Small Business Start Up Loans
“Love Money” is the money that those who trust the business owner loan in order to get the business started. For many business owners they simply keep track of the amount loaned and then pay it back as soon as they get it. Sometimes this isn’t even kept track of except on scraps of paper between the parties, and occasionally not even that. This is not a good idea. There are a few different ways that these loans can be entered into the company books that will benefit both the lender and that business.
Entering the Funds as a Loan
If you choose to enter the funds as a straight loan, then you will have to enter these on the liabilities side of your balance sheet. The advantage of a loan is that any interest that you have agreed to pay is 100% deductible as a business expense. The disadvantage is if you need other financing, such as bank financing, it will show as this kind of liability and that decreases the chances of obtaining the other financing, due to increased debt loads. Additionally, such straight loans should have a loan agreement that includes regular payments. This can be a drain on cash. If there are no such payment agreements, this must be within your written loan agreement and repayment terms must be specified. If there is an open end on the repayment terms, then the bank is likely to take this into consideration, making it easier to obtain financing.
Entering the Love Money as Preferred Shares
Preferred shares are a type of ownership in the company (it must be incorporated to issue this kind of shares) whereby those who own these shares do not have any control on the company and their risk exposure is only the amount paid for the shares. In this instance, there are usually no specified terms on when the shares must be redeemed and the original amount can sit on the books pretty much indefinitely. The biggest advantage of this is that the amount is also registered on the equity side of the financial statements, and will not show as a loan. Additionally, this kind of investment traditionally pays a dividend. As such the “interest” payments to the investor are paid from profits in the company. This means that there are no payments draining your cash flow until you actually have the spare cash. For the investor these are good in that dividends are taxed at a lower rate than interest income, since they are paid from company’s profits and the company basically pays part of the taxes.
Note, that being able to issue shares is one advantage of incorporating. Sole Proprietors cannot issue shares, and therefore cannot take advantage of this kind of loan structure.
