Get Financially Prepared for Self-Employment

The call of the wild beckons and for many the new frontier is self-employment. Breaking out of the corporate world, avoiding being downsized or just proving to yourself that you can do it are all tempting thoughts to start your own gig.

However, the reality may be that reality bites. Especially if the mortgage, student loans and eventual long retirement still require your financial attention. The best approach is not to jump until you're ready. Here are some tips to help you prepare for self-employment.

Be Careful with Capital

More than ever before, people are turning to self-employment, either because they want to or because they have to. At the same time, the US is rich in credit resources and the self-employed have greater access to capital.

This can be good, but before tapping into retirement funds or mortgaging the house, you need to come up with a sustainable financial plan. Why? Because if you're starting your own business, it's likely that two years will pass before you see a profit. And that's only if your business succeeds. If it takes you a few tries to get your business off the ground, you're going to want a soft landing.

Do an Honest Cost Assessment

If you think it's easy to replace your income with self-employment that's great! But, are you honestly looking at all the costs? Health insurance, life insurance, spending accounts and employer contributions to your 401(k) are all going to stay behind when you walk out the corporate door.

Maybe you've been diligent and saved several months worth of emergency cash. Great! However, you need to reassess what several months worth is because your overhead will change when you are self-employed.

For instance, if you've been in the corporate world awhile you might be in for a shock when it comes to health insurance premiums. They not light and remember, as a self-employed individual this necessity is now your responsibility.

Before you pack up your cubicle, take the time to add these new costs to your monthly budget. You don't want to six months of emergency cash to turn into two just because you underestimated your costs. Remember, when you're out on your own, income is not guaranteed.

While you're tacking the cost of lost benefits onto your monthly bills, be sure to keep a line for retirement and savings. When you become self-employed, you'll need to maintain your savings vessels just as you did when employed by others.

It's easy to say that these can wait while you're building your new business and that you'll catch up once your entrepreneurial self has taken flight. The truth is, you can't retire on borrowed time and you're doing yourself a tremendous disservice. If you keep up retirement plans and savings vessels, at least your money will be moving forward (with interest) even if your business doesn't.

Don't Sabotage the Golden Years

It just might work out that your business takes off and you retire early with as a young millionaire. It could happen but it is not a sound retirement strategy. If you're serious about living well later in life don't use your retirement accounts to fund a new business.

It doesn't matter how far you are from retirement age. Even if you're still on the uphill climb to midlife you need to protect your retirement savings. Tapping into your 401(k) to start a new life as an entrepreneur is a bad idea. You can expect to pay early withdrawal penalties to the tune of 10%, be taxed on the distribution and you are throwing away a precious commodity that any sensible business person must respect : interest.

Don't Rob Peter to Pay Self-Employed Paul

The same respect for interest must be applied to the two self-employment no-no's: home equity and credit cards. Using the equity in your home to fund your new business is creating a debt out of an asset. You'll increase your already increasing monthly overhead and, if your new self-employment route takes a downward financial turn, it's possible you could lose your house. You'd be better off placing your deed on the roulette table at the nearest casino.

The same principle applies to credit cards. No matter how great the introductory rate is at the start of your startup, it's likely to increase at just about the time your self-employment cash flow comes to a standstill. At the same time, I'll admit that if you can use credit wisely it may be useful.

For instance, years ago I decided to convert my day job as a construction laborer into my own business. I focused on a sought after specialty, lined up work and used about $800 of a credit card account to purchase tools. After about three small jobs, I was back in black. My initial debt was erased before it became a problem and it had helped start a thriving business.

The key to using credit is you've got to set a limit, one that won't lead to bankruptcy if your business venture fails. If the initial investment is small, don't be too gun-shy about using credit. Just be sensible and remember, as both president and chief financial officer of your own business, you will be the one who has to live with the debts you accrue.

Don't Walk Until Your Cash Talks

The reality is that if you want to be self-employed it's going to take some discipline. If you want to succeed at being self-employed over the long term, you need to start that discipline before quitting your current job.

The best way to get prepared for self-employment is by starting a savings account that will provide financial shelter while starting your new venture.

This is separate from retirement savings or emergency cash savings. This account should be built up to cover your family's expenses for at least six months, a year is better. From this account you should also be able to cover self employment overhead like health insurance premiums and retirement account contributions.

It may sound like overkill, but being self-employed is a commitment. Plus, building a lucrative business is much easier to do without extreme financial pressure -it will be hard to keep clients if you can't pay your phone bill.

If you really want to run your own business and work for yourself, start saving. Track your spending, find ways to cut costs and consider taking a part-time job for extra income. Keep the self-employment fire burning but just be sure your finances are fire proof before you venture out on your own.