When it comes to planning for the future, it can be hard for entrepreneurs to focus on anything beyond their current endeavor. Managing personal finances is often an afterthought as so much time and energy is poured into creating and growing a business. Fortunately, there are a number of strategies entrepreneurs can utilize to help set themselves up for financial independence while they concentrate on their true passion.
Diversify. That’s about as generic as financial advice gets, but it’s especially important for entrepreneurs as most tend to invest in only one thing - themselves. That confidence can ultimately lead to great financial reward, but putting all of one's eggs in a single basket comes with plenty of risk. According to the U.S. Small Business Administration, half of all new businesses won’t make it to see their 5th anniversary. Diversifying for entrepreneurs requires a commitment to stashing funds elsewhere in case their vision doesn’t pan out. That could mean seeding a second business, building a cash reserve account, or funding an investment account. It’s hard for entrepreneurs to be anything other than optimistic about the future, but unfortunately optimism doesn’t pay the bills.
Leverage the right savings vehicle. Saving can be hard for entrepreneurs because taking any money away from the business can disrupt its growth prospects. It’s not for a lack of wanting to save, but the priority is plowing earnings back into the business rather than planning for the next venture or a far off retirement. That said, beginning with even small contributions to savings accounts is better than nothing and it sets owners up to be less reliant on a sale of their business to fund future goals. Once an appropriate emergency fund is established, small business owners should consider one of the three following tax-deferred retirement savings vehicles:
Solo 401(k) - for self-employed individuals without employees (other than a spouse). Owners can contribute up to 25% of compensation along with an additional employee contribution of up to the lesser of 100% of compensation or $18,000 ($24,000 if age 50 or above). The total contribution between the two can’t exceed $54,000 ($60,000 if age 50 or above).
SEP-IRA - for self-employed individuals with (or without) employees. Owners can contribute up to the lesser of 25% of compensation or $54,000. If there are additional employees, they must also have SEP-IRAs funded at the same percentage of compensation.
Simple IRA – for businesses with fewer than 100 employees. Simple IRAs are similar to traditional 401k plans but made simpler and more affordable for small businesses to administer. The employer is required to contribute either a matching 3% of compensation or a 2% non-elective contribution for all eligible employees. Owners and employees can contribute up to $12,500 annually ($15,500 if age 50 or above).
Don’t forget about a Roth IRA. With their tax-free growth and tax-free distributions, Roth IRAs are great long term investment accounts for those who qualify. Depending on earned income (phaseouts begin at $118,000 for single filers and $186,000 for joint filers) funding a Roth each year along with contributions to one of the above tax-deferred retirement accounts can be a great way to maximize retirement dollars. Many high earning entrepreneurs overlook their ability to contribute without realizing they qualify once self-employment deductions are accounted for.
Protect the most important asset. Guard against the unexpected with appropriate amounts of term life insurance, disability insurance and health insurance. Be sure to carry liability and/or umbrella insurance as well. More than just the business, family and loved ones can be impacted without having these policies in place.
Plan an exit. It can be hard for entrepreneurs to picture not being a part of the business they started, but at some point that will be a reality. While this isn’t something to worry about right away, beginning to plan sooner rather than later should result in a smoother (and more profitable) ride off into the sunset. Having time to mentor key employees and “institutionalizing” the business by ensuring normal day to day operations can function without the founder will result in a more attractive business for potential buyers.
With so much time and energy spent on keeping a business running, it's easy for entrepreneurs to neglect their personal finances. For many, it’s not until they are ready to sell that they begin thinking about the ramifications of a payout for all of their hard work. Rather than waiting until that day does (or doesn’t) come, entrepreneurs should establish relationships with a team of independent legal, tax and financial advisers early on to protect their flank and enable the singular drive towards entrepreneurial success to stay on target.