For most startup business owners, personal savings are most often the only to go to the source of funds at hand. Statistics show that 77% of all small startups in 2018 were funded via personal funds as opposed to 34% financed via bank loans.
It is, therefore, an expected and frequent occurrence to use personal savings to bootstrap a startup. With own money, you will not have to pay back high interest on just right loans nor have to approach unfriendly and impersonal banks for a business loan in the first place.
You will not also have to sit at home fidgeting and counting down hours till the loan is approved, processed and disbursed. All you need to do is withdraw your cash from your account and voila! If you have a sketchy past as far as your credit history is concerned, getting a business loan will be an uphill task. With personal savings at hand, your business idea is good to go, poor credit scores or not.
The dangers of putting personal savings in a business
However, while there are many virtues to using personal savings to finance a business, there are disadvantages as well. A common problem is that while using own money is good no one really tells you the right proportion to put into a business use and how much should be left as savings.
Pouring down all your savings to your business can strain your personal and family financial life since you might not have much left to cover not only emergencies but day to day living expenses. It is paramount therefore to leave your rainy-day fund untouched. If the business goes burst with all your personal savings in it, you could also lose not only your home but all that you and your family own.
However, if done right, personal money in a business can help you stay in control of the business’s finances. A company fully funded through your own savings will keep you on the lead as proprietor, meaning that the business’s profits will fully be yours to enjoy and to plow back into the business as you deem fit. If you are planning to use your money in your business, here are seven steps you can use to do it right and mitigate risk;
1. Separate your bank accounts
It is vital to track and account for all funds in your business so that you can stay on top of what the company owes you. This will also help you understand how much business ownership you have. If personal and business funds are comingled, you will be at risk of both tax and accounting issues.
The first step, therefore, should be a separation of personal accounts from business funding. You can start by creating a legal business entity like an LLC or limited liability company to ensure that you and your household are safe from any poor business decisions or other forms of business liability. If both business and personal finances are mixed up, this protection could be waived in the future costing you an arm and a leg.
A business checking account is essential for business dealings including payments and checks deposits. You can also connect your account and send digital invoices without all the paperwork through Square or Stripe. Opening an account today is easy peasy and can be done under your roof via online banking.
2. Ensure that the business account is well funded
With a business account in place, you need to highlight these two significant cash transactions; one, a withdrawal from your personal account and the second, a deposit to your startup’s account. It is critical to funding the full amount your startup requires at a go, to cut down on the accounting procedures associated with multiple transactions. Once these transactions are done, let them be recorded in your books for future reference.
3. Record your personal money as equity or loan
If you have saved enough bucks to fund your business idea, you, of course, are not only doing it for the passion but for the profits as well. If you are going to plow back your hard-made money into a business ensure that the transaction is recorded correctly for accounting processes. These processes are the cogs that will have move to ensure that your cash has borne fruit and that in due time you hit pay dirt for your contribution in the startup.
Every transaction between your personal account and business account should be thoroughly recorded to keep every legal protection in place. When disbursing your personal money to your business ensure that you have correctly christened it either as a loan or business equity. If you call it business equity, then the company will not be under any obligation to pay you.
5. Debit that cash account
This is an accounting step, and it is done through the creation of an entry in a journal to debit the cash received into the startup’s checking account. The money is debited to highlight the growth of the business account. Once this step is carried out, it will lay the groundwork for any future payments or legal processes that may arise, and that could affect your financial relationship with the business.
6. Credit your capital account
By crediting your capital account, you will have proof of the equity you have injected in your startup. You should do the credit entry to your equity account to offset the entry made to debit your cash account. The listing will mirror each other since they are designed to balance out your balance sheet primarily.
7. Reconcile the cash deposit
With easy to use accounting platforms this step should be easy to do. You can alternatively double check it manually to ensure that it is done tight. Ensure that all the personal money has been added to the previous book’s cash balance. This new balance should be highlighted at the cash line part of your balance sheet’s assets section.
8. Reconcile the personal money deposit to your former equity balance
Again with a good accounting platform, this should be easy to do, but it involves the addition of the deposited cash to your previous account or stock balance. The sum should be featured at the bottom end of your balance sheet at the equity section. This step will help you in the future if you intend to take out your personal money injected into the business.
Tips on using personal savings in business
- Always keep at least $5000k in your own nest egg as personal and business protection. If you need a quick source of cash on a rainy day, this will be where you can turn to. It will help fix all those announced bills or nagging legal or maintenance jobs. This money will also help fund any time-sensitive business opportunities and keep you from making expensive and counterproductive hasty money decisions.
- If you are going to use your 401k savings, be limited about it. You can, for instance, acquire up to 50% of your accounts value, penalty free. Remember that since it is a loan, all interest will need to be paid back to your 401k account to replenish your savings.
- If you are going to use a low-interest card, stagger the expenses into small amounts instead of making one significant expense. Ensure that you steer clear of a balance build up on the card to avoid astronomically hefty interest charges.
The final word
To give money to a business is a virtue but it could leave a bad taste in your mouth if there is no paperwork in place to ensure that your rights and obligations are met by the business. Seek the help of an attorney to protect yourself and ensure that you grow the company well to enable it to pay you back what it owes you.