Many people like the idea of becoming entrepreneurs, but they can't tolerate the personal financial risk involved. If you're starting a business from the ground up, you might have to pay thousands or tens of thousands of dollars for the startup costs necessary to get your business up and running.
If you take out personal loans to fund the business, you could be held legally and financially responsible for those loans, even if the business fails. If you're able to start the business without taking on significant personal debt, you'll still have to deal with variables like income inconsistency, which can make it hard to budget effectively.
If fear of personal financial risk is holding you back, you should know there are some powerful strategies that can help you mitigate that risk.
Establish an LLC or a Corporation
One of your best strategies is going to be establishing the right structure for your business. If you start a sole proprietorship or a partnership, you could be held personally liable for almost anything related to the business; that means you will be responsible for paying any business-related debts you incur and you could be sued by your clients, employees, and other contacts.
By contrast, if you start a limited liability company (LLC) or a corporation, you'll have at least some degree of liability protection. These business structures allow your business to be treated as if it were an individual of its own. The business itself can take out a loan, incurred debt, and be the target of costly lawsuits - reducing your personal exposure to these financial risks.
Just be aware that this doesn't grant you unlimited liability protection; it's still possible to take on personal debt and you can be legally responsible for actions of gross negligence in many scenarios.
Never Take Out Personal Loans
New business owners are tempted to fund the business themselves, even if they don't have the savings to cover those expenses. They take out personal loans, max out their credit cards, or incur debt in other ways to get the money they need. A few minor expenses here and there won't hurt you, but for the most part, you should never take out personal loans. Instead, work with investors, tap into your savings, or rely on your business credit to take out loans in the business's name.
Focus On Independent Saving Strategies
You'll be far less exposed to personal financial risk if you have a strong financial foundation. That means having ample savings do withstand volatile income changes as your business develops and reduce the impact of a total business collapse.
- Budgeting and frugality - Be smart with your budgeting and try to remain as frugal as possible. If you don't have much in the way of savings and your business is going to be your primary source of earnings, you need to live a modest lifestyle and focus on pocketing your extra income.
- An emergency fund - It's also a good idea to put together a robust emergency fund. Set aside at least enough money to cover a few months of personal expenses. This way, if your business has a bad month or two, or if the business undergoes a total collapse, you can buy yourself enough time to properly respond.
- Tax-advantaged investment vehicles - With any extra money, use tax advantage investment vehicles to maximize your savings and plan for retirement. For example, the Roth IRA in the United States can help you grow 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 income streams, both inside the business and on a personal level. Within the business, that could mean selling multiple different types of products and services, monetizing your content or applications in different ways, or even targeting different audiences. This way, if any single income stream is threatened, you'll have the others to serve as backups.
The same principle applies to you as an individual. You can diversify your income streams by investing in dividend-paying stocks, investing in real estate, starting independent blogs or websites, or even picking up side gigs. These don't have to provide full-time income; any additional cash you generate will be valuable for mitigating your personal financial risk.
There's no way to completely avoid personal financial risk while starting a business. Risk is an inevitable part of the deal, but with the right strategies, you can mitigate your personal risks, assuage your concerns, and feel more confident starting your own enterprise.