How you can use your own money to cover your startup expenses
I've been in your shoes before as a startup founder who is just getting started. Before you have a product to show investors (or to sell to your customers), you will often incur business expenses that you will have to cover out of your personal finances.
As you start building your company, it is important to maintain a clear separation of your personal and your corporate finances to avoid liability and tax issues down the road.
There are a few different ways to “self-fund” your startup and cover corporate business expenses when you are just starting out. Maintaining the appropriate documentation of your finances is essential to avoiding potential issues with diligence down the road.
Can I just put business expenses on my personal credit card and pay myself back later?
Yes, you can do this if you are self-financing your startup but it's not without complications.
From a liability perspective this can present problems down the road if your company is sued. Mixing your personal and corporate finances can potentially open you up to personal liability in any lawsuits involving your company.
That being said, odds are your startup is not being sued left and right by shareholders, customers, employees and business partners. If you do business in an ethical, transparent way, this is likely not something you will ever have to worry about.
If you choose to cover company expenses from your personal finances and want to reimburse yourself later, you must maintain receipts and detailed expense reports for all expenses you incur on behalf of the company. Send these to your accountant when preparing your company’s annual tax returns. Even if you don’t reimburse yourself for the expenses in that calendar year, it is important to have them on the company’s accounting books.
When your company has the funds later — either by raising money from outside investors or by generating revenue from customers — you can reimburse yourself for the expenses.
I have my own money. Can I just transfer money into my company bank account and treat it as a loan?
Well, yes kinda, but it’s not always easy to pay yourself back. If you are self-funding your company with a formal line-of-credit, you’ll want to keep a clean record of the loan and protect yourself with documentation to avoid complications with your taxes.
Typically, even informal loan agreements from founders to their own company should include documentation of a few key points to avoid being classified as a capital contribution by the IRS:
- Written paperwork that creates a clear relationship between the business owner (the creditor) and the business (the debtor)
- Description of the amount loaned
- A clear expectation of repayment and the terms and conditions of that repayment
- A clear statement of what happens if the debt is not repaid
How do I pay back my personal loan to the company?
Up until the point you have raised money from outside investors, if your startup has enough cash to pay back your initial loan, simply pay it back.
When you’re in the market for investors though, things get complicated.
Investors are interested in deploying capital into startups in order to fund future growth, not to pay back loans to founders. So if you have some substantial loans outstanding and you are going out to raise a priced round, investors will sometimes ask you to “make them go away”. In other words: write off the loans and nix any chance of paying them.
If investors don’t do this, they will typically wrap your loan up in agreements that say you can’t be paid back until the company reaches certain revenue or capital targets... or your startup is acquired by another company.
What happens with taxes if I make a personal loan to my own startup?
If you’re loaning money to your startup, there are a few things to be aware of when it comes time to file your personal and corporate tax returns:
- Your company will be able to claim a deduction for any interest expense; however, you will also need to declare it as your interest income on your personal tax return.
- If you do pay yourself back any of your loan, it is not regarded as personal income so this doesn’t have any tax implications.
- If your personal loan is written off ("forgiven" in legalese), you will want to seek tax guidance on the treatment of the forgiven loan.
Alternative approach: Sign a SAFE with MFN terms to invest money into your own company
One alternate approach is to use the YCombinator SAFE agreement to invest money into your own company. This agreement is a simplified version of a convertible note without a maturity date or interest rate — the YC SAFE functions much like a warrant, instead of a debt instrument like convertible notes. Read more about key terms in SAFE agreements and how SAFEs are used in startup financing.
When a startup raises a priced round in the future, SAFE holders' investments will convert into preferred shares using the valuation cap in the agreements to determine the price per share.
For purposes of investing money into your own company, you can use the same financing vehicle. However, you may want to avoid setting a price or a discount on the SAFE you use to invest money into your own startup to avoid potential accusations of self-dealing. To achieve this, you can use the MFN version of the YCombinator SAFE.
The downside to this approach is that you will not be able to reimburse yourself for this investment and it is effectively a capital infusion, not a loan or expense that will be paid back. Effectively, executing a SAFE to invest funds into your own company dilutes your founder’s common shares with ownership of preferred stock in the next priced financing round.
This approach is unlikely to raise eyebrows when investors diligence your company… unless you are investing so much capital into your own company that it would affect the voting decisions for the preferred share class created in a future priced financing round.
How does MFN status work?
The SAFE agreement has 4 versions, including one with terms known as Most-Favored Nation (or MFN). Using these terms means your investment will get the same valuation cap as the most favorable terms any other investors receive.
If you raise a SAFE at a $10m valuation cap after issuing one to yourself with MFN status, your SAFE will have a valuation cap of $10m when converting in the next future priced round. If you subsequently raise a SAFE with a valuation cap of $8m, then your personal SAFE will have a reduced valuation cap of $8m when the SAFE converts in the next future priced round.
By default, the terms will be discounted to the most favorable terms any other investor receives in the future priced round.
Why does MFN make sense for investing your own money into your startup?
If you are putting money into your own company, you will want to avoid investors thinking that you gave yourself preferential terms for your investment into the company. SAFEs convert into preferred shares in the next priced round, so, by executing a SAFE, you will be getting preferred shares in the company (in addition to the common shares you already own), just like the other investors in the round.
Put another way: why would investors want to pay a higher price than what you paid to purchase preferred shares in the company? Giving yourself MFN terms potentially avoids such concerns on the part of investors since you are giving yourself terms equivalent to the terms given to other outside investors investing capital into the company.
- If you want to fund your business yourself, make sure it is well documented
- Two ways to fund your early company expenses: 1. pay expenses on a personal credit card and maintain expense reports, 2. extend a formal line-of-credit to your own company
- Investors can be wary of founders using investor funds to reimburse themselves for large personal loans to the company, so it is not always possible to pay yourself back
- Using a YCombinator SAFE with an MFN provision is a clean way to self-fund your startup
- Capbase makes it easy to register your startup and set up a bank account to start doing business.
Written by Greg Miaskiewicz
Security expert, product designer & serial entrepreneur. Sold previous startup to Integral Ad Science in 2016, where he led a fraud R&D team leading up to a $850M+ purchase by Vista in 2018.
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