Starting your own business can be a rewarding and life-changing experience. Pursuing a personal passion, developing a meaningful environment, and fulfilling a niche that meets the needs of others can give our work meaning. The rewards can certainly be great. However, it’s important to remember there are two sides to every coin. Understanding both the rewards and challenges of owning a business can help you prepare for changes in your financial plan.

Putting your personal and financial lives — as well as overall well-being — on the line is no small thing. We encourage our business-owner clients to approach decisions weighing pros and cons and, to the extent possible, considering long-term effects. This quarter, we’ll offer ideas as to exactly how business ownership might affect you personally, whether you’re starting small or taking a jump into the deep end.

How might your business affect your personal financial goals?

Running a business can positively and negatively impact your personal financial goals. With a successfully functioning business, many business owners experience higher income. But the increased income is often accompanied by increased expenses and financial risk. Business owners must be prepared for the possibility of financial loss if the business is not successful. Fluctuating income and unexpected costs might require dipping into personal savings, so increasing your emergency fund may be necessary to cover additional business expenses. Budgeting can also help identify areas of spending and savings and help make monthly income and outflow more consistent.

If your personal cash flow needs change, consider structuring your compensation (salary and/or distributions) to optimize your net income. A discussion with your accountant or financial planning professional can be helpful to determine what’s best.

Will you need to use personal assets to start the business?

If you will use personal assets as seed money, consider which accounts will most efficiently fund your initial investment. You’ll also want to think about how much of your personal net worth you feel comfortable investing in the future, while weighing the risk of losing those assets if the business doesn’t succeed as planned.

Do you have a contingency plan if the business does not grow as expected?

With a strong business plan, going “all in” can lead to the success you envision and leave you without regrets. But even the most refined business plan always has unexpected wrenches. If the business doesn’t grow as expected, a contingency plan should be in place. Maybe that’s altering the goals of the business. Or maybe it means having an alternative employment plan. Such plans can help avoid a financial catastrophe.

Do you intend for the business to be your sole source of income?

Recognizing that income can fluctuate before a business becomes stable and planning for that possibility by building up savings allows for more flexibility for the business to be your sole source of income. Part-time income can be a consideration when making the transition from a stable salary to going out on your own.

Are benefits available through your spouse’s employment?

Consider whether it makes sense to use your spouse’s benefits rather than purchasing benefits through your business (or the Health Insurance Marketplace). Be sure to factor in a cost comparison as well as any tax deductions/credits you may be eligible for.

Will your personal tax situation change?

As a business owner, you will be responsible for paying taxes on your business income. This includes self-employment taxes, which are taxes that are paid on income earned from self-employment, as well as income tax. These taxes can be substantial and can significantly impact your finances.

On the other hand, owning a business can also bring financial benefits such as tax deductions for certain start-up costs, home office expenses, health insurance costs, and other business expenses, depending upon your circumstances. There are several retirement plans that can reduce your tax liability. (We wrote about retirement plan options for the self-employed in a previous blog series. Click here to read those posts as well as other topics for business owners.)

A qualified tax professional can help guide you in your choice of business entity, which affects your tax situation. These professionals can also help answer questions about sales tax requirements, quarterly tax payments to avoid underpayment penalties, and eligibility for the qualified business income deduction.

Do you need to reassess insurance coverage in light of being a business owner?

Life and disability insurance are common coverages in personal insurance portfolios that should be revisited as a business owner. The growth of the business has the potential to increase the income of owners and executives, so life insurance should be reviewed. Perhaps a new policy should be added to cover the loss of potentially higher future income.

Life and disability policies are important to protect your family. Likewise, as a business owner, you’ll want to consider coverage to address business-related risks. To protect a business in the event of an owner’s or executive’s death, it is common for business owners to add key person insurance or a buy-sell agreement.

Key person insurance is a life insurance policy that a business takes out on the life of the owner or other individual determined to be critical to the business. The company owns the policy on the key person’s life, pays premiums, and is the beneficiary of the death benefit. This helps ensure financial stability for the business.

Buy-sell agreements are legally binding contracts that stipulate how a partner’s share of the business may be reassigned. The agreements often use life insurance policies on the life of owners to help ensure continuity of the business upon the death of an owner.

Disability events and facility damage can also be devastating to a company and should be considered as part of business insurance planning. Overhead expense insurance and business interruption insurance often cover these scenarios but have different purposes. Business overhead is coverage on a key person in the business, is paid to the business, and is deductible by the company. The purpose is to provide cash flow if a key person experiences illness or injury that takes them away from the business. Business interruption coverage offers protection if the business facility itself is damaged.

As a fee-only financial planning firm, we don’t sell insurance. Rather, we refer our clients to trusted independent agents to run analyses, offer recommendations, and establish policies that protect them.

How does business ownership affect work-life balance?

Business ownership not only has financial effects, but it also impacts an individual’s time and energy. Running a business can have high demands, and it often requires long hours and hard work. The sacrifice of personal time and energy to ensure the success of your business can affect other areas of life. For example, it can encroach on time committed to personal relationships, hobbies, and physical and mental health. Running a business can be a high-stress endeavor. It comes with many responsibilities and countless decisions to be made.

However, business ownership also allows you to be your own boss, make your own schedule, and have more control over your career path. It can give you a sense of pride and satisfaction, knowing that you have built something from the ground up. It is important to be prepared for the challenges and rewards that come with business ownership. And that includes having a plan to maintain a balance between work and personal life.

Much of a successful transition into business ownership comes down to preparation, both financial and personal. We at Flagstone have the experience and expertise to help equip our clients with the knowledge to successfully start a business. Contact us to see how we might be able to help you prepare to take the leap into business ownership.

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