There was a time when the “American Dream” was defined as owning a modest home, holding down a steady job, and raising a few children. Now, more than ever, the “American Dream” is defined as entrepreneurship. Owning a business is seen as the key to financial independence, as business owners aren’t beholden to their employer’s idea of what they should be making, how many hours they should be working, or how many vacation days they are entitled to.
It’s easy to get caught up in the dream of working for oneself, but there are serious financial risks that come along with starting a business. The failure rate is extremely high. According to the Small Business and Entrepreneurship Council, only 50 percent of new businesses survive their first five years of operation, and only 33 percent reach the 10-year mark. While no one can accurately predict success, the old adage, “failing to plan means planning to fail” is especially applicable to entrepreneurial ventures. Financial planning is critical for any entrepreneur that wants to set their business up for success.
1. Tax Planning
The way in which a business is structured has serious tax implications for both the business and the entrepreneur. Sole proprietorships are taxed differently from partnerships, which are taxed differently from limited liability companies (LLC) and corporations. For example, the business income of a sole proprietorship is taxed as personal income, but in other business structures, income flows through the company itself which can significantly complicate the reporting of gains and losses. It is important to work with a financial planner early on to determine the best way to set up a company’s structure.
2. Risk Management
Most heads of households know the importance of individual life insurance and disability insurance to mitigate against risk. However, business owners must also consider risks such as death of a business partner, natural disaster, and other interruptions in business, loss of property, and litigation. Specialized insurance policies must be put in place to protect both the business and its principals in the face of unforeseen circumstances.
3. Retirement Planning
Many entrepreneurs believe they will work until their dying day, but retirement planning is still a necessity. Proper retirement planning not only ensures that the entrepreneur will be taken care of in their golden years, but that their spouse and dependents will, as well. Additionally, business owners must decide if they will offer a company-sponsored retirement plan to employees. Working with a financial planner can ensure that everyone involved in the business has the ability to save for retirement, and realize the tax benefits of retirement planning.
4. Investment Planning
Once a business becomes profitable, entrepreneurs will have to decide when and how they will invest their money. Will it go back into the business itself? Will the company invest in other avenues? How will the business owner control those returns? These are all essential questions that can impact the long-term profitability and sustainability of a business.
5. Estate Planning
A profitable business is an extremely valuable asset, and business owners must decide how they will use that asset to benefit heirs. Family trusts and wills are not enough to transfer a business to other family members. Estate planning is complicated, and estate taxes can be a veritable minefield for those left behind. Early estate planning is critical to protect not only family members, but the ability of the business to carry on once the business owner has passed.
Start the Financial Planning Process Sooner, Rather than Later
It is never too early for an entrepreneur to work with a financial planner. Attempting to manage finances and planning alone can be a recipe for disaster. Professional expertise is critical in order to maintain profitability and protect assets over the long term. A good financial planner could mean the difference between a success story and a failure.