Insurance
Insurance tends to be one of those things you don’t give much thought to on a regular basis. It’s important, however, to ensure that your personal assets are adequately protected — including yourself! There are four main types of insurance to consider to cover your personal assets.
• Life insurance. Once you own a small business, you should reevaluate the amount and type of life insurance you carry. You will need to make sure your spouse, children, and other dependents will have enough to pay off the debts and live on comfortably if your source of income dries up. Keep in mind immediate expenses upon your death such as funeral costs. Also keep in mind future expenses you had been planning to fund, such as your children’s university educations and weddings.
• Mortgage insurance. The purpose of mortgage insurance is to pay off your mortgage balance if you die (and sometimes when you become disabled). Most mortgage insurance policies have inherent problems, however, and you should speak to your accountant or financial adviser before entering into such a policy. The premiums on most mortgage insurance policies are set based on the amount owing when the policy is first set up. So, for example, you may owe $150,000 now on your mortgage and will pay premiums based on that. In ten years, when you die, you may owe only $10,000, and that would be the amount paid out on the policy. In general, the premiums for mortgage insurance tend to be high compared to the payout. Mortgage insurance can be replaced with additional life insurance for a much lower cost in many cases.
• Property and casualty insurance. This is the insurance you get on your “stuff” — home, vehicle, and other assets. Some policies also have a liability clause that protects visitors from harm that has occurred on your property. The minimum amount of insurance you will want (and that will most likely be required by lenders) is what it takes to cover the debt that is secured by the assets. So, for example, if you have a car that you purchased for $10,000, and you still owe $4,500 on it, you will want at least $4,500 in insurance, otherwise you will end up owing money to the financing company if you total the car.
• Health insurance. The majority of people are underinsured in the area of health insurance. It is tempting to assume you will be healthy until you retire, but this is dangerous thinking. If your health fails, your ability to earn income may disappear, along with your plans for retirement. As a small-business owner, health insurance is essential, for you will not be able to rely on any employer- or government-funded health plans.
You need to consider two major areas of health insurance coverage. The first is that you will not have your income any longer. As a small-business owner, you will have to hire someone to do the work you once did or you may even have to close the doors of your business. Either way, you will have to replace your former income.
The second is that you may have ongoing medical and long-term care expenses in the future. For example, you may have to hire a private care nurse to attend to your medical needs.
There are many forms of health insurance. Some include coverage for drugs and dental expenses, some pay out a lump sum when you are diagnosed with a critical illness, and some provide ongoing payments for your lifetime. Discuss coverage with your financial adviser or insurance specialist to make sure you will be able to continue to meet your personal and business financial goals in the event of serious illness.
Sources of Financing
Once you have your business plan in place and you have reviewed and amended your personal financial situation, it’s time to look at the potential sources of financing for your business. Although a bookkeeping practice, like many service businesses, has lower start-up costs than a manufacturer or retailer, it is still likely that net profits won’t cover the funding of the start-up period. Therefore, you will have to look at either your own or outside resources (i.e., from lenders or investors) to cover start-up losses.
Internal Resources
The most available source of capital, at least in the start-up period, will probably be your personal savings and loans from family and friends. Until your business develops a track record of financial success, external capital providers, such as investors and banks, will be less likely to take a risk on your new enterprise. Luckily, there are many sources of internal capital. Your own resources could include the following:
• Savings
• Personal loan or line of credit
• Remortgage of your house
• Credit cards
• Borrowings from friends or family
Some of these sources are preferable to others. Be sure to weigh the risks of each type of borrowing. For example, remortgaging your home puts your personal residence at risk if you are unable to repay the loan. Credit card borrowing is usually an extremely expensive option and can damage your personal credit rating. Borrowing from family or friends can bring its own tensions if payments are deficient or late or if the lender wants the principal paid back sooner than you expected.
External Resources
Once your business has developed a track record of financial success, new avenues of capital become available. Outside sources of funds could include the following:
• Business bank loans
• Business lines of credit
• Business credit cards
• Private loans
• Leaseback agreements
• Business property mortgages
• Stock sales (in the case of corporations)
• Venture capitalists
• Joint venture partnerships
As with personal borrowing options, some types of business borrowing are preferable to others. Some of these sources of funding represent equity (i.e., the lenders own a stake in your company), while others represent debt to outside parties. The type of borrowing you choose may have an effect on the debt to equity ratio of your business, which may impact the ability of the business to borrow more funds.
In the start-up phase, personal borrowing may be all that you have access to. The more sophisticated forms of business financing, such as joint ventures and venture capital, may not be accessible for several years.
If you employ external financing, regardless of the type, there are some basic questions you will have to answer from a prospective lender or investor. The answers to these questions should be found in your business plan.
(a) Is the business built on a solid plan? How much homework have you done to prove that this is a viable business venture?
(b) Do you, as the business owner, have enough entrepreneurial and managerial skills to build and manage a business? Lenders will look for your training or ability in finance, bookkeeping, operational management, strategic planning, and human resource management. Simply having prior bookkeeping experience will not be enough.
(c) Is the business built on a model that will have sufficient cash flow to pay its creditors, including this particular lender? The lender will be concerned not only with their exposure to your business’s risk of failure, but the exposure of other lenders. For example, if there are other lenders who have priority repayment or repossession status, the lender who is assessing the extension of further credit may be worried that if you go under, there will be nothing left with which to repay their loan.