Tim Bainton and Alex Planes

Are you ready to start a business?

You’re probably mentally ready. You’re reading this article, after all.

But are you financially ready?

You might have heard that 90 percent of all businesses fail within their first five years of existence. This is quoted often, but it’s not true. The actual number is closer to 50 percent.

Do you know why that 50 percent fails? By far the most common reason for business failure is inadequate capitalization. They didn’t have the money to keep the lights on, pay the employees, run ads, and get new customers in the door.

If you jump into entrepreneurship, you’ll almost certainly be funding the business out of your own pocket until things pick up and you’ve got solid revenues. You’ll be dedicating much of your time to the business. You’re also likely to be looking for financial security from your business, or at the least some form of financial stability.

The more you understand about your finances before you begin, the better.

Start early, start now

Ideally, you should start setting goals and making plans for your finances before you transition from employee to entrepreneur. But a well-considered financial plan is valuable for all entrepreneurs, since you can’t reach your goals if you don’t know what they are or how to approach them.

Before becoming an entrepreneur, you should have an emergency fund and/or source of reserve funds for both yourself and for your business. Few businesses start off with all the clients they need, so most startups lose money for the first few months of their existence. As the owner of a brand new business, you might spend so much time on its development and operation that you won’t have time to maintain a steady job that’ll pay you a comfortable wage. However, many entrepreneurs develop their businesses gradually, focusing more on their full-time jobs until they’ve got enough momentum to jump unto entrepreneurship full-time.

The reality is that the early going of entrepreneurship is quite often difficult, but as entrepreneurs we accept this because we believe today’s struggle will bring tomorrow’s riches. Even so, it’s imperative that you have enough cash on hand to pay your bills and those of your business for several months. Bill Gates was famously obsessive about Microsoft’s available capital, wanting enough of it always on hand to pay the company’s expenses for a year, even if it lost all its revenue.

Calculate your needs, and those of your business, on a monthly basis. If you can trim any unnecessary costs, you should. You don’t have to give up that morning latte forever, but if you can live without it for a few months, you should try. If you can go a step further, consider paying off high-interest debts before starting your business as well.

Long-term planning

You’re not starting a business because you expect to be broke forever, are you? You shouldn’t start a business without trying to define the financial outcomes you you hope it achieves for you, either.

Do you want to run the whole thing yourself until you retire? You may hope to scale quickly, attract investors, and hire staff that can eventually run your business while you kick back and enjoy your good fortune. Or you might even have a goal of building and selling your business within a few years. The outcomes you want from your business will have a major impact on its — and your — financial needs over both the short and the long term. If you know what you want up front, you can better plan your approach to business ownership to ensure stable and comfortable cash flows for as long as you need.

How much money will you need to draw from your business every month to enjoy a comfortable life and provide for your family? You started figuring out your niche in the first part of this series, and now you can use your niche knowledge to figure out what people are paying for similar offers and how many clients you’ll need to serve in order to stay above your financial comfort baseline. Make sure you consider the cost of business — rent, payroll, equipment, marketing, and anything else your company will need to pay for — before calculating your take-home. If you take money before your company pays its bills, you set the precedent that you don’t care about its financial health, which will only set you up for failure down the line.

As your business progresses, you should find that it produces more income than you need for day-to-day comfort. We’re not entrepreneurs because we want to earn standard salaries, right? Whenever and wherever possible, try to invest whatever you can so that you’ll have multiple streams of income. Passive income is an amazing thing, and in the unfortunate event that your business goes belly up, you’ll bounce back much faster if you’re losing one of many sources of income rather than your only paycheck.

Now that we have a basic handle on our finances, we can get down to business and start setting up your company. Our next article will take a look at the value of business plans for every entrepreneur, even those who never expect to raise funding or take loans.