Funding a Side Hustle with Savings
Have you ever dreamed of someday owning your own business? Or maybe you just want a side hustle on top of your day-job?
Having the freedom to be your own boss, create your own schedule, and make money doing something you love is a lifestyle sought out by many. It's an attractive contrast from the traditional corporate life where the chain of command dictates your hours, schedule, vacation, pay, etc.
But like with anything, starting a business (and even a side hustle) can cost money. Depending on the type of business, it may cost a lot of money. As such, in many cases, people often need to forgo savings for a period of time to fund their new venture, with the hope that it will eventually pay for itself before too long.
And that's exactly what I want to look at today.
What kind of income will your business need to produce to make up for the savings that you forfeited to start that business?
Note: If you're interested in doing these calculations yourself, I have a spreadsheet here that you can use to play around with the numbers.
Let's look at a couple of scenarios. Here are some assumptions we'll use for both scenarios:
You're 35 years old today
You currently save $15,000 per year that is invested in an S&P 500 index fund
You put that $15,000 annual savings on hold to fund your new business for the next 3 years
Scenario #1: You build a business to provide some extra income
In this scenario, you don't plan to build a big enterprise and then sell it, you simply want to provide a bit of extra income until you retire. Let's assume you want to retire at age 70.
In order to "make up" for those missed 3 years of savings, your business would need to produce at least $6,000 in profit from age 38 to 70 (we're assuming you don't turn a profit in those first 3 years). Said differently, you would need to save $6,000 per year from your business income until retirement (32 years of savings) to break even from those first 3 years of not saving. That's about $192,000 in contributions over your lifetime.
So, the "cost" of starting this business was not $45,000 ($15,000 for 3 years), but $192,000 ($6,000 for 32 years), since you used money that would have otherwise been saved and compounded over the course of a few decades. Of course, you hope your business produces MUCH more than $6,000 per year, but I show that so you can see the true cost of using retirement savings to fund a business.
Scenario #2: You build a business with the purpose of selling it
In this scenario, you don't plan to run this business forever, you simply want to build it up to a point where you could sell it, then use the proceeds to fund retirement (or a nice Yacht) when you sell it in 15 years.
In order to "make up" for those missed years of savings, you would need to sell your business for at least $186,000 (net of taxes) in year 15. This is the break even cost of those missed 3 years of savings. In other words, this is what would your business have to sell at in year 15 to get you equal to where you'd be at year 15 had you just saved and invested instead.
If your business sells for less than this, you would have been better off investing your annual savings of $15,000 in that S&P 500 index fund. Of course, you hope your business sells for much more than this, but when forecasting the profit from the sale, you should factor in this amount.
Starting Your Side Hustle…
Both of these are VERY simplified scenarios, but the purpose is to give you an idea of the cost of using savings to start a business. You can't just look at the amount not saved, you have to look at the future compounded growth of that money, because that's really what you're giving up.
I'm in no way discouraging people from starting their own business--I actually think that’s one of the most inspiring things a person could do! Which is why I wanted to provide this free resource for people who are considering using savings to fund a business. I encourage you to use my spreadsheet to see what this might look like for your situation. Again, it's very simple, so if you have a more complex scenario, feel free to reach out and we can accommodate.
There are many other factors to consider when starting a business and multiple methods for funding that business, this is just one of them. You could borrow from your 401k (although the same principal applies), you could get a loan, you could cut personal expenses, etc. But those are topics for a different day.