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Building a business costs money. If you’re starting a traditional brick and mortar business, it can cost tens of thousands of dollars to get things rolling. When you’re dealing with an intensive infrastructure need, you may need even more – in the hundreds of thousands or millions of dollars. On the other end of the spectrum, you can potentially start a micro business for as little as a few thousand dollars.
In either case, you need to put together a plan to acquire these funds. You can take out a loan from a financial institution to cover most of your expenses, or you can work with a venture capitalist or angel investor (depending on the type of business you are starting). You could even try crowdfunding or seek help from friends and family.
As a complement to these approaches, or possibly as your only form of financing, you can consider tapping into your personal savings and investing your own capital. But is that a good idea?
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Inherent Benefits of Using Your Own Capital
There are some immediate benefits to using your personal savings to build a business. For example:
- Reduced interest. When you take out a loan for the company, you pay an interest rate on the principal. You can avoid this by depositing the money yourself.
- Higher ownership share. Accepting funding from VCs or angel investors often dilutes your ownership interests. You don’t have to do this if you are doing it on your own.
- Faster start action. Processing loans and formalizing investment agreements can take weeks or even months. If you want to get started as soon as possible, personal financing can help you build that momentum.
Before doing this, however, there are a few other nuances that you need to consider.
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Personal financial impact
Think about the impact this step will have on your personal finances and what it could mean for your future. In general, the better your financial health and the more savings you have, the less you need to worry about this dimension. For example, if your net worth is $ 1.7 million, you can safely add $ 35,000 to your business. But if your total savings are $ 35,500, and that $ 35,000 contribution leaves you $ 500, you’re going to be in dire financial straits.
There aren’t many strict rules here, but what matters to most people is:
- Keep a personal emergency fund. Whatever you’re doing to the business, you should set aside at least a few thousand dollars for personal emergencies.
- Avoid tapping into your retirement accounts. Tax-privileged retirement accounts like 401 (k) plans and Roth IRAs have great advantages for long-term savings. You can technically tap into them to withdraw funds, but you should avoid doing that. Not only are you missing out on potential benefits, but you can also face a heavy tax penalty. Use this as a last resort.
- Take your debt into account. If you are already heavily in debt, it may not make sense to invest your personal savings in a business when there are other funding options.
Before putting your personal money into the company, it is a good idea to spend some time evaluating your costs. There are many expenses related to business participation, including both startup expenses and ongoing expenses. If you invest your $ 35,000 personal savings in the business and later find that you need an additional $ 10,000, or if you need $ 15,000 per month to keep the business going, you will quickly become overwhelmed.
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Financial leverage and risk
It is also important to recognize the power of financial leverage and the benefits of reducing risk when receiving funding from any other source. When you take out a loan or offer it to another partner in the company, you are minimizing your own financial share – and with it your own financial risk. If an investor brings $ 15,000 into your business and you contribute $ 20,000, you will lose far less if the company goes down than if you had invested the full $ 35,000 yourself.
The only caveat to keep in mind here is that if you take out a personal loan, you will be personally responsible for the repayment even if the business fails. Because of this, in most situations it is better to take out a business loan.
So, should you invest your personal savings in a business? Obviously, unless you had a prime business idea and a formal plan to back it up, you wouldn’t consider this. If so, your personal investment could be a boon to your business. However, you need to make sure that you are not tapping into your retirement savings, keeping an emergency fund, and that the rest of your personal finances are in good health.