Creating a smooth transition from corporate executive to self-employed

It's no surprise that entrepreneurs, start-ups and small businesses will play a major role in the economic recovery and Boulder, Colorado is a hub for entrepreneurs.  What may surprise you is who is expected to lead this wave of new businesses.

A recent study by the Ewing Marion Kauffman Foundation entitled “The Coming Entrepreneurship Boom” predicts that the Baby Boomers, ranging in age from 45 to 63, will be at the forefront.

The reasoning – the oldest Boomers are on the cusp of retirement yet unable to retire due to shrunken portfolios. At the same time, they are not exactly the most attractive job candidates in the market due to age. So, many are exploring a third option – starting their own companies.

But before you quit your day job, individuals should not only examine their personal and potential business finances, but also think about the considerable lifestyle changes entrepreneurship can bring.

A visit to your certified financial planner can help you start to review your financial and personal capacity to make such a new enterprise work.  Also, consider these tips:

Start writing your business plan: There are some people who tell you that a business plan is necessary for a new company only if you want to borrow or seek investors for a startup. The truth is that sitting down and writing a formal business plan is an excellent way for anyone to examine the idea, structure and money sources for their business concept and most important, the potential of profit from the idea. One of the best places to get the basics of the business planning process is the U.S. Small Business Administration’s Small Business Planner website. 

Branch out for advice and assemble a wealth management team: A visit to your certified financial planner can help you start to review your financial and personal capacity to make such a new enterprise work.  But you should also seek advice from others with more specific areas of concentration, such as investment advisors who specialize in wealth management, tax advisors, attorneys and small-business peers.  Think of it as your wealth management team. The team will create a smooth transition and help avoid common mistakes with your investments, taxes and business structure.

 Get rid of your debts: With the possible exception of mortgage debt, there’s very little “good debt” in the life of a businessperson. So while you’re researching your business concept and putting together your own financial plan, start cutting back and erasing as much credit card and adjustable-rate debt from your personal life as possible. The continuing credit crisis is making it tough for any business owner – even experienced ones – to borrow money at attractive rates. You’ll have the most flexibility when you owe as little as possible.

Think about refinancing your house to lower your monthly payments, if the interest rates make sense. Another option may be to reduce your payments by going from a 15 year mortgage (if you have one) to a 30 year mortgage. Banks and mortgage companies will typically loan you more money if you have a steady income than if you don’t. Once your money is in your house, it is usually hard to access it if you have little or no income.

Get a home equity line of credit set up while you are employed full-time. You don’t have to access it, but you can if you run into trouble once you start your business.

Work on your emergency fund: While it’s wise for everyone to have three to six months of cash set aside for basic living expenses in case they lose their job or face a medical emergency, emergency funds are particularly necessary for new business owners. Startups can be particularly expensive, and most businesses are not profitable from day one. Plan a more extensive emergency fund such as six months to a year's worth of expenses for yourself and for the business as well.

Diversify your portfolio: If you are a corporate executive who is transitioning to the self-employed world, you should eliminate all company stock to dramatically reduce your individual stock risk. Your portfolio should be more conservative in the beginning due to the nature of the business start-up. Finally, your taxable accounts should be more conservative so you could tap those accounts if your emergency fund is exhausted.

Start thinking about your legal business structure: Your personal financial situation and the kind of business you’re starting should determine the legal designation of your company. 

Before choosing a business structure, such as a sole proprietorship, S or C corporation, partnership, Limited Liability Partnership (LLP), or Limited Liability Company (LLC), owners should reflect on their business in the context of their overall financial life and ask themselves a series of questions:

• Is the business going to be your primary source of personal wealth and daily cashflow?
• Is it a side business?
• Do you expect the business to pay for your retirement?
• Do you want it to provide other financial benefits?
• Do you want to pass it on to family members or sell it to existing employees or outside buyers?

The answers to these questions figure importantly into the decision, along with other key factors such as what type of business you’re starting, its risk factors, current tax laws, and regulations such as workman’s compensation.

Choose an accountant who works with the self-employed: If you are transitioning to the self-employed workforce and are certain you will have income, you will have to pay estimated taxes and you may want to set up payroll. In addition, you can set up a retirement plan for your business and save upwards of $100,000 per year if you have the cash flow to support it. Coordinate with your accountant and wealth manager to set up the most appropriate plan for your business.

Plan your healthcare and other basic benefits: Automatic benefits are the plus side of working for someone else. When you’re working for yourself, you become your own HR department and chances are you won’t be able to match your old employer’s buying power. If you support a family with these benefits or if you have particular health concerns, you need to price the out-of-pocket costs of such benefits before starting your own company – depending on the business and the cost of those benefits, you might want to rethink your plans. You should try to make sure your life insurance and health benefits are similar to your current benefits as you make your transition.

Price disability coverage now: You might have short-term disability coverage as part of your current employee benefits, but that will likely end once you quit your job. You should price long-term disability coverage based on your present working salary so you can qualify for the highest possible benefit. Disability coverage is critical for self-employed people since they’re their own support system.

Update your estate planning documents: If you haven’t updated your estate planning documents in the last five years then the transition to self-employed would be a good time for an update. Your estate planning needs are an ongoing process, so don’t neglect this part of your wealth management plan.

Plan how to market your business: Marketing will be a key part to get the word out about your new business. You can be the best at what you do but if no one knows who you are then it will be hard to survive. Understand the difference between pull marketing and push marketing. Read books about running a business such as Michael Gerber’s E-Myth. It is important to think about the long-term vision of your business right from the start.

Consider a slow transition: If your income will be too small to sustain your lifestyle, consider a slow transition to the self-employed world. Look to diversify your income streams to have multiple sources of income so you aren’t dependent on one client for your livelihood.

Robert J. Pyle, CFP®, CFA is president of Diversified Asset Management, Inc. (DAMI). DAMI is licensed as an investment adviser with the State of Colorado Division of Securities, and its investment advisory representatives are licensed by the State of Colorado. DAMI will only transact business in other states to the extent DAMI has made the requisite notice filings or obtained the necessary licensing in such state. No follow up or individualized responses to persons in other jurisdictions that involve either rendering or attempting to render personalized investment advice for compensation will be made absent compliance with applicable legal requirements, or an applicable exemption or exclusion. It does not constitute investment or tax advice. To contact Robert, call 303-440-2906 or e-mail info@diversifiedassetmanagement.com.

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