Before Launching, Organize Personal Finances
Aspiring entrepreneurs preparing to start businesses will find that savings, credit access, and credit scores matter more than market research and investor presentations
By Monica Mehta
(Corrects the name of the credit report website in the penultimate paragraph.)
What happens when your paychecks stop and your business isn’t bringing in steady cash flow or locking in meaningful investment? You live on personal savings. To give your venture the best shot, prepare for that reality before you quit your day job. You can get started with this checklist.
1. First determine how much you will need to cover personal expenses while launching your startup. Mint.com has a good monthly budget calculator. Budget for 18 to 24 months without a salary, to be safe. That length could vary, depending on how quickly you earn a profit or get a round of financing.
It took Sally Jones and Jill Friedman 18 months to raise $425,000 from friends, family, and angel investors for their first venture, Giddy, a manufacturer of kids’ snacks in San Francisco. They each invested $10,000 and dipped into personal savings to cover living expenses before getting that first round last November. “However long you think it will be before you can start drawing a salary, double [the amount of time], and then add some more,” says Jones.
2. Be sure to include your business partners in the conversation. Discuss not only the amount of capital they are planning to invest in the startup, but also how long they can go without drawing a salary. Their financial well being is as relevant as your own.
3. To make sure you can last until cash starts coming in, get lean. Start by making a list of expenses for the past three months; most credit cards offer detailed payment activity that can be downloaded to Excel or QuickBooks. Scrutinize expenses one by one, identifying those you can do without. Jones renegotiated her rent, cut back on restaurant dinners and beauty treatments, and canceled her gym membership. She also deferred her student loans.
4. Know that student loans can be deferred for up to two years by filing for a temporary economic-hardship dispensation. You must not be making any money to qualify; start-up life certainly fits that description. To get deferment forms, reach out to your loan servicer. To find out which one you’re using, visit the National Student Loan Data System. Budget six months to research your options and get the ball rolling.
5. Take on part-time consulting gigs. Employers are increasingly relying on consultants to fill gaps without incurring fixed overhead costs. Search sites such as oDesk and Elance for opportunities. Also make your availability known to previous employers and co-workers.
6. Make big purchases now, while you can. “The lending landscape in recent years has become incredibly tight,” says Santa Fe (N.M.)-based personal finance expert Manisha Thakor. “In the absence of steady income, your ability to attain a home mortgage or car loan will not only deteriorate, but potentially stop altogether.”
7. Consider increasing your credit limit on existing cards and applying for new ones. Your reliance on credit will increase dramatically in your company’s early days. Young businesses get about three-quarters of their funds from banks via loans, credit cards, and lines of credit, according to the Small Business Administration’s Office of Advocacy. Seek adjustments while issuers still think you are a worthy risk.
8. Strengthen your credit score while you are still employed. “Your credit score is like a hot dog,” says Thakor. “No one entirely knows what goes into it.” While the exact formula remains a mystery, four moves taken at least six months in advance of quitting your job can help boost it.
First, pay bills on time. Even being one or two days late can reduce your score and it can take months to bounce back; Thakor suggests you set up as many online automatic bill payments as you can. Next, make sure your ratio of revolving usage to available credit remains below 30 percent. The best way to lower utilization is to increase availability of credit. That’s why I suggested above that you increase the amount of credit you have access to. The trick is to refrain from using it now.
In addition, keep your oldest credit cards intact; the length of your credit history plays an important role in the way your overall score is calculated. Finally, clean up any errors on your credit report by pulling a free copy from annualcreditreport.com. A study released in May 2011 by the Policy and Economic Research Council found potential errors in nearly 20 percent of reports examined.
9. Once you launch your business, keep spending on track in the early days by setting up a weekly cash burn analysis, to track budgeted vs. actual costs for major expenses. By catching unexpected increases quickly, you can make counterbalancing cuts to preserve your capital.
Monica Mehta is managing principal of investment firm Seventh Capital in New York City. She has advised hundreds of small businesses over the past 15 years. Follow her on Twitter @monicamehtanyc or read more of her writing at monicamehta.com