Loan Money or Invest Money to Start Your New Business: Which is Better?

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When you begin a new business you know you’ll be putting money out of pocket to cover your start-up costs. Legal costs, accounting costs, filing fees, licensing, equipment, supplies … the list goes on. How do you account for those costs? You have choices.

Capitalize Everything

To capitalize your start-up costs, you add everything up and then consider the stock (for corporations) or interests (for LLCs and LPs) as repayment for all of the money and assets you’ve put into your business so far. So, if between legal fees, and the value of the equipment and assets you’re putting into the business, you have about $5,000 in up-front costs, you could capitalize at something like 5,000 shares at $1 each, 2,500 shares at $2 each. With interests, it’s a little different, because they are generally issued as a percentage. Your capital contribution would be booked at $5,000, and you would receive 100% of the issued interests, assuming it’s just you.

The downside to this method is that you have to wait to get your money back out. This amount is considered an asset to your business and depreciated gradually, over the first few years in business.

Treat As Shareholder’s Loan

Alternatively, you can document all of those costs as a shareholder’s or member’s loan instead, and have the business pay you back as it earns income. To do this you would prepare a Promissory note for all of your cash contributions and a Bill of Sale for all of your asset contributions, and then have your bookkeeper or CPA record the transactions properly. One of the bonuses to this method is that it’s a way to take income out of the business without paying taxes – because it’s a loan repayment.

The downside to this method is that you still need to invest some money into the business to cover the stock or interests you are receiving. Otherwise you run the risk of being considered undercapitalized, and challenged that you aren’t following all of the corporate formalities.

Blend the Two

This is my preferred option. If you treat the value of assets contributed as your capital contribution and the money you put in on top as a loan (or a little of each, depending on how much you’ve had to spend), you accomplish both goals – proper capitalization, and a faster return on your investment.

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