Starting a new business can be a challenging period for your finances. It may be tempting to utilize some of the equity in your home to fund the startup.
“Of course, the entrepreneur is an optimistic person and they’re trying to plan their business for success. They need to be aware failure is something that could happen,” says Chris Gordon, financial advisor at Edward Jones in Mississauga. “More often than not, the reasons for failure are internal, in other words, failures of the business in terms of the experience or knowledge of the entrepreneur as opposed to anything that happened in the economic environment.”
Mr. Gordon suggests exploring other avenues for funding before risking your home for a new business venture.
“Other sources of finance might be a straight business loan or asking your friends or family for money. Depending on the size of the venture, there may be venture capital or angel investors,” Mr. Gordon says. He notes that in Canada there are a variety of federal and provincial programs that the business may be eligible for in terms of loans, grants, subsidies and also intellectual capital or advice.
If, after taking financial and legal advice, you decide that you will use your home to back your business finances, Mr. Gordon says any joint owner of the property, for example your spouse, should obtain independent legal advice so they are aware of the risks.
The type of business you are running, your liability and your cash flow will all help determine whether it is better to obtain a line of credit against your home or to remortgage the property.
“A home equity line of credit is for short-term borrowing. It allows you to get away with interest-only payments, to borrow and pay back very easily,” says Kelly Wilson, a mortgage broker with Invis in Ottawa. “If you’ve got good cash flow coming in, you can make regular deposits without having to limit yourself to particular payments. That will in turn save you interest.”
Ms. Wilson says if you require the money for a longer period, for example if you are paying a lump sum into a shareholder arrangement, then a mortgage against your property may be more cost effective.
“If the loan wasn’t going to be paid back for a long time and there was a certain amount of money coming back to me on a monthly basis, I will generally look at taking a mortgage,” Ms. Wilson says. “The financing is less expensive than a line of credit. A variable rate would be as low as 2.15% versus lines of credit which are generally 3.5% to 4%.”
Mr. Gordon says business owners must check if the loan can be called in at short term or no notice. He says that it is important to have separate accounting of personal and business income and expenses, especially if you are deducting the loan interest against the business income.
“The business owner should make sure they consult with the financial planning, tax and legal professionals if they don’t have that expertise themselves,” Mr. Gordon says. “Plan the venture for success but also to keep in mind the consequences if things don’t go well and make sure that that’s not going to be disastrous for their personal finances.”