How Financing Your Small Business Can Lead to Issues Down the Road
By Dipendra Bhatta, Last updated: 2022-09-01 (originally published on 2022-07-29)
Every business needs capital — not just to get up and running, but also to sustain the company until it starts generating significant revenue. Traditionally, seeking business loans or venture capital investors are the main options. However, these processes can take a long time and you may have to pitch multiple times before gaining any funding. When you’re enthusiastic about your start-up, this delay can be frustrating. As such, you might be tempted to utilize your personal finances to initially fund operations.
While this can seem like a good solution, it can lead to issues for both yourself and the business in the future. Let’s take a look at some of the things you need to consider before committing to financing your small business yourself.
It Can Leave You Exposed to Risks
If you’re funneling personal capital into your business, you could be exposing yourself to serious financial risks — beyond all the other risks you already have to take as an entrepreneur. In all likelihood, you’re doing so with the full expectation of being able to receive some or more of your outlay back in due course. However, this return on your investment is far from guaranteed.
When financial institutions and investors take on similar risks, the personnel providing them aren’t likely to suffer if they don’t see a return in the short term. If your business fails and you’ve financed it on your own, you and your family may be significantly worse off as a result of the fallout.
Financing your own business can also leave you at the risk of taking on more personal debt. In many cases, it’s quicker and easier to get personal loans than it is to secure business loans. Your decision to direct your cash or savings toward your business may cause you to rely on those forms of debt for your personal finances. This is a stressful and unreliable way of operating and can result in lasting damage to your finances, such as harming your credit score.
It’s Not a Sustainable Option
Unless you’re independently wealthy, it’s important to recognize that financing your startup with personal funds is not a long-term solution. You may be relatively confident if you have enough liquid assets to buy some essential equipment, pay a few months’ property rent, and maybe keep a couple of employees hired for a short time.
This puts a lot of pressure on you to make quick profits to maintain momentum. In reality, it can take years for your company to become profitable.
As such, it’s vital to consider how your plans for the company within the first couple of years might impact your financing. While growth is positive for your company, it can also take significant initial capital. Without reliable sources of long-term financing in place, you may struggle to keep up with the growing needs of your business.
It Can Put Your Employees in a Precarious Position
Whether you’ve found a single freelancer or cultivated a team of full-time workers, your employees rely on you for correct and prompt payment. Not only that, but they rightly expect you to be able to provide them with the resources they need to perform effectively. Financing your company with personal funds can lead to a situation in which you’re unable to keep up with these responsibilities.
You should also consider how taking on new employees can involve varied financial obligations depending on your industry. For instance, effectively onboarding new hires in construction requires extensive resources and planning to result in potential profitability. You need to arrange the paperwork to protect the company from liability in the event of accidents, provide clear hazard and compliance training, and ensure access to good quality communication equipment.
However, you’ll have different obligations if you operate a remote business. You may not have to train employees to ensure they’re safe on job sites, but you will likely have to pay for computers and other equipment so employees can work from home — and be willing to cover the cost of replacements should any of those tools fail.
Simply put, you have to consider the unique needs of your industry and business. This will help you understand the true financial needs of your organization and whether you have the means to support it without putting your employees in an unstable or even unsafe position.
It Isn’t Your Only Option
There are various reasons self-financing your business can lead to issues. However, one of the most important considerations is that it’s not your only option. Even if you’ve been unable to secure a traditional business loan or find investors, you don’t necessarily have to take the risk of dipping into your own funds.
One approach is to create a funding model for your business that is more attractive to finance providers. Hybrid financing is a method combining the risks of debt with the advantages of equity for potential investors. This essentially reassures those providing capital that they’re more likely to see at least a portion of their funding back as debt repayments.
It’s also worth exploring the potential for crowdfunding or a range of microloans. These methods ask for less of a lump sum from a single investor. Instead, you’re asking multiple people to provide smaller amounts. This can be particularly effective if you’re financing specific projects within your small business or you already have a significant social media following.
Financing your small business with personal funds may seem like a good idea, but there can be pitfalls. It can expose you to additional financial risks and can be difficult to sustain long-term. You may also put employees that rely on you in a difficult and uncertain position. It’s important to first take full stock of the alternative options available to you, such as hybrid financing or crowdfunding. With some patience and good planning, you can take your exciting business concept on the road to success.