You know you want to start your own business — whether for better hours, to be your own boss or to pursue your lifelong passion — but first you need to know if you’re financially and logistically ready. Your passion and desire will only take you so far — according to the U.S. Small Business Association, only half of small businesses survive five years, and only one-third survive for 10 years.
Here’s how to assess your risk factors for opening your own business. Look for these key indicators in your life to gauge your readiness to become a business owner.
1. Major Personal Debts Are Paid Down
When setting up a business, your primary goal should be expanding your customer base and getting the supplies, business signs, equipment or inventory you need. You should be prepared for the initial startup costs, from business formation and P.O. Box rental to marketing and taxes. These initial costs should not become a new personal debt or be added to existing debts.
If you have student loans, a monthly car payment and revolving credit card debt, you might not be financially prepared for opening your own business. Try a debt payoff approach like the snowball method: Make a list of your debt and work on making extra payments to pay them down each month, starting with the smallest debt. After the smallest debt is paid off, put more money toward a larger debt until your monthly debt obligations are significantly reduced.
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2. You Have Financial Projections for Your Business
Before you go out and purchase new computers and high-end photo editing software or high-speed wireless internet for your home office, have a plan for every dollar you spend. Create a realistic business budget by assessing which supplies, utilities and other costs are truly essential and which expenses you can add later when you’re turning a profit.
“Prepare detailed financial projections for the business and make them an integral part of your business plan,” said Deborah Meyer, CEO of fee-only financial planning company WorthyNest. “Most start-up businesses require a personal, financial commitment up front. Although technology has made barriers to entry lower, each business has startup costs that will not be funded through outside sources,” she said.
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One of the signs you should start your own business is you have the budget for the initial startup costs to get your business off the ground — and you have determined exactly what these expenses will be. Be specific. It’s not enough to list that you need a website. You need to research and itemize the actual cost of creating and maintaining the site.
You also might be ready to launch your company if you have an understanding of which startup costs are tax deductible the first year of doing business, which costs can be amortized in the following years, and which costs are considered personal expenses. Capital expenditures such as sales inventory, property and vehicles are one-time costs that might not be deductible but can be written off through depreciation.
“The financial projections will provide much-needed clarity on current and anticipated costs related to the business activity,” Meyer said.
3. You Have a Backup Plan — or Your Day Job
You have researched how to start a business and you have decided what business to start, but you also need a plan for what you’ll do if your business does not have the initial cash flow you anticipated or you do not reach your sales goals.
If you can afford to, don’t quit your day job right away. You might be telling everyone, “I want to start my own businesses,” and even think, “I know how to start my own business,” but you need hard, documented data to show on paper that you really can afford to do so.
If keeping your day job might be impossible because your new venture is in the same line of business as your employer, consider your monthly income of your current career and how long you can survive without it. You might decide to quit your current day job and take a part-time job in another field as a side hustle to provide supplemental income while you become your old employer’s newest competitor.
Your backup plan could include going back to work in your field for someone else as a full-time employee or consultant. You can reduce your number of clients to make it easier for you to work a typical job and do business on the side. Or, you can go back to school to pursue a new area of study. Either way, have an emotionally satisfying and logistically sound plan ready just in case.
Along with a backup plan for income, you should have an emergency fund for your business and an emergency fund for yourself. The last thing you want to do as a new business owner is mix your personal assets with your business assets. To avoid using business assets to pay personal bills, or vice versa, you can draw from the emergency fund if cash flow is tight one month. Be prepared for lulls in business and emergencies.
4. You’ve Written a Business Plan
“Some entrepreneurs fail to write business plans because they don’t want to test their ideas too much for fear they won’t withstand the scrutiny,” said Scott Shane, in his New York Times column “You’re the Boss: The Art of Running a Small Business.” But testing your ideas is the very reason you should write a business plan before you take the plunge.
“Taken seriously, a business plan will show that some businesses should not be started, a possibility some entrepreneurs don’t want to confront,” Shane wrote.
Start with a simple one-page business plan to communicate your service, identify how it solves a problem, how you will make money, how much money you’ll need, and how much money you anticipate you’ll make within a specific time frame.
5. You Have a Pitch
If you’re seeking capital funding, you might benefit from focusing on how capable you are of executing your business plan. “Focus on your executive summary rather than your business plan,” said Andrew Schrage, co-owner of Money Crashers Personal Finance.
“It should be brief, concise, and to the point,” he said. “Speak in plain yet convincing terms of your qualities and characteristics, while also covering the other facets of the summary. Avoid business jargon.”
Schrage also said you should include real-world, specific examples of how you’ve succeeded in the past, as well as how you plan on running the actual business. “Be sure to address the financial end of things, such as cost management, sales projections, and marketing strategies,” he added.
6. You Have a Good Credit Score
A credit score in the high 600s to low 700s will show lenders you are trustworthy and that you can be backed financially when you start your own business.
“If this if your first business, credit card providers and loan officers will carefully examine your personal credit score since your company has no credit history,” Meyer said. She advised prospective business owners to consider separating personal accounts from business ones.
“Once you set up the business, open a bank account and credit card in the business’ name to distinguish it from personal assets,” she said. “This will also enable you to build credit history for the business itself.”
7. You Understand the Tax Consequences of Your Business — and Its Structure
You have a variety of ways to structure your business, providing asset protection, limited liability and tax benefits. There might even be reasons to form your business or limited liability company in another state. For example, the state of Delaware is recognized worldwide as the most corporate-friendly state in the U.S. Part of your planning and preparation should include consulting a knowledgeable tax advisor on your best course of action.
“You should consider how you would like to set up your business in order to accomplish all of your goals,” said Laurie Samay, CFP with Palisades Hudson Financial Group.
“When selecting a business structure, you should seek asset protection as well as tax benefits,” she said. “Limited liability companies are extremely popular for small business owners. It is very flexible, providing liability protection to the business owner, while allowing profits and losses to flow directly through to the owner’s tax return, without being taxed at the entity level.”
Starting your own business can be exciting and scary. To avoid becoming a small business failure statistic — and to alleviate some anxiety for yourself and your creditors or investors — know how you’ll survive financially and seek guidance from tax and industry experts before you quit your day job and launch your business.
Holly Hammersmith contributed to the reporting for this article.