Taking that tentative first step to establishing your own business can be both an exciting and worrisome time. You may have given up a secure and financially rewarding position as an employee in order to follow your dream. You will also no doubt have consulted with family members and friends, spent many hours working on a business plan, checked out your potential market and produced a cash flow forecast for at least the first two years. However, one aspect of your new start-up that may have been overlooked is why and how to go about separating your personal finances from those of your fledgling business.
When first starting out you will have so much to do, marketing, preparing quotations and actually running the business, that it can be tempting to muddle through, using your own cash to settle suppliers’ accounts, for example, or having receipts from customers paid into your personal account. Taking this lackadaisical approach may seem harmless at first, but when it comes to producing your first year-end accounts and preparing IRS tax returns you could easily find yourself experiencing major issues. What’s more, if your new enterprise begins to fail, heaven forbid, you may find yourself in personal financial difficulties. Perhaps the worst-case scenario is that if you have used your home as collateral against a loan you might find you and your family out on the street.
It is a sad fact, but some 12% of new businesses in the U.S. fail in the first year. What this number does not reveal, however, is the personal trauma and distress that inevitably follows when a company fails. Marriages and personal relationships are put under tremendous pressure, which can easily lead to breakups. It is therefore essential that if you have a family, you discuss what, if any, personal savings or other assets are to be used to finance the business.
Fortunately, there are a few simple steps you can take to ensure that before day one of your new career as an entrepreneur you maximize your chances of being successful.
As mentioned previously, not all new businesses survive past their first year. Even long established companies fail for one reason or another. If you find yourself in a situation where you can see no prospect of paying off your creditors, accept the fact without delay and contact a legal expert in the field of bankruptcy and restructuring. Thanks to the power of the Internet a quick online search will identify a plethora of highly reputable attorneys. A typical example is Suzzanne Uhland, a Partner at O’Melveny & Myers, LLP. Suzzanne graduated from Yale and Stanford Universities and holds three degrees in law related subjects. She regularly speaks at national conferences and events on subjects such as ‘Treatment of Intellectual Property Licenses’ and ‘Derivatives and Insolvency’
Planning, planning, planning
Before leaving your current job, calculate as accurately as possible the level of income necessary to pay household bills, children’s education, utility bills, holidays and car/fuel costs. Be sure to add in a contingency figure of say 10% of the total for unforeseen expenditure.
Prepare a detailed business plan and cash flow forecast covering at least the first two years of trading and use this to estimate what level of income you can expect to generate. It is frequently the case that little or no profit will be forthcoming for the first year or so.
Set up a separate bank account for your new business. This is the only way to truly maintain a firewall between your business and personal finances.
Many budding entrepreneurs obtain funding from personal savings or friends and family. This is all very well, but be sure to treat any such loans as if they were from a bank or other financial institution, which means documenting the amounts involved, the loan period, any interest due and the repayment terms.
Other options include business loans from banks or similar, crowd funding and venture capital companies. All will require you to provide comprehensive business plans, budgets and cash flow forecasts.
Credit cards offer a useful source of short-term funding, but should only be used as a last resort because the interest rates they charge make them unsuitable for extended periods. Be sure to obtain a card or cards specifically for business use, in the name of the company. Never be tempted to use your personal card for business use.
One final tip, on the subject of loans and credit cards; should your company run into difficulties and you are unable to make scheduled repayments, your personal credit rating will suffer should you have taken out personal loans on behalf of the business.
To conclude; separating personal and corporate finances may seem irrelevant when you are just starting out as a one-person business, but establishing a ‘big company’ ethos from day one will make coping with growth easier, ensure you avoid problems with IRS tax returns and prevent your personal financial status being compromised.