I won’t waste time on the clichés like “don’t quit your day job”, or “expect the unexpected”, or the long hours you might have to work if things don’t go as planned, or that things never go as planned. Instead, I want to write about the financial issues that may not have occurred to you, oh would-be entrepreneur, because the rules have changed since 9-11 and the 2007-ish crash of the real estate bubble.
In a nutshell, the credit system is now rigged against small business start-ups. My first example was in trying to refinance my house, given the low interest rates. I had invested a big chunk of change in my business, and was now living on “return of investment” (i.e., taking it back tax-free). So what was my income? Nearly zero, on my tax returns! This counts the same as living on savings or pulling down your 401K funds. My business was making serious profits and I could afford the payments, but I could not prove future income to make future payments. Even though the payments would be LOWERED by refinancing, and it was through the same bank! This is because it is approached as a fresh case by the underwriters.
Trying to buy a new car would be the same deal – no provable income stream! Advice – make sure you pay yourself a small taxable salary even if it means sending more money to Uncle Sam than you have to, sooner than you’d have to based on returning your seed investment, just to keep your borrowing options open.
On the subject of 401K’s — they are a vehicle for getting the working class to save money on the assumption that they will be earning next to nothing in their retirement years. But if you are an entrepreneur, you will be earning more money AFTER your ship comes in, and are desperately needing seed money to invest during your prime working years. You’re living backwards to the norm (isn’t that often the case?) Advice – while you’re still in your day job, planning a jump, avoid locking your money into a 401K or any such tax-deferment vehicle that carries a cash-out penalty — unless of course your employer is offering matching funds. Then the match is probably bigger than the tax penalty for early withdrawal, so that’s a free perk. And watch the penalties levied by the investment firm itself. ING tries to lock you in for 10 years from initiation of the account.
Credit cards. Believe it or not, credit cards start looking awfully good when you are in the financial trough trying to turn your start-up into a paying proposition, and you’re sure that’s just around the door. You need some quick cash, and aren’t going to need it long enough to worry about what the interest rate is. Problem is, even with your mailbox stuffed full of “pre-approved” credit card offers, nobody is going to give you credit without you saying what your monthly income is. And with you in a startup – it’s not even zero, it’s negative. Advice? Get as many good cards with as high a limit as possible BEFORE you quit your day job.
Pre-tax dollars. The second most important reason to incorporate is that you can write off, as “expense”, so much of what you were going to do anyway, because your business is your life, yes? Tools, supplies, computers, software, food, travel, and on it goes. You must maintain the corporate veil (what is yours, and what is the company’s – after and before taxes, respectively), you must maintain at least an excuse why the business might need it, and show that you’re in the business with intent to make money — that it’s not just a hobby to use pre-tax dollars. Even if it really is.
The very most important reason to incorporate is to protect yourself from frivolous lawsuits. You want to spread your eggs out in multiple baskets so that a bad lawsuit against your business (which has public exposure) won’t take your house, your car, etc. Don’t have your business own buildings and capital equipment and such – own it personally and rent things back to your business.
Oh yeah, insurance. If you’re doing anything new and different, and not just running a cookie-cutter franchise, you are going to have a heck of a time getting liability insurance for more than your building and grounds exposure. The underwriters won’t understand a creative business, and will reject anything they can’t pigeon-hole. This is a reason to minimize holding value in your company, and move the book assets to yourself personally — your business may be exposed without insurance, and you might have to shuck it and move on, if the worst happens. A personal liability umbrella to cover your personal assets is then needed – and readily available.
A business that sells retail is of course most exposed to liability lawsuits from the public. A business that sells to other businesses is generally not going to have to worry about lawsuits – it is going to have to worry about getting paid. It’s shocking what a macho pissing match financial transactions between businesses can become. Often companies won’t pay vendors for the last shipment until they need to buy something else. Companies will work through their vendor list until they’re forced to go back to the top and pay off the oldest bill, to be able to buy supplies. Nobody seems to pay on time – it’s a dance on the edge of what can be gotten away with. My advice – if you can, make a point of paying your bills on time and making sure your vendors are aware of this, so that they’ll value your business and work with you when you need extended terms. And never expect to see your money unless you’ve got somebody riding herd on what you’re owed, making sure nothing is “forgotten”.