The Most Effective Way to Invest in Your Startup Business

Is It Better to Invest in My Business or Lend Money?

Startup Business

Starting a Business requires investing capital, which you can refer to as “seed money” if you’d like. How should I account for that money the best?

Your bookkeeper asks, “How would you like to book this?” as you have the cheque in your hand. Is that a loan? or a financial investment?” Each course carries risks and tax implications.

Lending Funds to Your Startup Business

As your portion of the business capital, you will typically need to make an owner contribution when forming a limited liability company (LLC) or partnership. Instead of taking out a loan in this situation, you would be investing. You become a lender when you make a loan to your company. A business financing agreement must be written. Make sure the loan terms are drafted in a way that creates an arms-length transaction, clearly separating you from the business, and lays out all the details in writing, including the loan’s interest rate, repayment schedule, and repercussions for default.

Take note

This page provides sample parts and instructions for putting together a company loan agreement. Seek legal counsel while drafting your loan agreement to ensure that no details are overlooked.
When the loan is repaid, you will personally be responsible for paying the interest. At the end of the year, your business should issue you a Form 1099-INT that details all of the interest you received. Since you have already paid the taxes on the principal, your business repayment of it is not taxable.

Putting Money Into Your Startup Business

You are an investor if you have invested capital in ownership shares or stock in your company. You can invest money in your business by simply writing a check and depositing it into the business bank account if it is not
a corporation. The funds should be deposited into your personal capital account, which is listed on the balance sheet as owner’s equity. (This procedure, known as a distributive share in partnerships, functions similarly.)

Formally speaking, you can invest in your business by incorporating and taking up shares in it. You may own most or all of the business if it’s small and there are just a few shareholders (referred to as a closely held corporation).
You are free to withdraw the funds at any moment if your investment isn’t in stock. An owner’s draw, for instance, can be taken from your owner’s equity account. Because you have already paid taxes on your business’s net revenue, you are not required to pay taxes on your draw when you withdraw it.

Capital gains taxes are levied on money you withdraw from the market through the sale of stock or dividends received on your investment. A Form 1099-DIV detailing the total amount of your dividends for the year must be provided by the firm to you.

Each Option's Risks

The ideas of debt and equity are what surround the possibilities of investing or taking out a loan for your company. When it comes to debt (lending), your company is the debtor and you are the creditor. With ownership shares in the second scenario, you are a part-owner of the company. Investing in stocks carries a higher risk than lending money. Having a loan document will add you to the list of creditors in the event that the business is unable to pay its debts, and you may be able to recover a portion of your investment through bankruptcy procedures. In the event of a bankruptcy, shareholders come last in line and might not get anything at all.

How to Prevent Tax Problems When Making a Contribution

Think about how your personal taxes may be impacted before making an investment or lending money to your company. A 2008 ruling from the Tax Court exemplifies the problem. In this instance, the company’s owner asserted that he had paid unpaid business bills and intended to classify them as bad debts. In its conclusions of facts, the Tax Court stated that the owner “did not demand or receive payment for any of the expenses he paid on behalf of his corporation.”

The Tax Court also noted that the loan must meet these requirements:
* Written paperwork that creates a clear relationship between the business owner (the creditor) and the business (the debtor)

* Description of the amounts loaned
* A clear expectation of repayment and the terms and conditions of that repayment
And a clear statement of what happens if the debt is not repaid
* The owner’s payments were determined by the tax court to be capital contributions rather than loans. They claimed that the owner was contributing more funds to the company, in other words. If the owner withdraws their investment, they will be required to pay capital gains tax as this is not regarded as business income.

Prior to Making That Investment or Loan to Your Startup Business

Make sure you have documentation in place that outlines the terms of the loan, the payback responsibility, and the penalties for non-repayment before you lend money to your Startup Business. Hire a lawyer to draft the loan agreement, ensuring that it includes all necessary terms. Next, ensure that the corporation pays back the debt or that the lender (you) upholds the repercussions of non- payment.
The same goes for investing in your company: be sure to prepare shareholder records that attest to your status as a shareholder and that show the value of the shares you are buying as well as how much they have increased in value over time.

How Should You Invest Money in Your Startup Business?

It depends on your individual tax and financial circumstances and your business type.

Prior to Investing Funds in Your Startup Business
1. Discuss the options with both your tax professional and your legal advisors,
2. Put the agreement (loan or capital contribution) in writing, and
3. Keep good records of the transaction and make sure it is clear how the
money is to be accounted for in the book of the business.

Disclaimer: This article’s content is only meant to be used as general information. The writer is not an Enrolled Agent, CPA, or tax lawyer. Every state has its own restrictions, tax laws and regulations are subject to change, and business situations are unique.

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