Thousands of young businessmen and women start new companies in the United States each year. Most will not last. However, whether you decide to form a limited liability company or go out on your own, you can increase the odds that your business will be one of the few that makes it. Success is not a question of good genes or dumb luck; it’s usually just about being prudent. Avoid these nine common financial mistakes of young entrepreneurs.
Not Separating Personal and Business Assets
You should always keep your personal and business assets separate. Not only does this help to streamline your business operations, it also allows you to take advantage of tax deductions, such as writing off business expenses.
One way is to set up a limited liability company (LLC). There are many benefits to establishing an LLC, including the ability to safeguard your personal assets if your business loses money or in case of a lawsuit.
Racking Up Personal Credit on Business Expenses
If you’re using the same credit card for your movie tickets as you are for ordering branded stationery, you need to stop. Don’t mix your personal and business spending. Business credit card issuers stipulate that you can only use these cards for business purposes anyways, so it’s best to steer clear of such practices.
Another key reason for keeping your personal and business spending separate is that putting both expenses on the same credit card jeopardizes the protections that having a limited liability company gives you. Most business expenses are tax deductible, so separating personal and business spending makes life easier during tax time.
Not Preparing for Unforeseen Circumstances
When you’re young, it’s hard to imagine difficult situations such as death and divorce. However, it’s important to make provision for unforeseen circumstances to protect your loved ones—and your business. Having a buy-sell agreement in place outlines what will happen with your shares of a business should the worst occur.
You can use a revocable living trust to decide who will get your property when you die. This can be altered as your wishes and circumstances change, but the most attractive aspect of a living trust is that it allows you to avoid probate. Probate is the legal process of handling an estate, and it can be expensive and complex.
It may not be very romantic, but if you have your own business, it’s also a good idea to sign a prenuptial agreement before you get married. This legally binding contract describes who owns what assets, and how those assets would be distributed in a divorce.
Insurance is a legal requirement if you have employees, but even if you are a solo operation, insurance protects you if anybody makes a claim against your business. Business Owners’ Insurance provides an income if your business is temporarily out of action due to a disaster, and covers expenses such as rent and utilities you would’ve incurred during that period.
You may be cash-strapped when you’re starting out, but not taking out insurance could become a very costly false economy.
Not Planning for Taxes
When you first launch your business, it can be tempting to focus all your energy on generating income. But have you thought about taxes?
How LLCs are taxed depends on the number of members it has, and whether you decide to treat your LLC as a different business form for tax purposes.
This checklist from the IRS will help you ensure that your new business complies with federal tax requirements. Each state has its own tax rules, too. It’s not all bad news, though: You can also take advantage of tax incentives relating to energy use and other aspects of your business.
Not Paying Yourself
It’s very common for young entrepreneurs to deny themselves an income. However, you should still pay yourself the market rate for the job you’re doing as soon as the business can afford to do so. When you don’t compensate yourself, it can be hard to determine whether your business model is profitable.
Not Hiring/Speaking to an Accountant
When you are starting out, it can be tempting to try to do everything yourself. This is understandable, considering that your funds are probably limited, and your enthusiasm is unbridled. However, thinking you can be your own accountant can end up saving you money upfront, but costing you more over time. Unless you have financial training, you’re better off hiring a professional. He’ll be able to help you build a strong foundation for your business and save you money in the long term.
Expanding Too Quickly
While it may seem hard to believe, growing too quickly can sometimes be as bad as not growing at all. This is largely because rapid expansion can put too much pressure on your fledgling business, and you have neither the infrastructure nor the experience to deal with it.
The result can be customer dissatisfaction because of your inability to handle an influx of orders, employee burnout from too many long days, and even cash flow problems because you might be shelling out for inventory while customers owe you money.
Likely the biggest mistake that young entrepreneurs make is not having enough money to fund their business properly. Either you, your partners, and/or your shareholders need to invest sufficient capital in the business to ensure its success.
If your business focuses largely on providing services (for example, copywriting or web design), you may not need much capital. However, it’s still worth remembering that the leading cause of failure for all businesses is a lack of money.