Count the Cost and Make the Leap - Pivot To Entrepreneurship or Cut Your Pay To Chase Your Dreams
February 24, 2021
By Matt Miner, MBA, CFP®
Have you dreamed of doing your own thing, of going out on your own? Have you looked at your career and considered what it would take to hit the reset button and do something very different for your job? And if you did either of these things, what would it take to make the money thing work?
That’s the focus of this episode.
I present a fictional case study to illustrate how to make your side hustle your full-time gig. Michael is a consulting engineer earning $175,000 and Amanda is a private school teacher. They’ve got three school-age kids and we use a sample budget to illustrate the impact of self-employment taxes, the huge benefits of the non-pivoting spouse working during a big career pivot, and how much consulting revenue it takes to replace a $175,000 salary.
If this idea intrigues you, I’m a fan of Chris Guillebeau’s books, especially The $100 Startup, and all Nick Loper’s stuff.
TRANSCRIPT
[00:00:00] Matt Miner: Have you dreamed of doing your own thing of going out on your own? Have you looked at your career and considered what it would take to hit the reset button and do something very different? Today, we look at the dollars and cents of making big changes to your work and to your income to chase a dream.
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Hey, and welcome to the Work Pants Finance podcast. I'm Matt Miner, your money guide, and Work Pants Finance is the show for MBAs, entrepreneurs, and other professionals who want their financial plan to work as hard as they do. Today's show is called Count the Cost and Make the Leap. You can read more at workpantsfinance.com/3.
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If you think it's time you made a financial plan that works as hard as you do, go to workpantsfinance.com/contact, and get in touch.
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Today's show is aimed at two groups of people with similar planning needs. Those who have a side hustle with real customers and revenue, but not enough revenue to live on, and career switchers with a specific job or skill that they'd like to pursue, but which results in a temporary reduction in income while they reskill.
I am such a fan of this second group of people that I've done it twice. Once when I went to business school, and again when I departed the corporate world to become a financial advisor. Though the planning tactics that I discuss are relevant for both groups, in our case study, I'm focused on a successful side hustler who wants to go full time. In today's show, I'm focused on laying out the strategy, moving pieces, and important interactions of this family's work, benefits, budget, and balance sheet.
Today's episode is not focused on nitty gritty details like budget or investment specifics, even though those things are important too. This episode is not about leaping to entrepreneurship with no revenue, nor is it about training for something for which there are no realistic job prospects. That's a hobby, and not a career. Instead, this is a clear-eyed look at one family's transition from full-time work with a big side hustle, to going out completely on their own for the main earner's income.
I'd like to introduce you to Michael and Amanda; both are 35 years old. Michael is a consulting engineer with a local structural engineering firm and earns $175,000 each year. Amanda is a teacher at a small private school. The best part of Amanda's job is that all three of Chris and Amanda's kids attend the school and love it. They get a big tuition discount as a benefit of Amanda's job. Amanda drives the kids to and from school, and other than activity fees, Michael and Amanda do not pay for childcare.
Though Amanda's job offers comprehensive group healthcare benefits, the benefits are not highly subsidized by the school. Employees basically pay the full cost of the benefits. Chris's benefits program is a much better value, so the whole family is insured for health through Chris's work. Though there is a lot to love about Amanda's career, her salary is modest at $36,000 each year. Michael is a PE, a professional engineer. His employment agreement permits him to serve clients on the side as long as he's not competing with his employer for business.
Michael's employers' clients are exclusively engaged in designing and building commercial office space. Michael's firm does not serve residential designers or builders. Three years ago, Michael was on a job site. He struck up a conversation with a subcontractor named Casey, who was installing the HVAC system. Besides commercial HVAC, Casey has his own residential general contracting business, and he'd won a large remodeling job that needed a PE stamp on the plans in order to get the City of Charlotte building permit.
The engineer Casey used to work with retired and moved to Thailand and is not responding to emails. Casey asked Michael, can you help? Michael can. He and Casey got together. They reviewed the plans, which are much simpler than what Michael is used to reviewing. Michael agreed that the new screen porch will not fall off the house nor will its roof collapse. He affixed his professional engineering seal on the plans and received a $1,500 fee for a couple of hours of work.
Casey hired Michael once more that year and introduced him to several of his contractor friends who began using Michael services. Michael launched a website and YouTube channel called Long and Strong, where he talks about how homeowners can run their own projects, including when they need plans and building permits. Michael maintains a database to make connections between his followers and suitable architects, designers, and general contractors, who in turn hire Michael for more PE work on their jobs.
