Separating Business and Personal Finance: 3 Questions for New Business Owners

Small Business
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By Dmitriy Fomichenko

Learn more about Dmitriy on NerdWallet’s Ask an Advisor

Starting a business is an exciting move, but it can be quite taxing on the business owner. Entrepreneurs typically dedicate all their time, effort and money to growing and sustaining the business. This single-minded dedication can result in an ongoing, successful venture. But sometimes, without proper planning, it can also jeopardize the owner’s personal finances. The key is to strike a smart balance between the business and the owner’s personal funds.

Here are the three questions to consider when starting a new business.

1. Will the business be a burden on your personal savings?

Irregular cash flow is an unavoidable part of most new businesses. As a new business owner, you will see better cash flow in some months, and very little or even none during others. When the business is not bringing in any money, how will you survive? It is essential to set aside an emergency fund for yourself—separate from your company—and keep your business expenses under a close watch.

Also, many business owners ignore their retirement savings and planning once the business is born. This is not a smart move; we never know what will happen down the road. If you have no other full-time employee, the Solo 401(k) plan offers a great deal of flexibility for retirement planning. Creating a self-directed IRA is also an option. With these retirement plans for the self-employed, you can start saving for your retirement and take advantage of many tax benefits. For example, besides the tax-deferred or tax-free contributions and investment gains, you can claim the cost of setting up a Solo 401(k) as a deductible expense for your business.

2. In a worst-case scenario, how will your business’s failure affect you?

No one wants to talk about the possibility that his or her fledgling business may fail. However, it is always better to prepare for the worst than to be caught unprepared. So how will a business failure affect your personal finances? Will creditors be able to come after your personal assets to recover their loss?

This concern is the main reason why businesses are set up as corporations or LLCs. These structures offer asset protection to the owners of the business, which means all personal assets will be separate from the business’ assets. If you are operating a sole proprietorship, there are ways to achieve asset protections. For example, retirement plans—such as the Solo 401(k) and self-directed IRA mentioned above—come with asset protections. In case of a business or personal bankruptcy, creditors cannot go after your Solo 401(k) or IRA. For other asset protection strategies, it’s best to talk with a specialized attorney.

3. Is the business your sole investment?

Diversification is the first rule of investing. By diversifying, or investing in different assets, you can minimize the risk and spread and optimize your investments.

By dedicating all your time and resources to your business, are you ignoring the rule of diversification? A private business is a risky investment and your need for diversification is even higher. Review your personal finances and talk to a financial advisor about the best investments that fit your appetite for risk, as well as your financial goals.

You should also keep a diversified retirement portfolio with assets of your choice. Self-directed retirement plans often come with the flexibility of investment choices to help business owners optimize their portfolio. A self-directed Solo 401(k), for example, can hold real estate properties, trust deeds, precious metals and many other alternative options, in addition to stocks and bonds.