Establishing a company requires an initial investment. Discover how to finance your own company and how to approach friends and family for a loan.
What you’ll discover:
What are the benefits and drawbacks of establishing a company with your own money?
How much money should I have saved up before beginning a business?
What are the advantages of borrowing money to start a company from friends or family?
What are some safeguards I can put in place to protect my friends, family, and myself while borrowing money for my business?
Establishing a new company takes a lot of time, effort, and, of course, money. It is vital to have adequate money to get your new enterprise started. So where is the money going to come from? Will you self-fund from your savings account if obtaining a bank loan is out of the question, or if it will not cover all of your initial costs? Will you enlist the help of family and friends? Continue reading for legal concerns and practical advice on self-financing a company endeavor using personal savings or loans from family and friends.
Table of Contents
What are the benefits and drawbacks of establishing a company with your own money?
Let’s start with the benefits. When you self-fund, you are more likely to manage a more efficient and effective business since you are financially invested in its success. You are more likely to thoroughly assess the financial risk at each stage of the process. You will also have ultimate control over your company. You retain the earnings without having to worry about investors seeking a return on their investment.
Let us now consider some downsides. For starters, you may not have enough money to completely support your firm. Assume you have enough money to design and produce a product for sale. Finally, after your concept has taken off, you get an order for 1,000 units. You may be stranded if you do not have the money to self-fund the manufacturing side of such a huge order, and your firm may suffer as a result.
If you rush to find the missing assets and withdraw monies from your retirement account to support your company, you may incur fines and extra taxes. Spending your own money may also imply diminishing your savings, which may result in personal difficulties down the future.
How much money should I have saved up before beginning a business?
If you decide to self-finance your firm, you should accumulate several months’ worth of spending for both personal and commercial needs. The number of months you need save is determined by your monthly costs and the sort of company you are establishing. Putting numbers on paper may help you understand the big picture of your finances, both short and long term.
Consider how much it takes to cover your monthly personal expenditures when choosing how much money to save. In a Personal Financial Statement, it might be useful to mention costs such as:
Rent or purchase?
Utilities.
Insurance and groceries.
Gas and a car.
Consider your essential company expenditures and record them on a Business Financial Statement. Depending on your industry, this might include:
Rent
Employee compensation.
Supplies for the office.
Manufacturing.
Distribution.
Security.
IT development expenses.
Income taxes are paid quarterly.
Taxes on self-employment.
Next, consider if you have supplementary revenue that can support the start of your firm. For example, your spouse’s salary might cover the majority or all of your monthly costs. You might also keep working full-time or part-time while launching your new company. This revenue may offset some of your startup expenses and influence how much you need to save.
What are the advantages of borrowing money to start a company from friends or family?
If utilizing your own money is not a possibility, or if you need more cash than you have, borrowing money from friends or relatives may be a choice.
Borrowing from friends and relatives may be less difficult than receiving a bank loan, but there may be some conditions attached. You may not have to qualify for the loan or deal with piles of paperwork like bank applications and loan documentation. Moreover, you may be able to acquire a cheaper interest rate and greater flexibility from relatives and friends than from a lending organization. You may not have to provide any collateral, like you would with a bank loan.
Yet, borrowing from family and friends has drawbacks. Combining personal and professional interactions may lead to strained relationships. It is critical to analyze your connection with the person from whom you want a loan. Personal concerns might arise if things do not work out, and legal disputes can become emotionally charged and nasty.
What are some safeguards I can put in place to protect my friends, family, and myself while borrowing money for my business?
While borrowing from relatives and friends is often an informal transaction, it should nonetheless be formalized. You may wish to draft a Loan Agreement to formalize the terms. The written agreement should contain the loan amount, interest rate, loan period, and payback conditions. It may also contain rules for what happens if payments are missing. A written agreement establishes expectations and duties for all parties involved.
When approaching friends or relatives for a loan, be prepared to demonstrate them your company’s and your personal financial status. If your firm is already up and going, creating a Profit and Loss Form might help you demonstrate its health. Together with your financials, you may want to provide them a Business Plan that illustrates how the company works. If you’re just getting started, show them what kind of company you’re establishing, your marketing strategy, sales plan, and other important aspects of beginning a business.
Lastly, as an alternative to taking out a loan or paying interest, you can consider giving your family and friends a stake in your company. This may be done with membership interests if your firm is a limited liability company, or with equity if it is a corporation. With this method, your friends and family will participate in the company’s earnings and losses and will have a vested stake in its success.
