Sep 07, 2017

Financial Considerations for Prospective Entrepreneurs

By Jarrod Upton

For many people, the desire to be self-employed is a very strong and compelling motivation. These are people who desire to be their own boss, to set their own hours, to determine their own agenda, and to chart their own destiny. This desire for independence is an admirable virtue but too often they are not fully aware of all the ramifications and consequences that being self-employed can mean.

Often a person will have a great idea, or have a special skill, or will find a product or service they believe will do well in the marketplace, and they decide to start a business. However, their ideas, skills and products/services aside, they may not have the background, education or understanding about what it takes to successfully manage a business.

In this article, I’d like to highlight a few of the major considerations:

Legal Business Structure

First and foremost, a person starting a business has to decide what kind of business structure they are going to create for their company. This decision will have a major impact on the amount of money you will pay in taxes; the personal liability you could face; the capacity of your business to raise money; and the paperwork your business will be required to generate.

The most common forms of business are:

  • Sole proprietorship
  • Partnership
  • Corporation
  • Limited Liability Company
  • Limited Liability Partnership

Because each business structure has its own discrete tax consequences, you will want to make sure that the structure you select most closely matches your business's needs.

Here’s a great article from Entrepreneur Magazine that provides a detailed explanation of the different kinds of business structures.

Sufficient Capital

According to the U.S. Small Business Administration, over 50% of small businesses fail in the first year and 95% fail within the first five years. One of the primary reasons for this failure rate is because the business wasn’t properly capitalized, meaning it did not have sufficient money in reserve to support and sustain the business until it became profitable.

Sometimes this is referred to as “burn rate.” How much money – either from personal savings or investment – do you have in reserve that you can “burn through” until you business generates sufficient income to sustain itself? More often than not, most people don’t have sufficient capital reserves to last until that point.

Cash Flow Management

Another major mistake that some new business owners make is not managing their cash flow properly. Often they do not have an accounting background themselves, or they fail to engage the services of an accountant or bookkeeper, in which case it is very easy for business receipts and expenses to go unaccounted for.

Too often they might co-mingle business and personal expenses, making it difficult to ascertain an accurate picture about how the business is faring. Also, this can be a very slippery slope when it comes to paying taxes.

A couple of solutions to that problem: Have one credit card for your business and one for your personal use, and never mix them up. Also, Quickbooks is an excellent software accounting program specifically designed for small businesses.

Self-employment Tax

Any small business owner who is generating an income is obligated to pay taxes on that income, just as if they were a wage earner working for an employer. But what is often new to a small business owner is their additional obligation to pay for their own Social Security and Medicare taxes. This is referred to as a Self-employment Tax (SE tax).

People who work for a company are accustomed to having their employer pay for a portion of their Social Security and Medicare taxes. So it can be quite a shock when a small business owner has to pay for all of their SE taxes themselves.

Currently the SE tax rate is 15.3% - 12.4% for Social Security and 2.9% for Medicare.

We Depend on Entrepreneurs

According to U.S. Census Bureau data from 2014, there were 5.83 million employer firms in the United States.

  • Firms with fewer than 500 workers accounted for 99.7 percent of those businesses
  • Firms with less than 20 workers made up 89.4 percent of businesses

As a result, America’s economy depends on small businesses and the entrepreneurs who create them. Small business is a powerful engine for creating new jobs and it continues to be an incubator for invention and innovation. Yes, it might be inherently risky to start a business but we need people who are willing to take the risk, and we need for them to be properly trained and educated so their businesses can succeed.

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