Being a small business owner or entrepreneur is fun, exciting, and rewarding. But it can also introduce your business to certain levels of risk that employees of other organizations don’t have to face. Thus you need to be proactive in protecting your personal finances from unwarranted risk.
Smart Tactics For Protecting Your Personal Finances
The road to entrepreneurial success is laced with risks. And even when you arrive to a point where you’re deemed “successful,” you still face numerous challenges.
One of the biggest challenges involves protecting your personal finances from any financial or legal challenges that the business may face.
Here are a few suggestions:
1. Choose the Right Business Structure
Most people think about business legal structures in terms of tax favorability. But there’s also something to be said for protecting your personal finances.
The four most common types of business entities include:
- Sole proprietorship. This is the most basic type of entity. (In fact, you don’t even have to declare anything to be a sole proprietor – it’s the default.) The problem with a sole proprietorship – from a legal perspective – is that there’s no separation between personal and professional assets. Thus, if you were to get sued, the other party could come after your cash, investments, house, etc.
- Partnership. When a business is owned by two or more people, a partnership is often the preferred option. There are two types of partnerships: (1) A general partnership, where everything is shared equally; and (2) A limited partnership where one partner controls the operation and the other partner contributes to and receives part of the profits.
- LLC. This entity is basically a hybrid structure that allows business owners to limit personal liability and still enjoy the tax advantages of a partnership. LLCs are easy to set up and maintain.
- Corporation. Finally, there are corporations. These entities have their own legal rights independent of the owners. In other words, the business can be sued separately from the individuals who own or operate the business.
Each of these four business structures comes with its own unique set of pros and cons. It’s up to you to determine how much protection you need, which opportunities you have, and how to proceed. (Most small business owners like LLCs for their ability to separate assets.)
2. Follow the Rules
Simply having a business entity doesn’t always grant you full protection. In order to enjoy these protections, you must play by the rules. A failure to do so could expose you to certain risks.
Let’s look at an LLC as an example. While an LLC is designed to provide separation between personal assets and business assets, all of this protection can be lost if you “pierce the corporate veil.”
Piercing the corporate veil is legal jargon for commingling assets. It could be as simple as buying a personal item on one of your business credit cards. Or it could be as serious as funneling extra money from your business accounts to your personal checking account without going through the proper steps. Either way, it causes the protective veil to disappear – leaving you vulnerable to lawsuits and other unwanted external threats.
3. Get Insured
As a business owner and entrepreneur, insurance is very important on multiple fronts. In addition to having the right insurance policies for your business, it’s also vital to have the right life insurance policy on yourself (and perhaps any business partners that you have).
The key when getting life insurance is to make sure you’re choosing the right policy from the right company. Check out this list of the 75 worst life insurance companies for paying claims so that you know which ones to avoid.
4. Diversify Income Streams
When you’re an entrepreneur, it’s always helpful to have multiple streams of income so that you don’t become too dependent on any one source of money.
Be on the lookout for ways to diversify income streams by looking at different sources outside of your primary business. This might look like starting another business, investing in income-producing assets, buying an annuity product, or something else entirely.
5. Build Up an Emergency Fund
You never know when you’ll experience a dry spell or the economy will take a downturn. And that’s why it’s always smart to keep a personal emergency fund on hand.
The general rule of thumb is to keep an emergency fund of at least three to six months of expenses. Thus, if it takes you $5,000 to pay your bills every month, you need somewhere between $15,000 and $30,000 in the bank.
An emergency fund should be kept separate from your checking account. This is money that you only touch if you absolutely have to. (And once you do touch it, your foremost objective is to fill it back up as quickly as possible.)
6. Separate Assets
Even with an LLC or other protective legal entity, it’s smart to establish as much separation as possible between your personal and business assets. Meet with an attorney to figure out the best route. You can use different investment vehicles to shelter certain types of assets. There may also be situations where it makes more sense to put certain assets in a spouse’s name. (With the right legal counsel, you’ll be able to formulate a game plan.)
Looking Towards the Future
It’s only natural to focus on the here and now. But if you want to be successful over the long-term, you have to keep one eye on the future. And that means implementing and executing financial strategies that set you up well for the months and years to come.
The most successful entrepreneurs tend to be the ones with the most discipline and patience. If you’re willing to put the right safeguards and contingency plans in place, you’ll find it easier to overcome mitigating circumstances and win.
Using the principles outlined in this article, take some time to develop an actionable game plan that steadily moves you from where you are to where you want to be – protecting and growing your business finances and personal finances along the way.