Should You Tap Into Personal Savings to Start a Business?
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Building a business takes money. If you’re starting a brick-and-mortar traditional business, it could take tens of thousands of dollars to get things rolling. If you’re dealing with intensive infrastructure needs, you may need even more — in the realm of hundreds of thousands or millions of dollars. At the other end of the spectrum, you may be able to start a microbusiness for just a few thousand dollars.
In any case, you’ll need to put together some kind of plan to acquire these funds. You could get a loan from a lending institution to cover most of your expenses or you could work with a venture capitalist or angel investor (depending on the type of business you’re starting). You could even try crowdfunding or seeking help from friends and family members.
As a complement to these approaches, or possibly as your exclusive mode of funding, you may consider tapping into your personal savings and investing your own capital. But is this a good idea?
Inherent advantages to using your own capital
There are a few immediate advantages to using your personal savings to build a business. For example:
- Reduced interest. If you take out a loan for the business, you’ll pay an interest rate on the principal. You can avoid this by contributing the money yourself.
- Greater ownership percentage. Accepting funding from VCs or angel investors often means diluting your shares of ownership. You don’t have to do this if you go it alone.
- Faster starting action. Processing loans and formalizing investment deals can take weeks or even months. If you want to get started as quickly as possible, personal funding can help you build that momentum.
However, before you do this, there are some other nuances to consider.
Personal financial impact
Think about the impact that this move is going to have on your personal finances and what it could mean for your future. Generally speaking, the better your financial health and the more savings you have, the less you’ll need to worry about this dimension. For example, if your net worth is $1.7 million, you can contribute $35,000 to your business without much of a concern. But if your entire savings total $35,500 and that $35,000 contribution is going to leave you with $500, you’ll be putting yourself in a bad financial position.
There aren’t many strict rules here, but for most people, it’s important to:
- Maintain a personal emergency fund. Whatever you contribute to the business, you should have at least a few thousand dollars set aside for personal emergencies.
- Avoid tapping into your retirement accounts. Tax-advantaged retirement accounts like 401(k) plans and Roth IRAs have major advantages for long-term savings. You can technically tap into them to withdraw funds, but you should avoid this; not only will you miss out on potential benefits, you may also face a steep tax penalty in doing so. Use these as a measure of last resort.
- Take your debts into consideration. If you’re already in deep personal debt, it may not make sense to funnel your personal savings into a business when there are other financing options.
Before adding your personal funds to the business, spend some time making sure you’re estimating your costs accurately. There are many expenses related to business ownership, including both startup costs and ongoing expenses. If you invest your personal savings of $35,000 into the business, then find out later you need an additional $10,000, or if you need $15,000 a month to keep the business running, you may quickly find yourself in over your head.
Financial leverage and risk
It’s also important to acknowledge the power of financial leverage and the benefits of risk mitigation when getting funding from another source. If you take on a loan or offer partial ownership of the business to another party, you’ll be minimizing your own financial stake — and thus your own financial risk. If an investor contributes $15,000 to your business and you contribute $20,000, if the business goes under, you’ll lose far less 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’ll be personally responsible for repaying it even if the business fails. This is why it’s better to take out a business loan in most situations.
So should you invest your personal savings into a business? Obviously, you wouldn’t be considering this unless you had a top-notch business idea and a formal plan to back it up. If this is the case, your personal investment could be a boon to your business. However, you’ll need to make sure you’re not tapping into your retirement funds, you’re retaining an emergency fund and that the rest of your personal finances are in good health.