In the business world, one rule that everyone knows is to keep business and personal finances separate. The reasoning behind this is that there are benefits of building business credit. Also, business owners can have consequences for relying on personal assets.
If you are a startup, funding options may be limited without the right financial profile or backing. This is why people sometimes pay for business expenses with their own personal funds. Read on to find out if it is appropriate for you to use personal funds for business expenses and the other options that are available.
When Should You Invest Personal Funds in a Business?
There are many options available to choose from if you choose to invest using your personal funds. This includes your personal savings, emergency funds, investment or retirement funds.
The following reasons make sense when using personal funds to pay for business expenses.
- The amount of the loan is small
- The interest rate on a personal loan is better than for a business loan
- Your return on investment for your personal funds is greater than investing in the business
- You cannot get approved for business funding
Amount of Funds the Business Needs
Before taking funds from your personal assets, you must know first how much your business actually needs. There are ways to determine what your business financing needs are like your business plan and financial projections. Start by making a list of business expenses that you expect like rent, supplies, equipment, labor costs, etc.
The amount of how much you can dedicate to your business makes a difference whether you should use your personal funds or not. You can also choose to contribute a small amount of the investment from personal assets. Partners may contribute the rest, or it could a loan that requires personal contribution like an SBA loan.
Personal Loan vs Business Loan Interest Rate
Personal loans may be more accessible at a better rate if you have a good personal credit history. This means that over time you will save money. You should also be prepared to repay the loan by having a plan. If you find that you do not know how you will manage the loan, then it is not the option for you.
If your personal credit is poor, then you do not have many options. Sometimes using personal funding may be your only option and take the risk.
Pros and Cons of Using Personal Funds for Your Business
There are some pros and cons that come with using personal funds to start and grow your business.
- Save money on fees and interest
- Delay debt financing
- No stipulations on how to use funds
- No monthly loan payments
- Business tax benefits
- May put your personal credit history and score at risk
- Prolongs process of separating personal credit and business credit
- Possible depletion of future collateral
- Puts future livelihood at risk
- Possible tax or early withdrawal penalties for investments
Handling Tax Deductions When Using Personal Funds to Pay Expenses
The IRS has rules on how you need to write off business activities. There are two ways to deduct business expenses. Each deduction type may apply to personal assets you use to operate.
The tax rules say that businesses need to capitalize some expenses instead of deducting them such as startup costs, assets, and improvements. If you happened to use your personal assets, you need to include that amount of funding in your capitalization.
With personal loans, you are only allowed to deduct the interest amount. If you use all of the loan for the business then you would deduct 100 percent of the interest.