Dr. Rick Franza, Professor of Management at the Hull College of Business, discusses a different, timely business topic each Monday in this column. This week, he talks about the pitfalls of mixing personal and business finances. The interview has been edited for clarity and impact.
ABD: Often, when an entrepreneur or small business owner needs capital, it’s tempting to dip into personal funds for use in the business. What is your advice on that?
Rick: It’s a huge challenge for small businesses or entrepreneurs to separate the two. Often, they use their own money to fund the business.
When I was coaching one of the winners of J-Tank at the Jessye Norman School in downtown Augusta, she was using her personal funds for business expenses. I encouraged her to separate the two. One, it gives a distorted view of what your actual business costs are and two, it can run into tax issues. Those are a couple of reasons to separate them.
As you’re tracking your finances, you want to have a good sense of how the business is doing without tainting it with personal expenses.
ABD: Is paying yourself a salary a good way to avoid that?
Rick: Yes, if you’re tracking your own salary, you can accomplish knowing what your business cash flow is and avoid tax penalties. But the opposite problem is that sometimes, entrepreneurs forget to pay themselves.
ABD: We’ve heard the horror stories of a small business owner or entrepreneur taking out a second mortgage on their home or draining their savings to start a business, only to have it fail. Is doing that a wise idea?
Rick: That is certainly a challenge, but people do it all the time. Sometimes there’s no avoiding it, you have to take a second mortgage or max out a credit card, but you run the risk of financial turmoil.
ABD: Often businesses are started by partners. What if one partner is dipping into the business funds for personal expenses?
Rick: If you’re commingling personal and professional funds, you both need to be aware of it. Communication is critical. It’s very important that contracts be written and keep it legal. It’s also important that both parties bring money to the game.
ABD: I know that sometimes, business startups are funded primarily by family or friends. Is that wise?
Rick: That’s fraught with danger, too. You must discuss if they’re going to have equity in the company and how you’re going to pay the money back. Have legal notes and formalize as much as possible.
When you’re starting a business, it’s important to formalize as much as possible, especially if you’re taking money from other people. Outline what the prospects are for that person. Communicate what the risks are. It’s important that your partner or whoever else understands that there are risks involved. If someone is investing with you, you need as much transparency with those funds as possible.
When it’s your own family, it’s less about formalizing and more about communicating. But you’re always better off taking the formal route, no matter what the relationship is. Accountability is the key – you can’t just say, “Trust me, I got this.”
The giver should at least know what the risks are. There should be clear communication and providing assurance that they’ll be paid back.
ABD: Startups notoriously have a short life span. How does that figure into the financing?
Rick: There’s always uncertainty involved. You always think “This can’t miss” but then something happens in the marketplace, and it becomes a miss. The keywords are accountability, communication, and proactivity.
You should separate the personal from the professional finances with legal documentation. It will help keep personal relationships more secure.