With a start-up business, however, lenders generally need further assurance that they will get paid back. From their perspective, if your personal credit history is a mess, it’s more than likely that you will end up making your business’s credit history the same way. Your personal financial situation may end up crippling your business’s ability to attract investment capital.
From your own perspective, if your personal financial life is a mess, you will have even less time to clean it up after you’ve started your business than you do now. Considering your personal financial well-being and integrating it with your business goals will help you to look at your entire financial situation more rationally and holistically.
Here are some issues to consider when straightening up your personal finances.
Credit History
There are three major credit bureaus in the United States and two in Canada. If you have ever borrowed money (even to arrange a mortgage), you will most likely have a file with these agencies. Lenders report credit history to the bureaus and use the accumulated information to make credit decisions about people and companies. The report will include your current and past borrowings, any late payments, your employment history, and any bankruptcies or other financial judgments against you.
All of this information is distilled into a credit score, which lenders then use to assess how risky you are to them. You should review your credit history at least annually to ensure that it is accurate and that you know what it includes. Any inaccuracies should be corrected as soon as possible, as the corrections may take a few months to show up. Each credit bureau has its own procedure to investigate and correct errors.
In the United States, the three national credit reporting agencies for individuals are —
• Equifax, www.equifax.com,
• Experian, www.experiangroup.com, and
• TransUnion, www.transunion.com.
In Canada, the two reporting agencies are —
• Equifax, www.equifax.com/EFX_Canada, and
• TransUnion, www.transunion.ca.
Debt Management
Besides your credit history, lenders will also be interested in the level of personal debt you’re carrying. More debt makes you a higher risk. From your own perspective, it’s wise to review your debt agreements and interest rates to make sure you’re paying the least amount of interest possible and also that you have a plan to pay down your debt. This plan has to agree with the amount of earnings you plan to take out of your business.
Take the following steps to minimize your debt and interest payments:
(1) Record your debts. List all of your personal debts, the terms left on them, and the interest rate(s).
(2) Rank your debts by highest to lowest interest rates. You will find that the highest interest rate debts are generally credit cards, retail cards, rent-to-own situations, and payday loans. The more the debt is secured by underlying assets, the lower the rate will be. For example, because the bank can take back your home if you do not make the mortgage payments, mortgage rates tend to be lower — because the risk to the bank (not to you!) is lower.
(3) Review your budget. Based on this review, calculate how much you can set aside for debt repayment.
(4) Make a formal debt repayment plan. For each debt, you should know how long it will take to pay off (not just the minimum payments required by the lender). Start with the debts with the highest interest rate and pay them off as quickly as possible.
(5) Stick to a budget! Make sure you make the payments you have calculated every month in order to be out of debt when you have planned to be. Setting personal budgets and cash-flow projections is every bit as important as setting business goals.
Retirement Goals
It’s important for every person to review their retirement goals frequently to make sure they’re on track, but it’s critical for a small-business owner to do so. If you’re planning, for example, to retire a millionaire and buy a yacht to sail around the world, you need to make sure your business plan and your exit strategy are in line with that goal. Your minimum financial goal is to be financially independent. Financial independence means that you will be able to live off your financial capital for the rest of your life without working, if you wish.
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
