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Financial planning for the entrepreneur

December 31, 2007 12:21 IST

When Rajeev Verma, 40, senior general manager of a leading bank just walked up  to his boss and said, "I quit", he shocked everyone. No, there was nothing wrong with his boss, but Verma had decided almost a month back that it was time he did something on his own, rather than report to someone  else.

Sounds familiar? Yes, many of us dream of that day when we would be able to do things our way. Sadly, a large of number of those dreams just stay --'dreams'.  However, if you are one of those who wish to start an independent business venture, it's important to remember that this newfound freedom comes with a whole set of financial issues.

Setting it up

For starters, decide the ownership structure of the company. That is, whether it will be a sole proprietorship, partnership or a company -- private or public. In case you are the only person behind the venture, you can opt for the sole  proprietorship format, for its simplicity and reduced statutory compliance.

If, however, you intend  to project a corporate image or have others partnering you in your  enterprise, you may consider a private limited company, since it provides both, a corporate setup, as well as limited liability.

This is because, in case of a proprietorship firm, even your personal property can be attached to settle claims against the firm. On the other hand, in a private limited company, only the assets that are owned by the company can be attached  to settle claims.

Funding your needs

With no access to a regular pay check, you will need to work out a sustainable method for meeting your personal and family expenses. The best way to manage personal expenses in this situation is to sit with your family and draw up a realistic monthly expense budget.

Add to this, expenses that occur over longer periods, like quarterly or annually, such as insurance premiums, on a proportionate monthly basis. Also, add to this all the monthly investments you need to make to meet your financial goals like children's education and marriage, your retirement and others.

This exercise will give you an idea of your monthly outgo. From the very start, pay yourself this amount from your business every month as salary. This will help in two ways.

One, it will act as a substitute for your monthly pay check and will give you and your family adequate time to psychologically adjust to the change in your work status.

Two, it will curb the tendency to overspend by drawing from the business at will. It is important to remember that ad hoc withdrawals from the business can lead to bankruptcy. Also, treat this salary as a business expense, as it will act as an incentive to generate revenues in your new business.

Contingency fund

A new business is likely to face situations where the cash flows are volatile. This can lead to a situation where you may feel tempted to overspend at times, when the income has been good and delay your personal expenses or investments during times of cash crunch. However, neither situation is desirable.

The best way to tackle this situation is to have a contingency fund in place at the very outset and withdraw from this when the business is not doing so well as well as in case of other emergencies.

Business people need a bigger contingency fund in place than salaried persons. It is recommended that there should be at least 18 months of expenses kept aside in a fixed deposit with an overdraft facility or in a short- term debt fund. However, make a rule that whatever is withdrawn will be replenished, as soon as the situation improves.

Investments

While, investing remember that your asset allocation has to be tweaked to accommodate your status as a businessman. So, you could opt for high yielding investments like equities and real estate.

Also, if you are borrowing for your business needs at higher rates, it may not make much sense to invest in lower yielding fixed income instruments. But segregate personal investments from business funds and investments.

It is often noticed that when there is a cash crunch in the business, or when the business is generating higher returns, such investments are liquidated and ploughed into the business. This could adversely affect your ability to meet your financial goals, in case of any adversity in your business.

Insurance

The first thing you need to check is whether you have any personal life and medical insurance. Most employers provide group life insurance and family medical covers to their employees. Therefore, it would be imperative for you to immediately take out a family floater medical cover for the desired amount.

Also, buy a new cover, which should be at least 10-15 times your annual income. Along with these term policies, you should add on riders such as accidental death and critical illness benefit.  Regarding your business, depending on its nature, you may have to take out various insurances like office policy, fire, burglary, marine, cash or goods-in-transit, etc.

When you venture out on your own, as you were doing in your job, there has to be a very big difference in the mindset to handle this transition. While you have more independence, there has to be greater responsibility to make your venture a truly fruitful one.

The writer is director, Touchstone Wealth Planners.

Rishi Nathany
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