How to plan your finances before you take the leap into entrepreneurship

Creating an adequate reserve, reduce the risk in your investment portfolio, and buy sufficient life and health insurance

August 21 was World Entrepreneurs’ Day. On this occasion, many people in salaried jobs must have mulled over their plans for starting their own ventures. Before taking the plunge, however, potential entrepreneurs must plan their finances carefully.

Myriad challenges

The key challenge a potential entrepreneur faces is building a large-enough reserve that will sustain both his business and his family until his venture starts generating adequate cash flows.

Take the instance of 37-year-old Shahab Alam (name changed on request), who works in Mumbai. Recently, he acquired the CFP (Certified Financial Planner) certification and now wants to start his own financial planning firm.

Echoing the dilemma many would-be entrepreneurs face, he says: “To a person who comes from a middle-class background, the regular cash flow from a salaried job provides peace of mind. One doesn’t know how long it will take before the financial planning firm starts generating enough cash flow to meet my regular expenses. Until then I will have to rely on my savings.”

Alam adds that having a conversation on this issue with his spouse is not easy. “If things go wrong, we could face a severe cash crunch,” he says.

Build a corpus

According to financial planners, a would-be entrepreneur must build a corpus that is adequate to meet his fixed and discretionary expenses for two-three years. “Provision adequately both for the initial investment and working capital needs. You must also have sufficient money to meet your household expenses,” says Vishal Dhawan, chief financial planner, Plan Ahead Wealth Advisers.

While calculating your household expenses, factor in those expenses that arise quarterly, half yearly, and annually as well. “Include things like children’s school or college fees, insurance premiums, etc,” says Arvind A Rao, certified financial planner and founder, Arvind Rao & Associates.

If you leap into entrepreneurship without adequate reserves, you could put yourself under enormous pressure. Even if your idea is good and has a high probability of success, it could fail because you are unable to sustain it for an adequate period of time.

Reduce investment risk

When a person is employed, he has a stable salary and more or less stable expenses, so he can invest regularly. These regular investments for personal goals will have to be put on hold when he decides to launch a start-up.

Experts suggest altering the risk profile of one’s investment portfolio before starting the entrepreneurship journey. “You will take a lot of risk in starting a business. Consider reducing the risk in your investment portfolio. In case the business doesn’t take off, you will have to fall back on it. Hence, taking high risk in both business and investment portfolio is not advisable,” says Dhawan.

Your investment portfolio must also be in sufficiently liquid instruments so that you can withdraw money from it whenever required.

Once your business starts generating cash surpluses, remember to replenish your portfolio. “Put in more than you took out to make up for lost time,” says Rao.

Buy personal covers

When you are in a job, you can depend on the health insurance cover provided by your employer. Now, you must buy an adequate cover of your own before you quit your job.

Similarly, you must purchase adequate life insurance. “Once you quit, your income will plummet, which will make it harder for you to buy a large cover,” says Dhawan. Rao suggests buying a personal accident cover as well.

As for loans, either pay them off before you begin your entrepreneurial journey, or set aside enough to pay the EMIs for at least three years.

Minimise expenses

Expenses must be kept at the bare minimum in a start-up. “Even when you manage to raise money, make sure you budget salaries for founders and co-founders that are reasonable and not extravagant,” says Bhagwan Chowdhry, professor of Finance, Indian School of Business (ISB).

See if a supplemental source of income can be created. “If your spouse or another family member can support you while you immerse yourself in the start-up, that can be very helpful,” adds Chowdhry. 

Avoid over-optimism

While an entrepreneur must, by nature, be optimistic, he should err on the side of caution when it comes to projecting his income and expenses from his start-up. “Avoid overestimating the income and underestimating the expenses from your venture,” says Rao.

Don’t burn your bridges at the time of quitting your company. Despite your best efforts, your start-up could fail and you could be forced to apply for a job within your industry. Therefore, part from your employer on a good note. Also, keep your network within your industry alive.

Finally, give your venture a fixed time period to succeed—whatever you think is objectively necessary. Once that time period is over and the venture has not turned cash flow 

positive, either change course or close it down. Continuing to burn cash while pursuing a strategy that is not working could land you in a deeper mess. According to Chowdhry, taking personal loans to fund day-to-day expenses is a strict no-no.