You’ve taken the plunge to go into business for yourself. You have an excellent company name, a stunning website, and all the talent and passion for your area of expertise – you’re bound to succeed, right?
But in entrepreneurship, talent is only half of the puzzle.
What’s the other?
Many new business owners don’t fully prepare for the massive financial undertaking required – incorporating, saving and paying for quarterly taxes, saving for retirement, buying insurance, start-up costs, ongoing maintenance, hiring employees, etc.
Entrepreneurs encounter many financial risks, so it’s essential to protect yourself as you forge a new path. Here are some simple yet foundational ways business owners can financially protect themselves.
1. Separate Business and Personal Money
When it’s just you and your laptop, it might be easy to pay for a new printer or office chair with your trusty credit card, but blending personal and business finances can be extremely messy.
Once you go into business for yourself, it’s imperative to open separate business banking and credit card accounts. Why is this step so critical?
Separate accounts are paramount for tax purposes. As a business owner, you can take many tax deductions like office expenses, travel, business meals, utilities, supplies, contract labor, and more. But to legally take these deductions, you need to have a clear record that these expenses are paid with a business – not personal – account. If the IRS audits you, you want a clear, unobstructed paper trail to your business accounts.
Creating different accounts can also help you manage business debt. For example, you want any small business loan or other debt tied to the business, not your name. This way, should something happen, your personal assets won’t be an open invitation for creditors.
Personal liability is another important area. If your personal and business money are intertwined, it’s nearly impossible to distinguish between the two – meaning you could be liable should any customer or vendor bring a lawsuit.
Keeping money separate is actually much simpler than digging through a hodgepodge of receipts and statements come tax time. So how can you effectively keep business and personal money separate?
- Open a business bank account
- Open business credit cards
- Establish a reliable accounting system
- Put yourself on the payroll and pay yourself a salary
2. Create the Right Business Entity for Your Company
Are you an LLC, C corporation, sole proprietorship, or one of these but taxed as an S corporation?
Did that sentence just sound like business alphabet soup?
Fear not, these are simply different business entities you can create to support your company. Establishing the proper business structure can make tax time less stressful and provide a layer of legal protection. So which is right for your business?
A sole proprietorship is the simplest business entity as it’s owned and run by one person. Freelancers and contract workers tend to benefit from this entity. A sole proprietorship is a pass-through tax entity, meaning the business doesn’t file a tax return. Instead, all tax documents pass through to the owner’s personal tax return.
While the owner retains complete control over the business, a sole proprietorship doesn’t offer much legal protection. You still have risk exposure and would need to supplement personal liability with other insurance policies.
Limited Liability Company (LLC)
LLCs are one of the most common small business structures as they are relatively inexpensive and straightforward to set up.
Unlike a sole proprietorship or a business partnership, LLCs offer more robust personal liability protection. This means that as the owner, you’re not necessarily personally responsible for any debt incurred by the business. It protects your personal assets (house, car, investments, etc.) from creditors or lawsuits.
LLCs are also pass-through entities for tax purposes, so business profits and losses pass through to the owner’s personal tax return. Pass-through entities also offer additional tax deductions via the Tax Cuts and Jobs Act – a 20% deduction for net income earned by the business.
Keep in mind that while LLCs can be tax-friendly on the federal level, they can incur additional state tax.
Corporations are the most complex option yet offer the most legal separation between the business and its owners. This designation is usually best for established companies with several full-time employees.
There are two types of corporations, each taxed differently:
- C corporations (C-corps)
- S corporations (S-corps)
C-corps are taxed as a separate entity, so the business files its own tax return. Shareholders also have to pay personal taxes on the company’s profits, which is where c-corps get their “double taxation” reputation.
S-corps aren’t a legal entity, rather just a tax election. C-corps can choose to be taxed as S-corps should it make more sense for their business and shareholders. For tax purposes, S-corps elect to pass business profits and losses through to the shareholders. Since shareholders pay taxes on their personal returns, S-corps avoid double taxation.
Which entity is right for you? Consider the following questions:
- How much personal liability is appropriate for your business?
- How many employees/contactors do you have now, and how many do you anticipate having in the future?
- Do you see your company growing beyond just yourself?
- What tax structure makes the most sense for you, short- and long-term?
