I recently had the privilege of working with a client who is opening her own business. It’s rare that entrepreneurs seek financial advice before they leap. Most people, if they looked too hard at the realities of business ownership, wouldn’t do it.
One of the goals in our pre-launch work is to find some financial clarity about what her investment is, and what an acceptable rate of return is. If you buy $10,000 of mutual funds, it’s fairly simple to determine if your investment is earning 10%, 5% or losing 25%. But investing in a business has so many other components to it.
- The lifestyle component: how much you would be willing to ‘pay’ to do what you absolutely love and be your own boss.
- The opportunity cost: the difference between the salary and benefits you are leaving behind and the salary and benefits your new business will be paying you.
- Building a sellable asset: are you creating an asset that can eventually be sold and sold for how much?
If you’re considering opening a business, here are some great questions to ask yourself before you leap. What if things don’t turn out the way you planned? What if your business ends up costing you money? Would you be willing to give up a $70,000 job if you could own your own business and still earn $50,000 with the potential of building a sellable asset? Probably. Would you be willing to do the same if you were only able to earn $20,000, or $10,000?
What if your business actually started costing you money?
In accountant-speak, that’s called “Owners Investment” and it’s hidden in the balance sheet in the equity section. I hate that. What it really means is that your business didn’t earn enough to pay all of its commitments so you’ve drawn from your savings, your spouse’s income, your home equity line or even a retirement fund. When a business owner takes $1,000 from their personal account and puts it in their business account, they aren’t thinking “oh, I’m buying a $1,000 investment that will pay me a good rate of return.” They’re thinking “oh, I have to cover the payroll shortfall today.” Technically it’s an investment, but emotionally, it’s not.
How many of us would run down to the bank to transfer $1,000 of our money to buy more of a mutual fund that wasn’t performing? None. What if the fund manager promised us that it would perform better? There’s a continuum on the scale of emotional investing. It starts with mutual funds, and then specific stocks (and you crazed Apple fans know who you are), then real estate, and then business ownership. The closer we are to the asset, the more emotionally tied we become to the investment, and the less able to make analytical decisions.
Should your investment decisions be purely analytical? Nope. But they shouldn’t be purely emotional either.