Launching and growing a business, while an exciting adventure, can also bring considerable financial risk to the founder. Bootstrapping a business may involve scooping into savings, taking on new debt and relying on inconsistent income.
Passionate entrepreneurs often go all in, committing their wealth, time and energy to the new venture, and may not consider the near- and long-term consequences on their own financial well-being. Those personal finances, however, deserve attention.
Diversifying your portfolio and resources can go a long way toward maintaining solid finances now and in the future, even if you're starting a business.
"Most startup founders rely on their own personal capital and that of family and friends as they bootstrap the company to reach a certain point that will attract outside capital from angel investors and VC firms," noted Nichole Walker, City National Bank senior wealth planner.
The time between the initial funding from personal resources and landing outside investment is a "delicate period," she added.
"The founders oftentimes must demonstrate 'proof of concept' of the product or service in order to attract outside capital," so entrepreneurs often decide to deploy a significant portion of their own money to take the product or service to the viability stage, "which may take longer than anticipated," said Walker.
Scrappy founders focused on achieving business success often tap into savings or retirement accounts, home equity or other family funds to make their entrepreneurial dreams come true.
A survey of nearly 2,000 entrepreneurs by Manta, a small business resources firm, found that 34 percent of entrepreneurs reported that they had no retirement plan, with many reinvesting income into their companies instead. Significant numbers had drained their past retirement funds to finance their companies, weren't earning enough to open an account, or expected to one day finance their retirement by selling their business.
The U.S. Small Business Administration cautions self-funding entrepreneurs not to spend more of their own money than they can afford and to be particularly careful about the risks involved in drawing down retirement accounts early.
Before entrepreneurs sink a significant portion of their wealth into startup ventures, said City National's Walker, they should first create a financial strategy with assistance from a professional advisor.
The startup founder and the wealth planner or financial advisor should, she explained, "craft a plan for cash flow needs over a short-, medium- and long-term period. The plan should also provide guidance on budgeting for how much the individual can expend on the startup before running out of funds."
"Many entrepreneurs do not think of their startup ventures as an investment. They are often driven by a passion to solve a problem or a desire to create a product or service that benefits a specific market," said Walker.
"Entrepreneurs, however, should position their startups as a part of a diversified portfolio" invested in equities, fixed income and cash — for emergencies and liquidity needs — and in alternatives, including the business, she said.
"A certain percentage of the portfolio could be allocated to the startup venture. This provides a clear and disciplined road map for the entrepreneur in order to ensure that not all of his or her wealth is tied up in the startup. Obviously, this is easier said than done — particularly when many young founders may not have the ability to invest in a diversified portfolio. But even if they do not have the resources, there should still be a disciplined approach to financing a startup venture, rather than sinking one's entire savings," said Walker.
Indeed, a thriving startup could eventually turn founders and other insiders into multi-millionaires if a successful company experiences a "liquidity event," such as an initial public offering or acquisition. One "big data" real estate agent, for instance, predicted 5,000 or more employees in the Silicon Valley and Bay Area could become millionaires from tech IPOs slated to debut this year.
If your company goes public someday, in fact, you'll need to address diversification as you prepare for the event to make sure your post-IPO portfolio isn't too heavily weighted in the firm's shares. (You'll also need to protect your wealth, in that case, by setting up trusts, a will, a health directive and a power of attorney.)
That event may be far down the road, but it's not too soon to diversify your personal assets so that all your eggs aren't in one basket as you launch your venture — even if that basket is your baby, the business into which you're pouring your heart, hopes and sweat.
Consider your risk tolerance, and the tolerance of close family members for risk, as you work with a financial advisor to develop your investment portfolio and financial plans, and you define the role your company will play in those strategies.
While Walker had no specific cautionary tale, she noted "the typical horror story is one in which a founder runs out of cash and has to file for bankruptcy then experiences foreclosure, followed by divorce."
Many entrepreneurs get creative in finding ways to preserve capital — by bartering services or offering equity in their companies in exchange for attorney or accounting services, office leases or other business expenses.
Meanwhile, a variety of tools are available to help entrepreneurs maintain personal cash flow while growing their businesses. Walker cited several sources:
If you're looking for professional expertise as you launch your startup and navigate its early stages, City National Bank's wealth planners and business bankers can help guide you in a sound direction for your personal and entrepreneurial needs.
This article is for general information and education only. It is provided as a courtesy to the clients and friends of City National Bank (City National). City National does not warrant that it is accurate or complete. Opinions expressed and estimates or projections given are those of the authors or persons quoted as of the date of the article with no obligation to update or notify of inaccuracy or change. This article may not be reproduced, distributed or further published by any person without the written consent of City National. Please cite source when quoting.
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