There are many reasons why the entrepreneurial bug strikes many people in their mid-life. By now they have gathered invaluable experience and may sense an untapped opportunity in the very field they have been working in. Sometimes people strike out on their own to fulfil a vision that they are passionate about. Moreover, working long hours for a corporation is no longer as appealing as it once was. The desire for independence and being one’s own master becomes more attractive than the security provided by the monthly cheque. Also, by now the individual may have accumulated a considerable corpus and that gives him the confidence to chart his own course.
Whatever the reason, when someone decides to take up entrepreneurship, the instinctive response is to give up the job and get started right away. However, a lot of meticulous planning must precede this decision, not just on the business front but also from the personal finance perspective. After all, the decision has a bearing on both you and your family. The basic thrust of your efforts should be to insulate your family finances from the vagaries of the business. Your family’s goals, such as your children’s education and their marriage, should not become hostage to how your business fares. Here are some steps you need to take before you venture out on your own.
Build an emergency corpus: First, the entrepreneur needs to set up a business emergency fund. This fund should be able to cater to the needs of his dependants for at least three to five years. Usually it takes at least three years for a business to stabilise and start yielding surplus cash flows. In the current slow state of the economy, it might be better if you make provision for five years.
This contingency fund should account for not only the daily expenses but also all the insurance premiums, utility bills, children’s education fees, and EMIs on home loans.
The business emergency fund may be put in a liquid fund from where it can be withdrawn via a systematic withdrawal plan, or it may be put into a sweep-in account provided by select banks [the funds you require are paid out to you and the surplus gets automatically swept into a fixed deposit].
This first step of setting up a business emergency fund is absolutely mandatory before you leave your job.
Keep family and business finances separate: A young business devours capital rapidly. As it expands, so will its needs for money. You may be tempted to redirect money from the business emergency fund to meet the working capital needs of the business. This should be avoided at all costs. You may think that you will replenish the fund once your business starts yielding a surplus. But if the venture fails, you will be in dire straits.
Similarly, money should not be withdrawn from business for funding needs on the home front.
It is also important to maintain accounts of expenses both on the home and business fronts. This will provide you with a good sense of where the money is going, and how you can curtail expenses.
Buy adequate life insurance: A term policy is absolutely essential to take care of all liabilities [such as a home loan] and the family’s needs in case of an unfortunate event. Hopefully, you have already bought one. But if you take out a loan for your business, then you should increase the sum assured on your term plan by a similar amount. This will ensure that in case of an unfortunate event, your family does not get saddled with extra liability.
Besides life insurance, you should also buy a personal accident cover.
Buy adequate health insurance: Now that you are leaving your job, you will no longer enjoy the benefit of health winsurance from your employer. Find out if your spouse’s cover will provide you with adequate healthcare protection. If not, buy adequate health insurance cover for all your dependants. In addition to your spouse and children, it should also cover your aged parents if they are dependent on you.
Once you have adequate health insurance, it is also prudent to supplement it with a critical illness cover.
Don’t touch the retirement or children’s education corpus: When you leave your job, you are likely to get a substantial sum of money from your Provident Fund [PF] account that would have accumulated over the last 12 – 15 years or so. This money in your PF account was working as your retirement corpus. Again, don’t use the PF corpus for your business. Put it in long-term growth-oriented investment instruments such as actively-managed equity funds or index funds so that it caters to your retirement needs. Do not use this money for funding your business, in the assumption that when the business does well you will put the money back.
Similarly, any funds that were saved in order to meet the children’s education needs should not be funnelled into the business. If you use the retirement corpus or education funds for business, and it does not succeed, all the hard work that you have put in to achieve certain life goals will get nullified.
Entertainment and travel allowance: When you are in a job, you are entitled to entertainment and travel allowances. All these will disappear once you quit. If you have lifestyle needs that you can’t do without, you need to put aside additional funds for these expenses. You can’t withdraw these expenses from the business. Remember that tax breaks in the form of entertainment and travel allowance only happen once the business turns profitable. If you can’t afford them, you will have to be prepared for a more frugal lifestyle in the first few years.
Alternative sources of income: In the initial years, it helps a great deal if you can tap into alternative sources of income. Rental from real estate can be a great source of help. The spouse’s salary can also provide sustenance in the early years.
Clear liabilities: Before you start your business, it is better if you clear off your major liabilities, such as home loan. Sometimes funding both the loan and the business can become difficult. If not, make sure that you have made provision for EMIs in your contingency fund.
Your foray into business must be a calculated risk. Without the daily stressors of whether will be able to make ends meet, you can plunge into the world of entrepreneurship wholeheartedly. And if any contingencies do arise, take heart in the fact that you have planned well for them.
This was first published in the August 2013 issue of Complete Wellbeing.
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The amount of money you put in each of your short and long-term emergency funds will depend on what you can afford and what you’re comfortable with. For my needs, I keep about $2,000 in the short-term fund, while I aim to build up six months’ worth of expenses in my long-term fund.