Many people like the idea of becoming entrepreneurs, but they cannot tolerate the personal financial risk involved. If you are starting a business from scratch, you may have to pay thousands or tens of thousands of dollars for start-up costs necessary to get your business up and running.
If you take out personal loans to finance the business, you could be held legally and financially responsible for those loans, even if the business goes bankrupt. If you are able to start the business without incurring significant personal debt, you will still have to deal with variables such as income inconsistency, which can make effective budgeting difficult.
If the fear of personal financial risk is holding you back, you should know that there are powerful strategies that can help you mitigate that risk.
Establish an LLC or Corporation
One of your best strategies is to establish the right structure for your business. If you start a sole proprietorship or a partnership, you could be held personally liable for almost everything related to the business; this means that you will be responsible for paying all debts related to your business and you could be sued by your customers, employees and other contacts.
On the other hand, if you are starting a limited liability company (LLC) or corporation, you will have at least some degree of liability protection. These business structures allow your business to be treated as if it were a whole person. The business itself can take out a loan, incur debt and be the target of costly lawsuits, reducing your personal exposure to these financial risks.
Just be aware that this does not grant you unlimited liability protection; it is always possible to incur personal debt and you can be legally liable for acts of gross negligence in many scenarios.
Never take out a personal loan
New business owners are tempted to fund the business themselves, even if they don’t have the savings to cover these expenses. They take out personal loans, max out their credit cards, or go into debt in other ways to get the money they need. A few small expenses here and there won’t hurt you, but most of the time, you should never take out personal loans. Instead, work with investors, dip into your savings or rely on your trade credit take out loans in the name of the company.
Focus on independent savings strategies
You will be much less exposed to personal financial risk if you have a solid financial base. This means significant savings withstand revenue volatility as your business grows and reduce the impact of a total business meltdown.
- Budget and frugality – Be smart with your budget and try to stay as frugal as possible. If you don’t have a lot of savings and your business is going to be your main source of income, you should lead a modest life and focus on your extra income.
- An emergency fund – It is also a good idea to build up a solid emergency fund. Set aside at least enough money to cover a few months of personal expenses. That way, if your business has a bad month or two, or the business suffers a total meltdown, you can buy enough time to react properly.
- Tax-advantaged investment vehicles – With any extra money, use tax-efficient investment vehicles to maximize your savings and plan for retirement. For example, the Roth IRA in the United States can help you grow your retirement savings tax-free, while the RESP rate of return in Canada can help you save for your children’s college education.
Diversify your income streams
Next, try to diversify your sources of income, both within the company and on a personal level. Within the business, this might mean selling several different types of products and services, monetizing your content or apps in different ways, or even targeting different audiences. That way, if only one revenue stream is threatened, you’ll have the others to act as backups.
The same principle applies to you as an individual. You can diversify your sources of income by investing in dividend-paying stocks, investing in real estate, starting freelance blogs or websites, or even taking side gigs. These do not have to provide a full-time income; any extra cash you generate will be valuable in mitigating your personal financial risk.
There is no way to completely avoid personal financial risk when starting a business. Risk is an inevitable part of the deal, but with the right strategies, you can mitigate your personal risks, ease your worries, and feel more confident about starting your own business.