It’s not unusual for a business to need help with financing – particularly a new or small business. In most cases, these small businesses and entrepreneurs are able to use their own money to finance their businesses or keep them afloat during hard times.
More often than not, businesses will choose to deposit their funds into their business accounts and label it as equity – money that the business does not have to pay back and therefore has no other agreements. Still, in most states, you can mark this contribution as a loan to your small business.
To lend money to your business – at least legally – you’ll need to make sure you have the proper paperwork that acknowledges what your business owes you and how it intends to repay the loan. You’ll need to include all the essentials of what would be included in a normal loan in your loan agreement, such as:
Instead of drafting a loan agreement on your own, it’s recommended that you have an attorney or professional prepare your loan agreement. Once you’ve officially established your loan, you need to ensure that your business actually repays the dept and upholds the terms of your agreement.
While the paperwork alone can be a handful, you have to also consider the effects of loaning money to your business on your taxes. Your business may receive some deductions thanks to loan payments, but you as the owner are still taking credit for the interest earned.
The payments from your business to you will essentially be split between principal and interest – as with any loan. The IRS will consider any interest paid to you as taxable income but the amount paid to the principal will not be considered taxable income.
For your business, the IRS is going to treat your personal loan to your business the same as it would any other small business loan. The loan is not considered taxable income, but the interest paid on your loan does count as a deductible business expense.
Establishing a loan between you and your business can sound like a great idea when your cash flow is slowing down, but the final expense and headache can make it more difficult than it’s worth. Depending on the legal fees and time, you may end up spending more than you were prepared for to ensure your loan is legal.
As with any lender, you also put yourself in a position of financial risk and responsibility. If your business hits hard times, there is a possibility that your loan may never be paid back – taking a hit on your personal finances.
With all the negatives associated with loaning money to your own business, there are almost as many positives. Loaning your own money to your business allows you to avoid a credit check and your cash flow won’t be looked at by a bank.
You also recieve a quick influx of cash for your business and shows investors that you have faith in your business’s success and ability to pay you back.
Still, you should carefully consider which method of adding cash to your business – whether that’s as equity or a loan. Consult with ModVentures today to make the best decision financially for your business.