Most entrepreneurs are not sure wether to use their own cash or borrow the money. Here’s the answer.
That’s a perfectly reasonable question — and often there are certain circumstances where you should go ahead and use your cash. But there are also times when it makes sense to borrow or move the money out of your business or leave the money in place.
Let’s consider three critical issues to prove my point:
Spread the risk.
You should consider how much of your net worth is tied up in you business versus other avenues. There should be some balance, as you don’t want to be too top-heavy in any aspect of your financial picture.
While you might have the utmost confidence in your business (as well as your own ability to succeed), there are plenty of things that are out of your control that could impact you life.
In other words, you might want to diversify your risk and have fewer assets in your business. This could be a reason to take some of the cash out of your company, and put it into a mutual fund or a CD.
Protect yourself against legal woes.
If you have a bunch of cash sitting in your business and you get sued — and it doesn’t matter if the complaint is legit or not — those assets are fair game for a suit-hungry lawyer. If you lose the suit or have to settle, any assets in the business are fair game.
But if the cash is not on your business’ books, it’s a lot harder for it to be included in legal action. “Don’t make things easy for lawyers” is sound advice every day of the week.
Six months is an eternity.
When it comes to personal finance, advisers always counsel their clients to maintain six months of expenses in cash reserves. As mentioned in the first example, it doesn’t take much to wreck most people’s finances. The loss of a job, even for a short time, can do it. So can uncovered medical expenses or a personal tragedy such as a house fire (even with insurance, you’ll be dealing with a ton of unexpected costs).
So, it makes sense to have six months of cash in reserve.
The same is true for your business. A business can find itself in dire straits if it loses a key customer, is unable to access critical materials, has an unexpected setback such as a fire, or suddenly finds itself lagging behind a competitor with a significant competitive advantage.
Having a six-month cushion can right a lot of wrongs, not to mention help you sleep at night.
If you have more then six months of burn rate in your business account, it’s safe to consider using the surplus to fund investments. But before you do that, evaluate your overall financial picture and decide if it makes more sense to move some cash outside of the business, and let the company borrow the money you are looking for instead.