By Tim K. Dean, Founder and CEO of lending platform, Credi. 

The impact of COVID-19 on both personal and business financial arrangements is going to be critical over the coming months, if not years. As such it’s critical that SMEs solidify, or take some measure of action to safeguard, their financial arrangements. If you are a business owner and have personal finances invested in your business, now (more than ever) it’s essential you put structures in place to protect your assets and investments in order to protect your financial wellbeing.

It’s a scenario eerily reminiscent of the 2008-09 global financial crisis (GFC), during and after which there was a huge influx in self-employment and new business commencement. COVID-19 will have a similar effect on the business landscape.

So whether you are a start-up, an expanding business, or one simply working hard to get along, finance will be one of your biggest ongoing challenges.

Will economic conditions put more pressure on founders to bankroll their businesses? Should you dip into your savings to help fund your business? Can (or will) you ask for financial support from a friend or family member? What processes do you have in place to mitigate risk when lending (or borrowing) finance to (or from) your business.

Many SMEs may consider self-funding their businesses as a legitimate ‘stopgap’ measure to ensure the business remains liquid. But any investment comes with a degree of risk. So how can SMEs avoid their own financial crisis by safeguarding personal investments into their own business?

Protect and preserve your principal

The golden rule of investing is to protect and preserve your principal. Ensure the business is properly valued, and that you have an exit strategy, so that your liability is minimised should something go wrong.

20% of small businesses fail in their first year! If a small business fails, self-investors can be responsible for unpaid bills or other liabilities. To protect you from liability, you have several options:

• you can consider creating a limited liability corporation (LLC) – or equivalent – to protect your personal assets, should the business go under.
• Consider lending the money to the company rather than investing. Investment means you may not see a return on that investment (ROI) for many years. When a loan is between individuals, sensible terms can be established to prevent any hardship being felt on either parties’ part.

Be sure to put all loan and repayment terms in writing to provide you with legal recourse should the loan not be repaid.

A look at traditional lending

Many small business owners consider accruing personal debt by using their primary assets, such as the family home, as collateral against a loan. They’ll re-mortgage to generate the necessary funds, or use a personal credit card to buy equipment, pay for rent, purchase stock, or cover payroll.

Applying for small business government grants and assistance is another way to access much needed funding; many grants do not require the borrower to give away equity. So research grant opportunities in your city or region to see what’s available.

The ‘friends and family’ option

Too few would-be entrepreneurs consider asking friends and family to invest in their businesses. Those numbers seem to be changing as the financial landscape changes. In a 2020 Australian survey of 1,036 people (631 of whom were business owners) commissioned by peer to peer lending platform, Credi, nearly 89% said they had had trouble securing finance or capital to start or grow their business. When asked if they had considered asking a family member or friend for a personal or business loan, 81% said they had, and when asked if the current economic pressure made them more or less likely to take a loan from someone they knew, 90% said they were more likely.

This is an avenue more budding entrepreneurs and SMEs are exploring – the pre-existing relationship can certainly make the transaction more straight-forward, however unless the loan is properly documented and managed, there can be relationship damage and financial losses incurred.

Expert wisdom – me, myself and I

Ask any accountant and they will counsel you to separate your personal finances from your business finances. It’s common sense. If you are personally covering business expenses, you’re establishing a line of credit arrangement. These should be documented, and further protection put into place if necessary. Always draft official documents and put things in writing to protect yourself and the other party; even (especially) if the other party is you.

Doing so will benefit both you and the business. Traditional lending processes are often bound by red tape, and will bring about delays and necessity for their due diligence.  But if the investment is coming from you, the business owner, from private savings or equity, you are essentially acting as a ‘bank’ for your own business. So do as the banks do.

Through formally establishing the loan and then registering a secured charge over the business’ assets (in Australia, this is done on the Personal Property Security Register; similar agencies exist in NZ, UK and Canada; in the US there are state-based regulations), the investor – you – will be registered as a secured creditor. You’ll safeguard your investment, and put you at the front of the line to reclaim it if things don’t go as planned.

You wouldn’t drive a car uninsured, so why would you risk your livelihood without a safety net? Don’t just dump your own savings, or risk your personal credit rating, to keep your business afloat. There are better ways to secure finance for your business without putting your future financial wellbeing at any more risk than you need to.