Now, here's Michael and Amanda's simplified budget, excluding Michael's side hustle income. Michael and Amanda's total investments are $300,000. In addition to which, they have a $100,000 in cash. Now, each year they earn new about $1,000 in investment income, that's just interest and dividends from their brokerage account that may have gross earned income of $211,000 per year.
That leaves them paying social security tax of $11,086, Medicare tax of $3,060, federal income tax of $30,000, North Carolina state income tax of $9,250, after which they have $158,605 left over that they can do what they want with. They choose to put $30,000 a year into retirement savings, leaving them with $128,000 that they can take to Walmart.
Michael and Amanda's household expenses are $9,000 each month, or $108,000 a year. Their business expenses for Michael's side hustle are a $1,000 a month, or $12,000 per year. That leaves them with a $717 per month cash surplus, or $8,604 per year, which they are actively adding to their cash balance to support them when Michael is ready to make the leap to turn his side hustle into his full-time thing.
For the last three years, Michael has worked 45 hours for his employer, and spent his evenings and Saturdays on his own client work and building his web marketing. His revenue grew from $7,000 in the first year, to $25,000 in the second. Now, at the end of his third year, his revenue has reached $70,000. He loves his clients and the control he has as an entrepreneur. He believes that there's more work to be had for him, but he can't stretch his time any further, and he's still doing his regular job.
Michael wants to launch his own engineering firm, but he and Amanda are daunted by the thought of stepping away from Michael's $175,000 salary and valuable benefits. They wonder, can we make it work? Michael and Amanda paid taxes and direct expenses only from Michael's side hustle income. The rest of that money they've squirreled away in cash alongside their emergency fund. They begin this journey in a strong position with a $100,000 in cash.
At the outset, they agree they are willing to spend their cash down to $20,000. At which point, they will realize $30,000 from their investments, and keep trying the business for another three months if they still believe things are promising. If those final three months go by and they continue their cash drain, Michael will try to return to full-time work for his old employer or for someone else.
Michael and Amanda are prepared to buy their healthcare through Amanda's work, even though that will be devastating for Amanda's take-home pay. This will require an increase of $1,200 in their monthly outlay. Michael and Amanda also believe that they can reduce their general household expenses from $9,000 to $8,000 per month as they make this transition. Michael gets all his work projects into excellent shape. He gives his employer a nice long notice, including a week of overlap with his replacement on his old job, and walks out of his office on a Friday afternoon as an entrepreneur.
Now, let me walk you through these budgets. Even though Mr. Money Mustache would choke at this level of expenditure, for a family of five used to earning $211,000 per year, this budget feels realistic based on my experience with clients like Amanda and Michael.
In Michael's first year full time as a consulting engineer in his own business, Michael and Amanda continue to have a $1,000 of investment income from their portfolio. Michael's revenue is $120,000, which is really substantial for a first year in business. Amanda's salary continues at $36,000. On that income, they pay $17,112 in social security tax, which is approximately $6,000 more than they were paying when they were earning much more money as employees.
The reason for that is that Michael is now paying both the employee and the employer portion of his social security and Medicare tax. This is a tax that self-employed people pay that employers pay on behalf of their employees. Even though their income went down, their social security tax went way up. Their Medicare tax likewise increased from $3,000 to $4,000 for the same reason.
Now, their federal income tax has gone down quite a bit from $30,000 to $15,000, and their state income tax has dropped to $6,000 per year, leaving them income after taxes of $78,886. After that, they do choose to contribute $5,000 through Amanda's work to her employer-sponsored retirement plan, leaving them $73,886 to take to Walmart.
Now, on their new reduced monthly family expenditure of $8,000, they still need $96,000 per year to live. Also, because Michael is doing his business full time, expenses have increased from a $1,000 a month to $2,000 a month, or $24,000 per year now going to the business. Finally, their benefits have gone way up in cost. It's an extra $1,200 per month to buy the benefits through Amanda's employment compared to what it used to cost to buy them through Michael's employment for an additional $14,400 being spent primarily on healthcare.
With these budget figures, they drain their cash by $60,514 after one year as an entrepreneur, and their cash balance is now $39,486. Nevertheless, Michael has several exciting contracts on deck, and things are looking better for the coming year. In Michael's second year full-time as an independent consulting engineer, Michael and Amanda still have $1,000 in investment income.
Michael's revenue from clients has grown to an astounding $180,000, and Amanda salary remains $36,000. Now on that income, they will pay social security tax of $19,840, Medicare tax of $5,742, federal income tax of about $20,000, state income tax of about $7,500, and that will leave them with about $128,000 after they've paid taxes.
