Life and Money as an Entrepreneur
In my first episode, I shared Caleb & Charlotte Whitmore’s story about their experience as entrepreneurs at the company they founded, Analytics Pros.
In this article, we share specific personal finance tactics that will help employees, managers, and founders in entrepreneurial companies.
The winning process in personal finance is to do the big things right, again and again, for a long time. And to avoid spectacular mistakes from which you cannot easily recover. The goal of this article is to enumerate good habits to cultivate and unhelpful habits to avoid.
Founders
Company founders have the most opportunities and the most to do from a financial planning perspective.
Obviously, founders often have the bulk of their net worth tied up in a very specific asset – their business. On the one hand, this means they need to put maximum energy into making sure their business is performing the way they want. Founders must heed Andrew Carnegie’s classic investment advice to “put all your eggs in one basket, and then watch that basket.” As go their company’s fortunes, so go their own.
Finance literature is rife with examples of CEOs who reach the top by focusing maniacally on one thing, and then, at the pinnacle of their careers, become distracted by media appearances, book writing, constructing new company headquarters, making ill-advised acquisitions, and even building their own homes! Neuroscientist and Nobel Prize-winner Eric Kandel says the best way to lead your firm, learn from your team, innovate, and chart your course is to have the mental energy to focus on the vital few that really matter. It requires intense concentration to link new knowledge and ideas "meaningfully and systematically with knowledge already well established in memory," Kandel writes in In Search of Memory, his 2006 book.
On the one hand, it is critical that entrepreneurs remain intensely focused on their one thing. On the other hand, it is wise to find tactics to take a little risk off the table so that if your company fails for any reason, you have the softest possible landing.
As a business owner you do yourself a favor to set your lifestyle as low as possible – for example at 50 – 70% of your realized income – or less! Don’t let the big net worth number on your balance sheet drive your spending choices when that net worth is all tied up in the value of the company.
Second, as a founder you have all the regular wealth-building tactics available to you, like your 401(k), Health Savings Accounts, Backdoor Roths, real estate and taxable investments. And, you also have special tax planning opportunities open to you as the business owner.
Meaningful tax planning opportunities
For example, if your spouse is a marketing consultant and you have marketing work to be done, you can create a contract and pay your spouse $200,000 on a 1099. Your spouse’s consulting company can contribute $37,000 to the 401(k) on her behalf and she can defer another $19,000 for a total of $56,000 in 2019. Your spouse’s company will owe income and self-employment tax on only $145,000 less other “ordinary and necessary” business expenses. Your family will have socked away a good chunk of money for the future, all while avoiding tax on $56,000. That tax savings could easily amount to $15,000 - $25,000 depending on your state income tax rates and your federal tax bracket.
Another great tactic as the owner is to use income timing, creating high-and-low income years to maximize particular tax brackets in each year. You can do this through managing the timing of your charitable giving and your state income tax payments, and possibly by timing your personal compensation.
These are just two examples of special tax planning opportunities that may be available to you as the company’s owner. You should seek professional advice for your situation from a knowledgeable advisor or your attorney regarding these and other tactics at your disposal.
Managers
For managers, the biggest financial differences between working in a startup-y environment versus a more established firm, is the volatility of the employment itself, and the fact that a larger-than-average proportion of their pay may be tied up in company stock.
The challenge of employment volatility can be mitigated in a few ways. Keeping an above-average emergency fund is desirable. At minimum, six-months of expenses is recommended in this scenario. But if you’re a manager who also has a high salary (above the median for your industry), then another possible metric would be 1 month of expenses for each $10,000 in salary you’ll need to replace with your new job. It is not unusual for executive-level employees to search for more than a year for their next gig. And remember, the emergency fund is based on your household expenses, not income, so the higher your savings rate (link out to MMM), the lower your emergency fund can be. In my experience as an advisor, a whole lot of families just feel good with $100,000 cash in the bank. It’s a comfy feeling. On the other hand, Charlotte Whitmore responded to this advice with the quip, “when you’re comfy, you don’t run very fast!”
Some folks like the lean and mean feeling of a smaller cash emergency fund because it keeps them intensely focused on achieving their other goals. The decision on how big this pile of “safe” money should be is personal to you and your family, but if you’re ever faced with an unexpected interruption in your work, you will probably be glad you erred on the larger side of emergency funds.
When much of your pay, and possibly a considerable portion of your net worth is tied up in company stock awards of whatever kind, you’ll want to be alert to de-risking your wealth by diversifying at least some of this money away from company stock as you are able. With your career already bound up in the fortunes of this company, having an excessive amount of your wealth in the same spot is suboptimal, if you can avoid it.
Keep your CPA and financial advisor on speed-dial as you plan to sell company stock and reinvest the proceeds, to make sure you are managing this process in the most tax-efficient way.
I worked at Intel Corporation in my early career around 2005. At that time the company was still loaded with employees who had lived through Intel’s massive stock runup in the 1990s. On a split-adjusted basis, Intel’s stock traded at about $1.10 per share on January 1, 1990. The stock peaked at about $74 per share on a comparable basis on September 1, 2000, returning 6636% over a little more than ten years. Wow. Who wants to sell that?
But then, by September 2002, the stock was trading just under $15 per share, and bounced around between $15 and $25 per share over the next ten years. Managers had watched their paper net worth skyrocket, only to see the stock price drop by 80% from 2000 to 2002, and then to go sideways for a decade. And that’s in a highly profitable, established, company!
Employees
Finally, for employees who are paid on a salary and bonus, the biggest difference between your job and your peers working at firms like Microsoft and Goldman Sachs, is that your job is more likely to go away quickly, either through the sale of the company, through a layoff, through changes in a volatile business environment, or through the company closing its doors.
For these reasons, you also need a big emergency fund. Set your lifestyle considerably below your income. Keep your network fresh, and if your spouse works that is very helpful too.
From there, do the usual stuff, taking advantage of Health Savings Accounts, 401(k)s, Roth IRAs, and other investing opportunities so that when your work does change, you’re as prepared as possible.
Conclusion
Working in the land of entrepreneurship and startups can be rewarding and enjoyable. If you’ll keep the tactics outlined here front-of-mind in your financial journey, you’ll increase the odds of keeping more of the fruits of your labors. Happy Saving and Investing!
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