Starting your own business or investing are two great ways to grow your own wealth without depending on an employer. Owning a business or investing can threaten your personal finances, however, without the right planning.
Lawsuits and bankruptcy are two common threats that all businesses face. If you don’t protect your personal finances, these threats can sink your business and damage your own wealth. Here’s how to protect your personal finances when starting a new business or investing.
The most important thing any business owner or investor should do is create some separation between their business and personal finances. Different business entities will allow you to build this separation, potentially protecting your personal finances in the event that your business has to navigate a major financial crisis.
Many new entrepreneurs, for example, choose to operate their business as a partnership or sole proprietorship.
These business structures are simple and the associated paperwork is mostly straightforward. This simplicity can be a major advantage and streamline some of the administrative work associated with running a business.
However, these structures also personally attach you to your business, meaning you may be held personally liable for business debts or legal liabilities. In the event of a bankruptcy or lawsuit, your finances may be in trouble.
Instead of a sole proprietorship or partnership, you may want to use a more complex business structure to provide a degree of separation between your personal and business finances.
Two popular options are the limited liability company (LLC) and corporation (like an S corporation or C corporation). From a legal point of view, these structures make you and your business two distinct entities, meaning your business can act as an independent agent in a lawsuit. If someone wants to sue your business, they can do so without suing you.
An LLC or corporation also enables the business to file for non-personal forms of bankruptcy, which can help protect your personal assets from risk.
The riskier a business, the more you’ll benefit from this separation. A medical practice, for example, can be extremely prone to litigation. The right incorporation strategy will protect you from the risks associated with running your business.
Separating your finances and your business’s finances won’t protect you from everything, however. For example, if you commit a crime while working as an owner or leader of your business, you may face personal liability. In many cases, you’ll find that separating your personal and business finances will help keep your personal wealth safe in the event of a crisis for your business.
Even with the right business structure, certain financial decisions can still open you up to serious risk, meaning it’s still possible to lose personal assets and wealth.
When possible, it’s a good idea to find a tax professional who can help your business navigate tax season. A good business accountant can help you find ways to save on taxes and maximize your profit.
In recent economic climates, for instance, economists believe that the U.S. is currently seeing an inflation spike that is weakening the dollar. This inflationary period can erode purchasing power, making it more expensive to acquire goods and services for your business. Inflation also impacts the real value of your debts and receivables, an essential consideration for financial planning and cash flow management.
If you want to manage your business’s taxes on your own, however, you should become as familiar as possible with the taxes you’ll need to pay.
For example, any business with employees on its payroll will need to pay payroll taxes. Payroll is often a major administrative burden, in part due to how complex payroll taxes can be. Understanding your company’s payroll tax obligations – including FICA and FUTA taxes – will be necessary if you want to accurately deduct payroll taxes from employee paychecks.
In general, it’s a good idea not to take out personal loans to fund your business. In the event that profits aren’t enough to repay these loans, you’ll be held personally responsible for failure to pay.
Defaulting on a personal loan can have a serious impact on your credit score and may even result in your lender sending you to court to collect. Your personal assets, like your home and car, may be threatened. A personal loan payment that is late by 30 days or more will have less of an impact but can still hurt your credit score by as much as 100 points.
When taking out a business loan, you can’t use your personal assets or credit score to convince a lender to loan to you or offer better loan terms. However, business loans will provide a degree of protection for your personal finances in the event that you cannot repay the loan.
Building up your business’s financial health and using that health to secure a loan is a better strategy than relying on personal loans in the long run.
It’s also important not to neglect your personal finances, even when your business is doing well. Sometimes new business owners will avoid putting themselves on payroll or will put their personal wealth second to building up their business.
This strategy isn’t a bad idea if you only care about your business’s long-term success, but it can harm your personal financial future. Receiving a regular paycheck from your business and investing frequently in an IRA or 401(k) will help you build wealth for when you’re ready to retire.
When running a business, it’s important to protect your personal wealth. Your business’s structure and the financial decisions you make can put your personal finances at risk without the right strategy.
Choosing a business structure that separates you from your business will protect your finances. The right financial decisions – like hiring an accountant and avoiding personal loans – will also make it easier to keep your personal finances safe in the event of a business crisis.
Cover Photo Credit: Photo by micheile henderson on Unsplash
Alex Quin is a full-stack marketing expert and global keynote speaker. Founder and Chief Marketing Officer of UADV Marketing - a member of the Forbes Agency Council.
