Just over a year ago, I took the plunge and started my own business. I had a lot of enthusiasm and the right set of skills, but what I didn’t have was financial preparation or readiness. Eager to leave a toxic work situation, I dove right into self-employment without creating a budget or saving for emergency expenses.
That turned out to be a huge problem.
It only took four months of self-employed bliss before I lost my (only) high paying client. With zero savings and no backup plan, I spent the next eight months eating beans and rice, working my bum off to recover, and wondering if I’d made a huge mistake.
I’m proud to say it wasn’t a mistake, and these days my business is back on track. Still, that first year of self-employment would have been much less stressful (and I would have ended up with a lot less credit card debt) if I had taken the time to prepare financially for my big career change.
Wondering how to start a business without making all the mistakes that I did? I spoke with Michelle Schroder-Gardner, a former financial analyst and the blogger behind Making Sense of Cents, for five pieces of advice that will help you make the switch successfully.
1. Save for an emergency fund.
If you’re starting your own business, you need to do more than just have a little extra cash in the bank. Michelle suggests to save up an emergency fund equal to at least six months of basic living expenses.
“As a business owner, your income isn’t usually stable,” she points out. “An emergency fund can help you get through months when your income isn’t as high as it normally is. This way you can still focus on the business and not be (as) stressed.”
I had a tiny amount of savings when I started freelancing, but nothing compared to the six months Michelle recommends. So when I lost clients, I had to scramble. I took every gig that came along in order to add up enough money to resemble a living wage and put too many expenses on credit cards. And, if we’re going for full disclosure, I was lucky that my grad-student husband had a small stipend coming in every month. Without that, I might have had to swallow my pride and ask for my old job back.
I’ve learned my lesson and now put money into savings every month. I still don’t have the full six months saved up, but I’m working on it.
2. Keep business money and personal money separate.
Regardless of the type of business you have (whether you’re a sole proprietor or fully incorporated) you need separate bank accounts for business and personal funds.
Michelle points out that having multiple accounts makes tax time much easier. “You won’t have to wonder if payments were personal expenses or business related expenses. Trying to remember an expense a year down the road would be difficult.” But with separate accounts, it’s automatically taken care of.
When I wised up and opened separate accounts, I found that it made it possible to actually analyze my expenses. And when my income dropped dramatically, it made it easy to decide what to cut. My pricey Chamber of Commerce membership, for example, wasn’t doing my freelance business any good so it was the first to go. A job board membership, on the other hand, was a solid investment in my business.
3. Save for retirement ASAP.
When your business is young and finances are tight, it can be tempting to put off investing for an event that seems far away. But, Michelle cautions, “You never know when you may have to stop working. No matter how much you love your business, eventually retirement will be on your radar.”
This was one thing I did right. Even though I didn’t have a lot of extra money to invest, I opened retirement accounts for both me and my husband before I start freelancing. Because whether or not you know the formula for compound interest off the top of your head (I definitely don’t!), the earlier you start saving, the longer your money will have to grow. Even if it is just $50 per month, I always had something going into my IRA.
Oh, and if you’re lucky enough to have employer-sponsored retirement right now? Make sure you know exactly what happens to that money when you leave your job. You may need to roll it over from a 401(k) to a Roth IRA. Talk to a financial advisor to make sure all your savings come with you when you switch to unemployment.
4. Set aside money for taxes.
When you’re used to having an employer withhold taxes from your paycheck, it’s hard to know how much you’re actually paying. But all that changes when you start your own business.
“As a business owner,” Michelle says, “you have to pay social security taxes, Medicare taxes, self-employment tax, federal income tax, state income tax… all of that can add up very quickly, and it’s an area that most self-employed workers don’t save up enough money for.”
My mother was self-employed growing up, so I knew to pay quarterly estimated taxes in April, June, September, and January. What I didn’t realize was how much tax I would need to pay. (April 15th was a shock, and definitely not in a good way.) I now use the IRS website to help calculate how much tax I’ll need to pay. And I always try to overestimate – I’d much rather get money back in April than discover I owe taxes I didn’t plan for.
5. Start part-time.
When I asked Michelle what one piece of advice she would give to women planning to start their own business, her answer made so much sense to me.
“Start your business on the side first, if you can. It will be hard to manage your business and a full-time job at the same time, but it will be well worth it.”
I wish I had done this. Sure, I had written a little bit and landed one big client before I jumped into full-time self-employment. But there’s a big difference between having a client and having a business, which I discovered when they canceled our contract. If I had spent more time growing my business on the side (while still being fed and housed by a full-time income) I would have had time to grow a solid client base and a stable business before I went full-time freelance. And that would have made all the difference.
The main lesson here, of course, is that it’s better to take things slow, to have a plan in place before you dive in headfirst. But there’s a second lesson that I think is even more comforting: It’s never too late to start doing things the smart(er) way.
So, if you left your day job without a solid financial plan, start these five steps today. Call your bank and open a new checking account for your business; set up automatic withdrawals to a savings account for living expenses; talk to a financial advisor about setting up a retirement account. Because yes, things can fall apart in the blink of an eye. But they can also surprise you by turning around when you’re just about ready to give up.
Though if you’re just starting on that emergency fund, it probably wouldn’t hurt to buy some rice and beans. Just in case.