Securing investment dollars is often the number one priority for entrepreneurs when starting a business. Many will seek outside support—angel investors, personal investors, venture capitalists, and peer-to-peer lenders generally top the list. However, each “type” of investor brings a different level of risk — and, let’s be honest, not all businesses are attractive to investors.
You may need to fund the enterprise on your own. This presents the question—how much of your personal money should you put into your own business?
Pros and cons of using your own money for startup costs
One major drawback to this source of funding can be an over-reliance on your own cash. Few people have deep enough pockets to fund a business beyond launch. And there are often many unexpected expenses in the early stages of a new venture.
Office space, equipment, software, and talent are the most obvious, but you’ll also need tax help, general counsel, and marketing (among other services) to get operations off the ground. Your own personal funds will get you only so far.
However, sinking your own hard-earned money into a business can raise the stakes for you on a personal level. You have a vested interest in its success, which can provide you with the drive needed to overcome challenges and establish strong relationships with customers, vendors, suppliers, and so on.
Personal funding is also the quickest investment source — not to mention that you’ll improve your return on investment once you become profitable. Fewer financing fees and lower principal on any startup loans mean more money back to you and your business.
Calculating a realistic personal investment
Unfortunately, that number will be different from one person to the next, and it’s not always as straightforward of an answer as one would hope. There will be more than a few nuances at play in determining what level of upfront investment you’ll want to make toward your business.
Here’s how to approach the calculation:
1. Consider the personal financial implications
Though this should go without saying, it’s still worth mentioning the potential impact of investing personal funds into a new business. Take a realistic look at your own personal financial health. What sort of financial position will an investment put you in? Will you have enough money left in your accounts for personal emergencies? What’s your level of debt?
While the option of tapping into your 401(k) or Roth IRA is tempting, it’s not advisable. The tax penalty alone should be reason enough not to go this route. It also means you’ll miss out on the benefits associated with retirement accounts. To get a better idea of the potential effects on your finances, it may be wise to talk through your options with a wealth management consultant.
2. Conduct a cost estimation
Business ownership comes with many expenses — both startup and ongoing — making it crucial for you to arrive at an accurate cost estimation. Work up a detailed list of all necessary expenses. This may include things like rent, inventory, marketing, utilities, employee salaries, and so on.
Once you’ve compiled a list, you have the start of an expense budget and can begin to forecast your expected costs. Some expenses will be easier to determine than others, as you can request quotes from service professionals, third-party vendors, and so on. There will be expenses that require estimations. You can either consult with other business owners or review industry benchmarks to arrive at a sensible number.
Don’t forget to factor in a personal financial “cushion” should things go wrong or the business takes longer to gain traction than anticipated. Most financial experts will tell you to put away enough money to cover at least six months of personal expenses — regardless of whether you’re running your own business or working a more traditional nine-to-five.
3. Put yourself on the payroll
The biggest mistake you can make as a business owner is to treat your business as a retirement asset. There are no guarantees that someone else will want to buy your business or that it’ll be enough of a success for you to exit when the time comes to retire. Consider yourself an employee at the start with many of the same perks and benefits as other team members.
You’ll need to make some allowances in the early stages of the business. As time goes by, work in benefits such as a personal savings vehicle. It can be a solo 401(k), Roth IRA, SEP IRA, or traditional IRA.
Each will have its own benefits and limitations for contributions. You may want to connect with a wealth management consultant to arrive at the ideal solution for your own personal situation.
4. Weigh the potential risk versus the financial rewards
We’ve yet to factor in the potential of investments outside of the business owner. This should be part of the equation when determining how much to personally invest. Taking money from other sources can certainly minimize the personal financial risk, but it can also reduce the financial leverage you’ll possess with your own company.
Let’s say, for example, you secure an investment of $10,000 and contribute the same amount in personal funds. While you minimize the financial risk, you also minimize both the control of the company and the financial rewards it can provide. Mind you, this scenario doesn’t account for the various stipulations found in legal agreements between business owners and investors — but that’s a story for a different day.
Where you may begin to complicate matters on a financial level is when taking out a personal loan to fund a new business. You will be on the hook to repay that loan and any interest whether the business is a success or not.
Most of the time, a business loan is a much better option, which does come with certain stipulations itself. Lenders will require a business plan, an explanation of how you intend to use the funds, and some indication of your ability to repay.
Find the right funding mix for your business
Investing in your own business makes good business sense on many fronts, and the best course of action is often to use some of your own personal funds with those from outside sources. After you understand exactly how much it will cost to launch and run the business, you’ll get a better feeling of what you’re comfortable with in terms of personal investment.
Just remember to expect the unexpected, especially in today’s environment. You always want enough money to live — and just as much to keep your business’s lights on.