Launching a new business almost always carries some element of risk, but when personal assets are being used to finance the business, the risk factor can increase dramatically. With credit markets currently at a virtual standstill, tapping your personal assets to fund your business may seem like a quick and easy way to access the required capital without having to give up part of your business to a venture capitalist or angel.
Those looking to finance their business on their own may find that they have a lot of personal assets available to them: cash savings, personal credit cards, property on which a loan can be taken out, a 401K plan or other retirement account that can be cashed in early, or a life insurance policy that can be used as collateral on a loan.
As mentioned above, while each option may offer easy access to financing, they all come with significant drawbacks that should be carefully considered. Below is a rundown of the pros and cons of each option.
Pros: Cash savings are readily available and, depending on your situation, could be plentiful. There is generally little to no cost in getting access to your cash savings and since this is your own money there are no interest or loan costs to pay either.
Cons: If you are using your savings for a business venture, if your business fails then your savings are gone.
Personal Credit Cards:
Pros: Many small business owners use their personal credit cards for instant short-term financing. If you have a decent credit rating and you know where to look, there are lots of promotional offers still to be had, such as no or low introductory interest rates.. Longer term, you can continue to take new credit cards and look for no interest balance transfers to reduce interest payments on the loan. There is also the possibility of taking on more credit cards to continue to provide funds for your business if you need more money to get off the ground.
Cons: One major drawback of taking on credit card debt is that once the interest free period is up you may be subjected to crippling interest rates nearing 20%. If your business is doing well by this point then this may be fine, but if you pay off only the minimum interest per month you could find yourself sitting on a big mound of debt. Moreover, as you rack up more debt, your debt-to-available credit ratio increases and this can negatively impact your credit rating.
Home Equity Loans:
Pros: Most home-owners have a large amount of capital tied up in their homes that can be accessed by taking out a home equity loan. With such a loan, you can have at your disposal a lot of money for your business, and that can make it a tempting prospect, especially since interest rates are currently at all-time lows. A home equity loan used to be much easier to take out before the credit crunch, but since then with credit harder to come by so has the home equity loan, so bear this in mind.
Cons: Taking out a home equity loan means that if your business fails then you risk losing your home. It goes without saying that the potential financial and emotional costs of this funding option can not be overstated. Secondly, your personal costs with the expenses of this loan will have to be factored into your future monthly business expenses which will effect its early profitability.
Pros: Some people may have the option of removing funds from a 401k or other retirement fund. Many kinds of retirement plans allow for some kind of early withdrawal, and thus they are a possible source of business financing.
Cons: There are several drawbacks to this option. First, early withdrawals from a retirement account generally illicits a hefty fee. Moreover, if your business is not successful then you’ve also lost your retirement nest-egg. Even if your business is profitable, replenishing your retirement fund if you use it will be expensive, and as mentioned above, when starting a business personal and business funds become inseparable, and so this will become an added strain on the business.
Life Insurance Policies:
Pros: A final option is to take out a loan based on your life insurance policy, using the policy as collateral. If you are young and of good health then this could be a viable business financing option for you.
Cons: If your health is suddenly compromised by illness or injury rendering you unfit to work, or if your business is not successful, you can put your insurance policy in jeopardy. This could have dire ramifications for both you and your family.
In short, while personal assets may provide hassle-free access to vital business financing, new business owners should consider their options carefully before putting their assets at risk.