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Investing in a small business

Date posted:  8/20/15 09:15:00 AM When a small-business owner invests personal funds into the business, it can help the company grow and demonstrates faith in its success.

Small-business owners can benefit greatly from investing money in their operations. It's an effective way to create a more efficient and successful business, and when done correctly, provides a significant return on investment. 

Demonstrates faith in an operation 
According to Entrepreneur, other potential investors will look more favorably on an operation if the owners invest regularly. It demonstrates growth and that the founder believes in the mission and success of his or her small business. 

Typically, if an individual does not see a business owner put money into their own operation, he or she will be less inclined to invest in it either. A solid financial commitment is necessary for success. 

Consider investment options 
While taking profit and funneling it back in the business is one way to invest, there is another option. 

According to Nerd Wallet, small-business owners can also use a home equity line of credit to enhance an operation.

"It's relatively easy to get a home equity loan or line of credit, provided you have equity in the home, good credit and income to support the repayment," Craig Smalley, a small-business lending expert, according to Nerd Wallet. 

Due to its accessibility, this can be an appealing option for small-business owners who also own a house. Because a HELOC's collateral is also likely the borrower's most substantial asset, a credit score isn't as important when individuals decide to apply. 

In addition, you can access as much or as little money as needed. 

"When you get a traditional loan, you have to guess right on how much money you need," Smalley noted. "If you need more, it would be hard to get another loan. With an equity line, you can take the money as you need it."

Entrepreneur noted a home equity loan is another way to invest more in a business. This is a one-time lump sum loan that the borrower pays off over a specified amount of time. The interest rate and number of payments are predetermined. 

Understand the risks of a HELOC 
While it is a good idea to consider this option, it is also smart to become familiar with potential issues.

For example, a HELOC has the potential to have a variable interest rate, making the amount owed fluctuate over time. However, the interest rate will also likely be fairly low when compared to other loan options available, noted Nerd Wallet. 

Small-business owners considering a HELOC to further invest in their business should factor in closing costs and fees. While these are not as substantial as when closing on a home, they still exist and should be considered. 

The most obvious risk a business owner takes when using this type of credit toward expansion is the ownership of the home and operation. An owner may lose both property and business, which could have a significant negative impact. Owners should carefully weigh these risks with the potential return from the small-business investment.

Other considerations 
Before deciding to apply for a HELOC or home equity loan, Entrepreneur recommends evaluating a few factors to ensure the best decision is made. For example, determining whether property values in the neighborhood of a home are increasing or decreasing. If the value is up, that's good news for a business owner. However, if selling prices are plummeting, that could put a borrower in a tough financial situation. 

Deciding exactly where the money will go is another factor to think about. Ensuring the best business decisions are made with the invested funds will help improve success and growth.

All money should be spent wisely. 

"If you are using them to buy inventory it can also be a bad idea, because the value of the inventory could become worth less than what you purchased it for," Smalley told Nerd Wallet. 

In addition, small-business owners should know whether they can afford to continue repaying a home equity loan or a HELOC with their current cash flow. It's a riskier decision to take advantage of these types of investment tools when solely depending on the estimated earnings owners believe will result from plugging money into the business. 

It's no secret investing in an operation is a good idea. However, developing a plan and understanding the consequences is also crucial to long term success.