Self-financing may be your best option
Asurprising number of principals in veterinary practices depend on themselves for their financing needs. With conventional financing increasingly more difficult to obtain, it's now the No. 1 form of financing used by small business owners. It's quick, doesn't require a lot of paper work and often is less expensive than conventional financing.
The cost that comes into play is the "lost opportunity" cost — the amount that could have, or might have, been earned had those funds remained in savings or invested elsewhere. However, in the current economic climate, keeping financing within the family frequently produces the fastest and best results.
If you want to finance something yourself, know that the tax laws create a number of obstacles that must be overcome to avoid penalties and higher tax bills.Reversing the bottomless pit
Although many veterinarians look first to cash savings as a financing source, often there are other assets that can be used, despite certain risks and drawbacks. Consider this example:
When John Jones' practice was turned down by several conventional lenders, even non-conventional funding sources seemed to dry up. His answer was to personally guarantee a $100,000 loan, run up expenses on his personal credit card and defer his salary. In short, Jones put himself in a position where he had a lot to lose — and the only way out was to succeed and profit.
Putting oneself at risk can attract lenders or investors to provide funds a business needs. Here are some strategies that can put the owner at risk, provide the needed funding — or both:
When either lending to or borrowing from the veterinary practice, remember that, to count, it must be a legitimate, interest-bearing loan. A practitioner borrowing from his or her practice can face a hefty tax bill should the IRS view the transaction as a dividend payout rather than a loan.
Often, it is below-market interest rates or the lack of evidence of an arm's-length transaction that draw the attention of the IRS. The government is particularly interested in (1) gift loans, (2) corporation-shareholder loans, (3) compensation loans between employer and employee or between independent contractor and client and (4) any below-market interest loan in which the interest arrangement has a significant effect on either the lender's or borrower's tax liability.
If the IRS re-characterizes or re-labels a transaction, the result is an interest expense deduction when none was previously claimed and unexpected, taxable interest income on the lender's tax bill. The higher tax bills, often dating back several years, usually are accompanied by penalties and interest on the underpaid amounts.