Let’s look at your investment options. Don't make a loan to back a new business. When you lend money to a startup, you're risking a total loss. If the company goes belly-up, you might not be able to claim a bad-debt deduction. If the venture succeeds, you’ll get your money back — but you should ask yourself whether the interest on the loan is sufficient compensation for the risk you assumed.

As a stockholder, however, you have some chance of reaping returns that are commensurate with your risk. Besides, you're more likely to get tax relief if the venture fails.

Why is S corporation status important?

 If you’re a shareholder, all profits and losses pass through the company to your personal tax return. If the venture fails, you simply write off the loss. You don't have to sell your stock or prove to the IRS that your investment has become worthless. If the venture succeeds, you’re a big winner.
 Your personal assets are protected from the company’s creditors.

If you decide to invest, write a check payable to the corporation, not to the principal owner. And be sure to obtain a certificate for the number of shares you purchase.

Another option is to invest as a member of a limited liability company (LLC). In general, the tax and asset protection advantages of an LLC are similar to an S corporation. Companies that won't qualify as S corporations might qualify for LLC status. Either way, consult with your tax adviser and don’t open your checkbook until you’re certain that you’re protected.