Small and medium sized businesses tend to be good sources of economic growth during down-times (and surveys indicate in good times too). One obvious reason is that many ex-employees simply start a business as opposed to finding another job where the prospects of new positions are not very good. The Economist also pointed out recently that many big companies jettison promising but, not cash-flowing producing, projects which entrepreneurs spin off into their own business. Alternatively, big business simply abandons the field for entrepreneurs to take over. The most famous examples being that Microsoft and Oracle were both founded during down times.

If you are looking to be an entrepeneur what are some of the personal finance issues facing you?

Let’s look at the hard numbers. CIBC is a frequent researcher and commentator on this topic and they found the following in a October 2005 study looking at the Canadian entrepreneurship landscape (here is the study). I suspect the results are similar in the U.S.:

1. Entrepreneurs work harder but for less. According to the study, an average entrepreneur works 56 hours a week but earned on average $38,000 (or $5,000 less than employees).  However, I would note that the average salary figure may be misleading (the study did not reveal its methodology). An entrepreneur’s income is taxable income which is (revenue) – (legitimate business expenses). and legitimate business expenses include many items  which employees cannot claim as deductions (stationary, computers, cars etc.). Thus,  I am not sure if that’s an apples to apples comparison.
2. But you can’t trade love for money. 83% of all entrepreneurs say that starting a business was the best decision they made which is further reinforced by the fact that an entrepreneur’s tenure in any one business is 35% longer than an average employee’s tenure.
3. Its a life-style not a resting place between jobs: 33% of those surveyed indicated they owned or do own more than one business.

Now here’s the stuff the studies won’t tell you from personal experience:

1. Your business, and bank account, will suffer in the first 3 years. Most experts believe it takes a full 3 years to get a business really going and finding its feet. Prepare to be cash poor in year 1 and struggling in year 2 and 3 because cash has to be reinvested in the business.
2. You create a source of net worth not found by most employees. A properly built business has tangible net worth above and beyond hard assets (called goodwill). In some instances, the goodwill of the business can be worth in the six figures.
3. You personal portfolio tends not to resemble an employee’s. An entrepreneur, because they are investing so much into their business, tends to generally be more into cash. Entrepreneurs also tend to be insured greater (as a credit proofing, tax structuring and succession strategy) and subject to a lot more legal and tax structuring (insurance, individual pension plans, holding companies, family trusts etc.) because of the complexity and personal exposure of owing a business.

I readily appreciate that not everyone is fit to be an entrepreneur for a wide variety of reasons but I wanted to raise 2 points in the “entrepreneur is risky”  stereotype: (i) most people who say entrepreneurship is risky are employees- we fear what we don’t know; and (ii) controlling your own fate is a lot more secure than placing your security in someone else’s hands.

Risk occurs when we enter into something we don’t fully appreciate and, without such due diligence, every personal finance decision would be subject to the same level of risk exposure, regardless of being an employee or entrepreneur.