Sources of Investment in a Sole Proprietorship
The financial resources of a sole proprietorship business are intimately tied to those of its owner: when the business loses money, the losses come out of the owner's personal funds, and when the business makes a profit, this amount is recorded as income on the owner's personal tax return. Sole proprietorships tend to find investment funds by drawing on the owner's personal resources, either through an infusion of personal savings, loans from friends and relatives, or bank loans based on personal creditworthiness.
The owner and operator of a sole proprietorship has the greatest personal and financial stake in his company, so it is natural for him to use personal funds such as savings to start and build his business. When a sole proprietor invests in his own enterprise, he takes the greatest risk for financial losses, but he allows himself virtually unlimited freedom for using and paying back the investment. This freedom applies to how he uses the money as well as the time it takes him to repay it.
Friends and relatives are common sources of investment for sole proprietorship businesses. Because sole proprietorships are so closely owned and managed, individuals who know the owner well and believe in her vision are likely sources of funding. Investments and loans from friends and relatives tend to have relatively low interest rates because the lender makes the investment out of confidence in the individual and belief in her vision rather than a desire to make money. However, personal loans and investments can come with emotional baggage if a sole proprietor is unable to pay back the money.
A sole proprietor may invest in his business by using a personal or business credit card. Credit cards provide funds either through cash advances or by covering the cost of expenditures. If a sole proprietor's credit score is good, a credit card is a relatively easy source of business funding to receive and generally does not require collateral or a stringent repayment schedule. However, interest rates on credit cards tend to be higher than on any other source of business funding.
When a sole proprietor applies for a bank loan to invest funds in her business, the bank uses her personal assets and credit score as the basis for determining the creditworthiness of her business. Most banks require that a sole proprietor have collateral, or personal resources that she can pledge as a guarantee against a loan. Business credit lines tend to have less-stringent criteria but higher interest rates. Many banks work with the Small Business Administration, which backs small business loans, but the agency's criteria tend to be at least as strict as the banks'.