It’s not surprising that the most popular source of financing for a startup is using the personal savings of the business’s founders. There is a misconception that entrepreneurs must go into debt to start a business. There is not a perfect formula to starting a business, but through smart saving techniques it is possible to fund your own business.
Start Saving
First, get rid of your personal debt. You want to put your business in the best position it can be, and you can do this by creating a budget and tracking your expenses.Next, slash your discretionary spending. Using tools such as Mint.com and apps that track your spending on things such as Uber rides or your morning coffee helps you to gain perspective on how small purchases add up.
If you are planning on quitting your full-time job to focus on your startup, plan to set aside at least six months of living expenses. The return you earn from your small business will take a while, so this ensures you can still make your monthly payments without taking from the money that could be invested in your business.
What percentage of your personal savings should you use?
Factor in how much you have in the bank, how much annual earning potential you have, how much you have saved in retirement, and the obvious—how much you need to help your business take off.
Keep ample reserves in the bank. At least $5,000 according to entrepreneur.com. There is always a chance that you may need a sudden infusion of cash such as unexpected bills or a new client who won’t pay up-front. Having cash in the bank will allow you to limit unnecessary risk or make counter-productive decisions.
Another tip, is to limit the amount you pull from your 401(k) because you can always tap into that later. It is more financially responsible to turn to relatives and friends for small loans to spread risk. Better to borrow money in a position of strength rather than weakness (like if you run out of money). Than use your retirement savings to pay back those personal loans.
Be Realistic
You don’t need to do everything at once. Often, surface level tasks rather than important fundamental building blocks are where funding is used. Marketing materials are important and fun but are not essential when your business needs to first find a way to make money.
Additionally, using personal savings or your 401(k) is actually a very complex transaction and one the IRS considers legal, but questionable. It must be done right, or you could end up owing additional taxes and penalties. It is highly recommended that you seek the advice of an expert to handle the transaction and ensure you do not lose money.
Turning Your Idea Into Reality
Dylan Gallagher is the founder of two San Francisco-based travel companies that take tourists on personalized trips in the US: Orange Sky Adventures and White Wolf Private Tours. Using the small amount of money he had, he moved to San-Francisco and got a job. Once he ran out of money, he started to accumulate debt on credit cards.
Gallagher says the most challenging thing about running a company is consistently making money. Since his business is seasonal, most of his revenue is in the summer. The biggest mistake he made when starting his own company was believing he could go to the bank for a loan once he ran out of money. The bank needed three years of established tax returns to show enough credibility. Gallagher wishes he would have asked for a loan when he had a personal income and some savings.
Major Takeaway: Plan to save accordingly to put yourself in the best position for your business. Using your savings is possible to get your small business started. Know your budget, pay off your debts, and make financially responsible choices in investments.