Starting a business can be the gateway to financial success long-term. If you’re successful, you could multiply your initial investment many times over and/or create a revenue stream that can last you well into retirement. If you have the right idea at the right place and time, you could even become a multi-millionaire.
But of course, just starting a business isn’t a guarantee of success; about 20 percent of businesses fail within the first year, and 50 percent fail by year 5. If you want to improve your chances of success and minimize your losses in the event of a failure, you need to financially prepare for starting a business.
Why Personal Finances Matter
It’s true that you’ll be thinking about your personal and business finances as separate in at least a few key ways, but your attention to personal finances can have a major impact on your odds of success for several reasons:
- Debt and liability. Debt isn’t always a bad thing, but if you start a business with a lot of personal debt in place, you could be setting yourself up for disaster. Starting a business could force you to incur even more debt, putting more financial strain on yourself. Additionally, if the business fails, your debts may become too much for you, resulting in total financial collapse.
- Personal expenses and instability. Even the best businesses are sometimes unpredictable in terms of cash flow; there will be “hot” periods and “cold” periods, where your income is unstable. Having a good financial strategy in place allows you to better tolerate these volatile fluctuations.
- Financial habits. Many of the principles that will help you improve your personal finances will also help you improve your business finances. Think of personal finance as a kind of training ground that will help you set a better foundation for the business.
Financially Preparing for Starting a Business
So what steps can you take to financially prepare to start a business?
- Review your current debts and assets. The first step is awareness. Do a thorough audit of your current personal finances, and review all your current debts and assets. What is your current net worth? How much do you have in savings, and how much do you owe to your creditors? How much are you paying every month in living expenses? How much income are you currently generating, and would you be forfeiting it by starting a business?
- Pay down your credit card debt. Next, consider working to pay off your credit card debt. Certain types of debt, like a mortgage and student debt, is less dangerous because they carry lower interest rates and are tied to important assets—but credit card debt can hurt you. Start by signing up for an online debit card on this site, and using that instead of a credit card; this way, you’ll be less tempted to spend more than you actually have. Then, set aside a bit of money each month until you’re able to get your balance down.
- Improve your credit score. Next, try to improve your personal credit score. A higher credit score will allow you to qualify for better and bigger loans and will put you in a better financial position overall. Paying down your debts will help you improve your credit score, but it’s also important to make payments on time consistently and avoid opening any new loans or lines of credit.
- Set up an emergency fund. One of the most important staples in any personal finance plan is an emergency fund; this pocket of funds will serve as a buffer that can help you cover any unanticipated or excessive expenses you face. It will also help you stay afloat if there’s a period where your business isn’t generating revenue. Be sure to put away at least a few months of living expenses here.
- Create a retirement fund. Though not a strict necessity, you should consider starting a retirement fund before starting your business. Tax advantaged plans, like Roth IRAs, can help you set aside money for your future retirement. Even small contributions can quickly add up—and give you a financial safety net in case your business fails.
- Prepare to separate personal and business finances. Most business owners are best advised to keep their personal and business finances separate. For example, if you have to take out a loan, try to take out a business loan, rather than a personal loan, and don’t use business funds to pay for personal items.
- Get ready for taxes. As a business owner, you also need to be prepared to pay taxes. Depending on the nature of your business, you’ll likely be expected to make quarterly tax payments throughout the year, since there won’t be an employer to withhold taxes on your behalf. Don’t let these due dates take you by surprise.
- Have a backup plan. There’s no guarantee that your business is going to be successful, or that you’ll still want to be an entrepreneur in another year or two. What is your backup plan? Do you have a spouse or partner who can help support you temporarily? Can you go back to your old job? Do you have another source of income you can rely on? It’s in your best interest to have a solid idea (or several ideas) that could sustain you in the event of business failure.
A Note on Business Finances
It should go without saying that much of your success will also depend on your ability to manage business finances. When drawing up your business plan, spend additional time doing research so you can put together a realistic financial model—and estimate conservatively, so you have a buffer in case things don’t go the way you expect.
With a better foundation of personal finances, and a better financial outlook, you’ll have a much higher likelihood of succeeding with your first business. Take your time, and ensure you’re building the right initial momentum.