When you step into the world of entrepreneurship as a startup founder, you’re embarking on a journey that’s both exhilarating and challenging. As you navigate the ups and downs of building a business from the ground up, managing your personal finances is a critical component that often doesn’t get the attention it deserves. Whether you’re on the cusp of a life-changing financial windfall or facing the risk of your equity becoming worthless, taking control of your personal finances is vital. In this blog, we’ll explore key considerations and best practices for startup founders to master their personal finance.
Equity: Understanding Your Starting Point
As a founder, you likely received restricted stock awards (RSAs) as a form of equity in your company. These RSAs are shares that you purchased at a minimal cost. If you haven’t already, it’s essential to understand the significance of filing an 83(b) election. This action informs the government that you’re opting to pre-pay taxes on the shares, which can result in preferential tax treatment. Properly handling this step early on can save you significant money in the long run.
Moreover, consider exploring the qualified small business stock (QSBS) tax exemption. If you meet the criteria—holding the shares for five years, your business having less than $50 million in assets when you acquired the shares, and owning original, issued shares from a qualified C-corp—you could avoid paying taxes on the first $10 million of gains upon selling your stock.
Tax Strategies: Making Informed Decisions
While there are no “silver bullets” to dramatically reduce your tax burden, understanding your options and planning accordingly is crucial. Some founders consider moving states to save on state taxes. However, remember that choosing your location should align with broader considerations, such as community and lifestyle, not just tax implications.
Hiring a capable accountant might seem like a significant investment, but the peace of mind and the assurance that you’ll navigate financial complexities correctly can be well worth the expense. As you grow and manage equity decisions or delve into more complex financial matters, a Certified Public Accountant (CPA) can provide essential support.
Getting Liquidity: When and How to Sell Secondary Shares
As your startup thrives, you might explore the option of selling secondary shares. Ideally, this should be done with the blessing of your board, and you might also extend this opportunity to early employees as a reward for their contributions. However, selling secondary shares requires a careful analysis of the opportunity cost. Consider both the immediate liquidity and the long-term potential.
Imagine your company is raising a Series C, valued at $250 million, and you own 20% of the shares (a value of $50 million). If you’re allowed to sell $5 million in secondary shares (10% of your shares), assess the opportunity cost. The best-case scenario could be a $5 billion IPO without further dilution, in which case your shares would be worth $100 million. Weigh this against the worst-case scenario where your company doesn’t succeed, and your shares become worthless. The decision to sell secondary shares involves a gut-check weighing immediate liquidity against the potential long-term gains.
Investing: Strategies for Wealth Building
To build and safeguard your wealth, start by creating a cash flow plan to determine your personal expenses and salary. Working with your board and finance leadership can help you establish a fair salary. If your startup’s valuation and revenue justify it, don’t hesitate to pay yourself a substantial income. However, ensure it’s a figure you’d be proud to see in the news.
Before investing, set aside cash for short-term expenses, including an emergency fund (3-6 months of living expenses), taxes for the next year, and other significant life goals like a house payment or a wedding. This reserved cash defines how much you can invest.
Your network is a unique asset as a founder. Consider angel investing in startups launched by friends or explore opportunities to become a scout for a VC fund. While some may view this as a distraction, it can be a rewarding way to leverage your network and gain further financial insights.
Estate Planning: Preparing for the Future
Though it may not be as exciting as managing equity or making investments, estate planning is incredibly important. If you lack a trust or will when you pass away, your estate may go through probate, making your assets public and incurring additional expenses. Setting up a trust can help you avoid this.
Two types of trusts come into play: revocable trusts and irrevocable trusts. Revocable trusts help avoid probate, while irrevocable trusts can provide tax advantages. Assets held in an irrevocable trust are outside your estate and can benefit from estate tax exemptions.
Lifestyle: Balancing Financial Growth and Personal Burn Rate
As a founder, sudden wealth can be challenging, especially if most of your assets are illiquid. Ensure your personal burn rate aligns with this financial reality. Prioritize building your business over indulgent personal expenses. Find opportunities to make a positive impact, both through your startup and in philanthropy, which can be satisfying and encouraging.
Protect Your Future
Mastering personal finance as a startup founder is not just about managing money; it’s about securing your financial future and setting the stage for your business’s success. The financial decisions you make today can have a significant impact on both your personal and professional life. Remember that there are no one-size-fits-all solutions, but understanding your options and planning proactively can make all the difference. Consult with professionals in tax, law, and finance to ensure you’re on the right path to success.