With business startup finance, there is a standard model that is commonly used when starting a company. This is:
- Write a business plan
- Show the business plan to banks and/or prospective investors
- Receive financing for the business idea
- Start the business
This model is the most traditional and, some would argue, preferable. However, it is not without its flaws.
The problems with the traditional startup financing model
- The biggest issue people tend to experience with the conventional method of startup financing is convincing investors that their business plan is viable. Investors tend to be cautious, especially with inexperienced prospective entrepreneurs, and may be unwilling to lend the full amount entrepreneurs feel they need – or simply unwilling to lend at all.
- As noted above, experience is also crucial when seeking to pursue the conventional method of startup funding. An entrepreneur may have a fantastic idea for a wonderful business, but lack the expertise to produce a business plan that reflects their idea well. This makes the conventional route of funding rather intimidating for those who are making their first venture into the world of business.
- Small endeavors, such as a side hustle, often require too little in terms of startup financing for banks or investors to be willing to lend. For example, if an entrepreneur only needs $500 to get started, they will usually be refused, as there is too little scope for profit for the lenders.
- Finally, the standard financing approach also means that a business begins its life either in debt, as investment is arranged on the basis it will have to be repaid, or with the entrepreneur ceding control in terms of shares. Neither scenario is ideal.
As a result of the problems noted above, some entrepreneurs choose to explore other options – and the most common of these is investing personally in their business.
How does personal investment in a startup work?
The concept is very simple, which perhaps goes some way to explaining its popularity. Rather than seeking external investment from a bank or an investor, the prospective entrepreneur uses their own funds to start the business.
There are a number of benefits to this approach:
- The entrepreneur does not have to write a formal business plan. A business plan should still be written, of course, as it provides a blueprint for the business, but it does not need to be as formal and instructive as the kind of business plan a bank or investor would expect.
- The entrepreneur retains full control of their business, as they do not have to give shares away in exchange for investment.
- This plan is suitable for small businesses and side hustles, as the entrepreneur can supply small funds to the business rather than needing to meet a higher threshold for investment.
Do entrepreneurs just give money to their business, or is it a loan?
This depends entirely on the entrepreneur. Most people who are investing in a side hustle or small lifestyle business idea will just give the money to the business, expecting to recoup their investment either as a wage or in profits. This means that the money does not register as a debt for the business.
For larger businesses, startup funding is sometimes provided as a loan that the business has to repay.
It is best to consult an accountant to see which choice may be best for you if this is a route you wish to pursue.
Is personally investing in a business a good idea?
Frankly, there’s no easy answer to this, as it is entirely dependent on a number of factors. It may be helpful to ask yourself the following questions when deciding if personally investing in your business idea is the right choice for you:
What condition are your personal finances in?
This is the most crucial question, and one that may mean you need to investigate your current personal finances in depth with a number of additional questions:
- Do you have the funds available? Ideally, you should have the funds required for your business available in cash. Many entrepreneurs seek to borrow on a personal credit card to finance their business, but this can be incredibly risky, or even prohibitive if you have a poor credit score.
- What does your existing budget look like? If you can afford to finance your startup costs without impacting your existing budget, this is preferable. However, if your income is limited, actually obtaining the funds required can be troublesome.
- Are you in debt? Many people start small businesses or side hustles to help them get out of debt, so being in debt does not immediately exclude the possibility of financing your own business. However, you need to ensure that your debt is well managed and under control; you could look for loans no credit check to help consolidate debts into a single monthly payment, or speak to your creditors to see if you can agree payment plans that are affordable to you.
Do you intend to keep your day job while starting your business?
Choosing to invest from your personal funds is inadvisable if you will be leaving your day job to start your business. This is because your finances will take a double-hit with this course of action; the loss of an income, and then the extra expenditure on startup costs. If you’re going to invest your personal funds into your business, it may be preferable to keep your day job – at least initially – to ensure your financial security is well-protected.
Can you afford for the business to fail?
If the money you invest into your business were to vanish due to the business failing, how would that impact your finances? Some entrepreneurs believe in their business so much that they invest their life or retirement savings into their company, only for the business to fail to thrive. This is extremely perilous, so it’s usually best to only invest as much as you can afford to lose.
Are you willing to keep diligent records?
If you do invest your personal funds into your business, your record-keeping will need to be incredibly accurate, so you can be sure that your business is actually generating profits. Some entrepreneurs can fall into a trap of continually investing money in their business, which makes the business finances seem healthy, but in fact provides a false sense of security – the ‘profits’ are being powered by the investment, not the business itself. To avoid this scenario, you will have to monitor every cent that you invest, so you can be sure you’re able to judge the business’ performance on its own merits.
We hope the above has helped to clarify the major points for consideration when personally investing in your business’ startup costs.
