44% of new businesses fail in their first three years, according to Statistic Brain.
In spite of knowing the odds, about two years ago I left the steady paycheck, benefits, and general comfort of a corporate job for the world of self-employment. I’ve replaced the predictable paycheck with the potential for big ones, the benefits with freedom and flexibility, and general comfort for sleepless nights worrying if I can provide for my family.
It is very exciting being fully in-charge of my own success, but the thrill is frequently tempered. First there is daily reinforcement that I often don’t know how to do something or even that I don't know there is something that I don't know. Then, once I figure it out, it will probably cost more money than I have budgeted for it. Then, finally, no matter how long I think that something will take, it always takes at least twice as much time.
Today’s update may not eliminate the ever present challenges mentioned above. But there have been some lessons I have learned along the way that may help those of you that are considering making your dreams of self-employment come true. At the very least, perhaps they will help prevent you from waking up to a financial nightmare.
Build a Big Emergency Fund
I had about 12 months of normal expenses in cash the day I left my job. I wish now that I had twice that amount. Things that once weren’t emergencies, such as new HVAC for my home, car repairs, and just the everyday costs of raising two teenagers quickly whittled down my rainy day fund.
Nearly every successful entrepreneur I have met can tell a story about how short the runway is between starting the business, when they are spending their capital, and getting it off the ground when the enterprise actually turns a profit. No matter how flush you may feel at the beginning, the trees at the end of the runway will rapidly approach as you accelerate while struggling to gain lift.
Whatever you think you need in your emergency fund, double or triple it before taking off.
Take the credit before you need it
No matter how long you’ve been employed, how much money you used to make, or have saved up in your 401(k), the moment you walk away from the steady paycheck is the day the credit river will slow or even run dry. The time to refinance your mortgage, obtain a line of credit, or get your credit limit increased on a credit card or two is before you walk out the door to be the next Bill Gates.
Once you’re your own boss, creditors will want to see sustained success (typically two years) before considering you even a moderate risk. Even if you can find a willing lender, the rates will likely be higher than when you fit in a nice clean credit profile of a gainfully employed borrower.
Throw in the fact that underwriting standards are still pretty stringent following the mortgage meltdown in 2008, and you can almost forget about getting new credit unless you have assets to borrow against.
Don’t be shy about taking as much credit as possible before making the leap to self-employment. You’ll appreciate the flexibility of being able to pay off big expenses with the lowest monthly obligation as possible.
“It’s ok, I can deduct it,” may be true, but make sure you can prove it. Being a business owner allows you to offset revenue with expenses for things like office supplies, equipment, mileage, etc. Being sloppy with record keeping, however, can be costly in the event of an audit. According to the IRS 2015 Data Book, returns filed with a Schedule C (Profit or Loss from Business) with income greater than $25,000 are 8 times more likely to be audited than someone with similar income that isn’t filing small business schedules or claiming certain tax credits.
While the chances of being audited are still relatively low (between 2%-3%), you can avoid the headache of having expenses disallowed or additional taxes owed (and penalties) by saving receipts, keeping your calendar records, and tracking your mileage with a phone application like MileIQ.
Create a system, whether it is technology based or just a folder, to keep and track all of those expenses. Your accountant will thank you.
TIP – Cats like to eat receipts left on your desk.
Be Accountable to Yourself
New business owners tend to focus on what they do for a living, and rightly so. There is no doubt that offering a great product or service is a key to success. Many businesses fail, however, in spite of offering a compelling value proposition. The failure isn’t always due to failing to meet the needs of their customers, it often comes from not being accountable to themselves as they focus on what they do best and neglecting the actual business.
Taking these lessons to heart may not guarantee your success as an entrepreneur, but they will go a long way towards helping you avoid becoming a bad statistic.