The American Dream means something different to everyone. For some of us, it’s owning a home. For others, it’s making sure that we leave our children a better world than we inherited. And for others yet, it’s starting our own business.
While the appeal of entrepreneurship may be an obvious one — who doesn’t want to be their own boss? — it is important to keep in mind that running a business is far from easy. In fact, one-third of all businesses fail within two years and two-thirds fail within 10 years, according to the Small Business Administration.
When you’re ready to get started, it’s important to do everything you can to set yourself up for success. When you know the right financial steps to take before starting a business, you can better prepare for the unique challenges of entrepreneurship.
- KNOW YOURSELF
Just as you should aim to understand the market and industry that you want to break into before you quit your job and pursue entrepreneurship, it’s also incredibly important that you understand yourself.
Why do you want to start your own business? What goals (personal or financial) are you trying to accomplish? What does success look like to you? What does failure look like to you? How much risk are you willing to stomach as you work to get your business off the ground?
The answers to these questions will be different for everyone. By answering them honestly, you can put in place a plan that works for you and your family.
- KNOW THE LAW
Before starting any business, it’s a good idea to understand the laws and regulations that are going to apply to your business. Do you need a particular license or permit? Could zoning rules complicate your plans? Laws and regulations can vary by state and even by city or town, so don’t be afraid to turn to city hall, your local chamber of commerce or an attorney for guidance.
Additionally, which business structure is right for your business? While many small businesses are sole proprietorships, there are other options — LLC, S Corp, etc. — which can offer a number of legal and tax benefits.
- BUILD AN EMERGENCY FUND
While everyone should have an emergency fund, they are especially important for entrepreneurs. According to one study by U.S. Bank, up to 82 percent of business failures are due to cash flow problems — namely, not having cash when it’s needed.
Many businesses follow a cycle where demand is higher at certain times and lower at other times. For example, a landscaper will naturally see more jobs in the summer than in the winter, and a boutique shop may sell more merchandise around the holidays. Having a healthy stockpile of cash can help you to ride out these peaks and valleys and prevent the kinds of cash flow problems that could destroy your business.
How much should you aim for? While three to six months’ worth of expenses is typically recommended for most people, freelancers and other self-employed individuals may want to sock away even more — for example, nine months’ to a year’s worth of expenses, though this will of course depend on your financial situation. If you are married with a second source of income, for example, you can likely get by with less set aside; if your business is the primary source of income for your family, though, you may need more.
- PAY OFF YOUR DEBT
While this isn’t a requirement to starting a business, it can be a good idea, because reducing the amount of debt that you owe can have a number of benefits to your business.
For example, if you plan on relying on a business loan or other kind of financing to get your business off the ground, reducing your personal liabilities can make you more attractive to lenders, increasing your likelihood of receiving funding — and lower interest rates. Additionally, the fewer bills and obligations you have, the easier it will be to ride out the tough times without having to tap your savings.
- SEPARATE YOUR FINANCES
While it may not be the most important part of running a business, financial management is critical to success. That means knowing what money is coming in, what money is going out, and where it is coming from and going to, which can be difficult if you don’t separate your personal finances from those of your business.
Set yourself up for success early on by opening a separate business checking account. Use it to receive payments and to pay for any business expenses that you may encounter. This will help you understand exactly how your business is doing, make filing your taxes easier, and may even help if you’re ever audited by the IRS.
- GET THE RIGHT INSURANCE
Once you’re self-employed, you’ll no longer be able to count on an employer for your insurance needs (unless, of course, you are married and on a spouse’s plan). From health, vision and dental coverage to disability insurance and life insurance, it’s important to have a plan for how you’re going to pay for these additional expenses.
Beyond these, you should also have a grasp of the different types of insurance that can help protect your business, and work those into your plan.
- KNOW YOUR RETIREMENT OPTIONS
Just as you will no longer be able to rely on an employer for your insurance needs once you are self-employed, you’ll also no longer have access to an employer-sponsored retirement plan like a pension or 401(k). You are your employer.
But that doesn’t mean that you don’t have options. Generally speaking, entrepreneurs and the self-employed can choose between a number of different kinds of retirement accounts, including:
-Traditional or Roth IRA
Each of these types of accounts have their own requirements, limits and benefits, so it’s important to do your research and understand which is best for you and your business.
One additional note, you will have to contribute additional taxes to social security when you’re self-employed. That’s because you will have to make your own contribution as well as the employer contribution, a total of 12.4 percent.
- HAVE A CONTINGENCY PLAN
As mentioned above, up to a third of all businesses fail within two years. While there are steps that you can take to increase your chances of success, the simple fact is that you cannot predict the future.
That’s why all entrepreneurs need to be able to answer this question: If this doesn’t work, at what point am I willing to cut my losses? Without an answer, it’s far too easy to fall into a habit of chasing your losses.
- CONSIDER WORKING WITH A FINANCIAL PLANNER
Financial planners and advisors are trained to help you create a financial plan and reach the goals that you outline in it. If your financial plan includes starting a business, a financial planner can help guide you on the path to making it a reality — including many, if not all, of the steps above.