Entrepreneurship is hard. First time entrepreneurs make it harder for themselves by making some basic mistakes regarding their personal finances. Here is a quick guide on what these common mistakes are and what one can do to avoid them.
1. Don’t take a personal loan to fund the business
Problem: Entrepreneurs often take a loan (personal loan, credit cards, or loans against property) to fund their businesses. This high-risk strategy could personally expose you to financial distress.
Solution: As much as possible, you should bootstrap your business through savings, or using money that is not going to put your own financial future or those of your financial dependents at risk.
2. Estimate upfront the cash needed up to raising angel or venture funding
Problem: It’s common to see entrepreneurs underestimate the capital needed at the really early stage of a business for basic things like travel, communication, demos etc. You can burn through your savings well before you have anything significant to share with potential investors. As a result, you might be forced into making a rash decision such as taking a high cost personal loan in order to bridge the gap.
Solution: Understand what your personal capacity is to supply cash to the business. Before this “oxygen” runs out figure out if you can achieve milestones relevant to the angel or VC. If you think you do not have sufficient funds of your own, consider brining on a co-founder who can supply additional capital in addition to complementing your skills.
3. Avoid giving personal guarantees to friends and family
Problem: Strapped for cash entrepreneurs often raise money from their loved ones and give a personal guarantee to the backer, whether express or implied.
Solution: Recognize that an early stage venture is risky and make your backers understand that they could lose their entire investment in case things do not work according to plan. Under no circumstances should you assume any personal liability.
4. Incorporate at the right time
Problem: Entrepreneurs often spend significant amounts of their personal money during the very early stages of a venture on items such as travel, communication, market survey or a basic proof of concept. However, they don’t account for these expenses in the business because they have not incorporated a company. This might result in entrepreneurs not getting credit for the monetary resources they have invested into the business.
Solution: When the expenses become material, it might no longer make practical sense for you to fund the venture from your personal account. Consider incorporating the business and capitalizing it with your money. Thereafter, spend from your company account so that you load the venture with its true costs and also your business can claim tax benefits.
5. Protect your Foundation
Problem: There is a romanticized notion of entrepreneurs surviving on cheap noodles and sleeping on a friend’s floor in the early stages of start-up life. To keep costs low entrepreneurs stretch themselves beyond reason, thus ignoring basic foundation goals.
Solution: We agree that entrepreneurship calls for personal sacrifices. But, in India we have no state funded welfare support, so we are on our own. Ensure that life’s basic needs are being met. Additionally, when you raise funding, negotiate a reasonable salary so that you at least have your basic household and family expenses under control.
[Guest article by Kartik Varma, Founder of iTrust Financial Advisors.]