5 Financial Decisions Before Starting a Business By Joseph Anthony
It’s interesting to me that more people ask me for advice about starting a business when the economy is stumbling than when things are humming along.
However, that’s not as counter-intuitive as it may at first seem. Getting laid off — or just the possibility of losing a job — often causes people to focus on how they might create their own enterprise.
So, I find myself talking a lot about the financial decisions people must make before starting their own businesses. Here are five of the biggest:
1. How long can you live on your savings? This isn’t an issue for people who are able to raise enough money for their startup venture to pay themselves a salary from Day One. But most small-business startups include the disturbing feature of declining personal bank balances in the early going. As long as you’re looking at your expenses and how long you can live on your savings, you should also figure out now what personal costs you can at least temporarily eliminate. It’s usually emotionally easier to review your personal budget and tighten expenses when you’re contemplating a new venture than it is to cut back after you’ve started. The first path tends to feel voluntary; the second feels imposed by an economic struggle.
2. How deeply in debt are you willing to go? Business loans can fund expansion, help improve profit ratios, and improve overall cash-on-cash returns. In short, business debt can be good. For the smallest entrepreneurs, however, business debt is often personal debt. Many people start a venture by lending money to their business or by simply deferring any payments for their own labor. As many small-business owners will tell you, lenders may make loans to a business, but the business owner will often be required to personally guarantee the loan. So although the debt is on the business’ books, you’ll ultimately be personally on the hook if the enterprise goes sour.
3. What are you going to do about health insurance? In a country with no national system or guarantee of health coverage, this is a big issue. If you currently work for an entity that offers health insurance and is subject to Consolidated Omnibus Budget Reconciliation Act (COBRA) regulations, you can probably temporarily keep your coverage by paying the full premiums on your policy, plus another 2% for administrative costs. It’s possible to keep your coverage under COBRA for up to 18 months. I’ve also seen many people starting new ventures use COBRA as a stopgap, paying the premiums for four or five months until they find a health insurance plan more affordable or more appropriate for their individual needs.
4. Have you lined up your lines of credit in advance? The time to get approval for a loan is when you don’t need one. If you have a lot of equity in your home, it’s currently possible to set up a home equity line of credit that will let you borrow money at 1 percentage point over the prime rate or less. Banks and other lenders are, for obvious reasons, more willing to make loans to someone who has had a job with a steady paycheck for several years than to someone who has just quit to enter the wild, wonderful world of self-employment. If you have an excellent credit rating, you can probably get a home equity or other secured loan with a minimal amount of paperwork. Once you’re self-employed, you’ll probably have to provide at least your most recent tax return and other documentation before getting approval.
5. Are you covered against not being able to run your business? You may have some disability insurance through your current employer. The problem is, disability insurance (unlike health insurance) usually cannot be kept or transferred to an individual policy when you leave your job. To protect yourself, get your own disability policy while you are still employed. Once you have the policy established and are paying the premiums, you should be able to keep the policy when you go out on your own. (Check with your insurance agent to make sure that any policy will remain in force after you leave a job.) An added bonus: While the hope is that you never need to collect on a disability policy, benefits you receive on a policy you paid for yourself are free of federal income tax. Benefits on a policy paid for by your employer are taxable.
Joseph Anthony is a tax professional in Portland, Ore., who writes about finance and tax issues affecting small businesses.
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