If you have created a limited liability company, or LLC, the law protects you from personal liability for the company's debts. When the company runs into financial difficulties, however, you are free to lend your own money to it, in hopes of generating new business or to meet the obligations of the business. In some cases, this is preferable to borrowing from a bank or another source, thus creating more creditors and cash-flow issues.
Fit your business needs with the right LLC package
You set up a limited liability company according to the laws of your state. An LLC can be a sole proprietorship or a partnership. At the startup, you must deliver working capital to the business so that it can meet its operating costs (for rent, salaries, goods, equipment, and so on). You do this in one, or both, of two ways: investing your own money, and raising money from partners, banks, or other entrepreneurs whom you repay with shares of the company. You are free to inject more of your own cash into the business at any time, either by donating new capital or making a loan.
By extending a loan of your own money to an LLC, you demonstrate to other investors that you have faith in the company's future. (Many business investors, in fact, will require an investment of the owner's capital in one form or another.) You make a personal loan official and legal by drawing up a loan agreement and a promissory note, and setting up a regular repayment schedule. You can set any terms that you like: a minimal interest rate, long-term amortization (payoff) of the loan, and so on. You then write or authorize checks from the LLC to yourself on the repayment schedule. The outstanding loan amount shows up as a liability on the company's books, and an asset on your own.
Secured and Unsecured Loans
Business experts and advisors generally agree that personal loans to your own LLC should be made on an unsecured basis. In case the business fails, you would not have a claim to any property belonging to the LLC. If the loan is secured by property, and the business fails, you would then have a claim on that property — which has, perhaps, been purchased with funds from outside investors. This does not look good to the other investors, and could result in a legal tangle if you have to wind up the business and liquidate its assets.
The Internal Revenue Service considers any interest paid to you as taxable income, even if the interest was charged on money that you lent to your own business. If the ratio of the loan to the equity you've already paid is high, however, the IRS may consider it a capital investment. This means the loan repayments become a dividend, and you would pay capital gains taxes on principal as well as interest repayments. For the company, interest is a deductible expense, whereas dividends are not.
References & Resources
- Photodisc/Photodisc/Getty Images