefully and choose the one that makes the most sense for you.
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