Should You Use Your Own Money for a Small Business Start up?

Making Profit

When you're looking to borrow money for a business lenders will want to see you invest your own money before they put in theirs, but is it better to use it all or borrow more?

A number of factors come into play and you need to consider all your options and your own situation.

With the excitement of going into business you may be only thinking about the now. It is equally important to consider how you will make money from the business. This may sound overly simplistic but for many people what they can earn week-to-week is probably their main or only consideration.

As an owner manager you can expect to make money on a day-to-day basis from the profits, but consider also that you will get a payout when you sell it at some future date. It's therefore wise to take the long-term view on the profitability of your business.

If you are starting a new business from scratch the sales are more difficult to predict so it may be prudent to keep borrowings at a minimum to reduce the pressure on cash flow. It may be that it is preferable to keep the borrowings to a minimum because the overhead position is high if you are paying premium rent and rates for a prime location.

In these cases you may choose to put in as much of your own money as you can to get it off the ground.

When you use your own money you should always consider that it is a direct cost to you, after all you are losing interest and inflation will reduce its value in the long term.

Private investors know and understand the time value of their money.

Look at it this way, what would you choose if you could have £95 today or £100 a year from today? What if you could have £10 today or £100 a year from now. Most people would take the £95 today in the first instance, and the £100 a year from now in the second.

This would be regardless of inflation and it illustrates the time value of money, meaning that money now is inherently more valuable than money later.

If you buy a going concern you know its trading pattern and can therefore make a more informed judgement on what you can expect to earn. Lenders like to know trading history and may offer you higher borrowings than they would for a new start up. However, a change of owner sometimes results in a downturn in trade whilst you 'prove' your self, especially in a business that has been highly successful, and your cash flow forecast should reflect this. To counteract this you could look to use some of your own money to fund the cash flow until trading picks up.

You can keep your ready cash in the bank and although short-term money doesn't get the best interest rates, it will be earning and it is on hand to cover short term shortfalls and be ready for capital purchases as the business grows.

It is also worth serious consideration, in either case, that if the business forecast looks good it is often prudent to borrow as much as possible because of the tax advantage. You will pay more interest on the loan but this will be tax deductible and it could reduce your taxable income.

Over the life of a successful business it has been covering the loan repayments, providing you with drawings and you may also have benefited from year-end profits. The final bonus is if you come to sell it. The balance of the loan will have reduced which means that you will keep more of the sale price, even after capital gains tax. This could be a major part of your return on your investment so you could look at loan repayments as part of your earnings to be recouped at a later date.

Example:

Purchase price: £85,000 Own money: £15,000 Borrowed money from bank: £70,000 over 10 years Running the business for say, 6 years - and making a satisfactory living. The loan is being repaid monthly Sale price £85,000

Loan borrowings remaining, say, £35,000

Surplus £50,000 in your pocket from an investment of £15,000 plus you have had 6 years drawings.

This assumes the business hasn't increased in value, which is unlikely. Even with capital gains tax this example shows how it is possible to make real money on your investment. Even if you don't choose to sell its value to you has increased and is an asset for your family.

Valuing a business

A number of factors come into play when valuing a business.

How profitable the business is and the goodwill, a non-quantifiable series of factors including: reputation, the competition and market forces that contribute to its final value.

When the time comes to sell only you can determine whether the sale price of the business, coupled with what you have been able to make over the lifetime of the business has given you a satisfactory return on your investment and whether it was worth all your hard work.

Important

This advice is to offer you food for thought. It is recommended that you always take advice from an accountant.

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