3. Carry Appropriate Insurance Coverage
Small business insurance is a crucial way to protect you and your company, but most small businesses are woefully underinsured. Next Insurance found that 44% of small businesses in operation for at least one year didn’t have any insurance.
Why do businesses take such a risk?
It’s likely because small business insurance isn’t something many people consider at the beginning. People care about finding health insurance and maybe personal liability insurance, but there are several other types of insurance you should consider depending on your business, service, or product:
- Personal and professional liability insurance
- Business income coverage
- If you have employees, you’ll likely need unemployment, workers’ compensation, and disability insurance
- Product liability insurance (if you create or manufacture a product)
Along with business-specific insurance policies, you’ll want to find health coverage, life insurance, auto insurance, home insurance, and potentially umbrella coverage.
Why Entrepreneurs Need Disability Insurance
Many entrepreneurs often overlook disability insurance, but earning an income is a valuable asset worth protecting.
How would you pay the bills if you had a severe injury that left you unemployed for months? Yes, you may have an emergency fund, but that’s a short-term fix, not a long-term solution.
Disability insurance pays out a portion of your monthly income should an injury or illness prevent you from working.
But why should you add another monthly premium to your budget? Because the risk of long-term injury is much higher than you might think. The Social Security Administration estimates more than one in four 20-year-olds will become disabled before retirement.
How can you get good coverage? Many entrepreneurs benefit from group associations and leveraging a network like Freelancers Union. They offer group disability rates that protect 50% of your income up to $120,000 of salary. If you want additional coverage, you can explore private policies.
In short: disability insurance protects your paycheck. Your income is essential to keeping your business running and caring for you and your family. Disability policies come in many shapes and sizes, and depending on the income you need to replace, you can consider either group or private policies.
Insurance may not be the most exciting entrepreneur topic, but it can keep your assets safe in case of an unexpected event.
4. Save for Retirement and Beyond
When you strike out on your own, you have to work harder to save for retirement. Establishing a robust retirement savings plan as a small business owner is an effective way to ensure financial success. Depending on the type of business you own and the number of employees you have, consider the following avenues:
- SIMPLE IRA
- Traditional or Roth IRA
Each account comes with different benefits, but each allows you to save and grow funds for your golden years. Saving as an entrepreneur can be challenging, especially with inconsistent income, business expenses, insurance costs, and more. But establishing a plan now will allow your money to compound over time – its own valuable asset you don’t want to squander.
Retirement isn’t the only goal your business can save for, so think about your business goals long-term:
- Is there a new piece of equipment or software that will take your product or service to the next level?
- Do you want to pursue an advanced degree, obtain a certificate, or enroll in continuing education?
- Is it time for your business to have a storefront?
- Do your growth goals support recruiting and hiring top talent?
- Do you want to establish a company match, stock options, or other employee benefits?
- Are you looking to acquire another company?
There are several business savings ventures you may want to eventually pursue. Creating a savings plan at the outset will give you the flexibility to take advantage of potential opportunities later.
Bonus: Diversify Your Income
Just as you don’t want to mix your business and personal finances, you don’t want your business to be your only financial asset.
Be sure to diversify your income outside of your business. Perhaps that’s investing in a separate investment account, being involved in real estate, having a side-gig, etc.
Earning income from more than one source is essential for your protection should something happen to your business.
5. Adapt Your Financial Plan As You Go
When it comes to money, entrepreneurs have a lot on their plates. They have to save for retirement, maintain their personal funds, and keep the business running – no small feat.
To simplify, start with the basics and mindfully build from there. When it comes to long-term business success, stability is key. The more you can stabilize aspects such as cash flow, savings, spending, and investing, the more you can effectively control how money moves through your business.
That said, entrepreneurs know that in business, change is the only constant. That’s why flexibility should be emphasized in your business’s financial plan.
Your goals may evolve as your business grows, and your finances should evolve with them. Maybe you never saw yourself hiring another employee but now you’re excited about serving more clients and building a team. That goal will require a different financial approach, but will be worth the planning effort.
Entrepreneurship has many financial risks, so it’s essential to protect yourself now and in the future. Abacus advisors love helping business owners find confidence and clarity in their financial life. Are you protecting yourself and your business goals in a way that honors your values? Let’s talk about it together.