They continue to contribute $5,000 through Amanda's employer-sponsored retirement plan, leaving them now with $122,000 in income of that. They're still spending $8,000 per month or $96,000 to support their family each year. Business expenses have grown again to $2,500 per month or $30,000 per year. Benefits remain $1,200 per month, or $14,400 per year.
That even though revenue grew from $120,000 to $180,000, Michael and Amanda still burned through $17,482 of their savings, dropping their cash nest egg from $39,486 to $22,000 at the end of their second very successful year as entrepreneurs. Now, finally, in Michael's third year in business, they've got their $1,000 in investment income. Now, Michael's revenue has grown to a staggering $230,000 in year number three. Amanda's salary remains stuck at $36,000. I guess she should talk to the school about the possibility of at least a cost of living adjustment.
Social security tax has increased to about $20,460, Medicare tax at $7,192, and federal income tax now at $25,000, and state income tax at $9,000, leaving them income after taxes of $169,348. We can compare that with where they started this journey three years ago at $158,605. Now, they're still in this budget, only got $5,000 going to their retirement savings contributions. Although I would recommend that in this year, they might think about beefing that up.
If they leave it at $5,000, they will have managed a cash surplus in year number three with extremely successful revenue growth, a cash surplus just shy of $24,000, replenishing their cash to just less than $46,000 at the end of three years. Wow, they made it, but they saw their cash depleted from $100,000 to $22,000 at one point. That is a disconcerting feeling.
Here are a few key takeaways from our time with Michael and Amanda. Michael made this jump with meaningful revenue as a side hustler and significant experience in the industry he was going to serve. He transitioned to something that closely utilized his existing skills and experience. While Michael and Amanda cut their family spending budget from $9,000 to $8,000 per month, it is possible that they could have cut more here, especially on the front end. This would've stretched their cash and given them a larger gap between the trough in their cash balance, and the point at which they said Michael was going to have to go back to full-time work for somebody else.
At the end of our case discussion, Michael and Amanda cash balance is only just beginning to recover, but they have also forgone a meaningful amount of retirement contributions in the meantime. That's not a huge deal. They just need to be aware that they will either need to make that up at some future time, or their future retirement lifestyle will be less than it otherwise might have been, or they may just work a little bit longer.
That may be fine because when you're an entrepreneur and have so much control over your life and revenue, working longer is no hardship. Now, take-home pay from Amanda's job took a massive hit as the family purchased benefits through her employer. Nevertheless, the fact that these benefits were available was very helpful. The group rates that they paid were probably less than they could get on their own, and they got to pay those rates with pre-tax dollars, which you can't do if you buy insurance privately.
Also, Michael and Amanda didn't have to disrupt their children's school routine through this transition. I'd also like to point out the astounding amount of revenue that it takes to replace a $175,000 per year salary, somewhere in the neighborhood of $225,000. This just points up the fact that you probably already know, whether you're an entrepreneur or someone who works for somebody else, a salary is a very valuable thing.
Now, as Michael's business continues to grow, he may be faced with hiring help, and hiring someone will change the cost structure of his business. I'd just like to point out as we wrap up that this is a stylized, nearly best-case scenario, and it's still hairy. Michael and Amanda drained a $100,000 pile of cash down to just $22,000, and with a family of five. That is a gut check for sure. Also, most real entrepreneurs will tell you that it never goes this well in the first few years. The only reason I was comfortable portraying it this way is because of the three years that Michael spent side hustling before his jump to doing this full time.
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Thank you so much for sharing your time with me today. Thank you also to everyone who's been in touch via email, text, and social media with nice things to say about the new name and the new show. Please join me in just two days for Flashback Friday, and the next amazing episode of Work Pants Finance. Informational interviewing, learn cool stuff, meet amazing people, and stack the deck in your favor. Until then, this is Matt Miner, encouraging you to make a financial plan that works as hard as you do.
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[00:16:32] Female Speaker: Matt Miner is fee-only fiduciary financial advisor and founder and CEO of Miner Wealth Management, a North Carolina registered investment advisor, where Matt provides personalized, unconflicted advice to clients for a fee. He's also my dad, so please be nice when you talk to him. Matt is a certified financial planner professional, and holds a Series 65 securities license. He earned his bachelor's degree in finance from Arizona State University and his MBA from Duke University's Fuqua School of Business. Work Pants Finance is Matt's financial media business, where he talks about work, entrepreneurship, kids, and money, taxes, investing and other personal finance topics. Workpantsfinance.com exists to share wisdom to provide general financial information, does not financial tax or legal advice. If you're an individual and probably need personal advice for your specific situation, you should consider building relationships with helpful, caring and competent professionals who understand your unique context and can provide advice that is tailored to your needs.
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