Going from employee to solopreneur isn’t a transition you should enter into lightly. Whether you’re eager to put in your resignation, worried about giving up a regular paycheck, or a little bit of both, chances are you haven’t considered everything you need to know to make a smooth transition. If you truly want to have the freedom to build the life you want, you need to start by getting your ducks in a row and making sure that you and your family are prepared financially. 

If you’re not sure if you’re really ready, keep reading to learn about the seven steps every aspiring solopreneur should take to know if the time is right to make the leap.

Inspiration for Building the Life You Want

My grandfather has long since passed away, but Grandpa Lloyd was a very successful small business owner. When I was a kid, he owned a farm supply and seed store in Harlan, IA. 

Looking back, I remember that my family always had pictures of exotic vacations, but what I didn’t realize until a few years ago was that my grandpa was a badass business owner. All those exotic trips were rewards for his stellar business performance in serving his clients. I’d like to think I inherited a lot of who I am from him. He was a tremendous family man, very successful, and always had time to help out a neighbor.

My grandpa is my inspiration for building the life I want, which is why I always use the name Lloyd in honor of him when telling my client stories. My clients have their own inspiration, and they inspire me too.

So, enter Lloyd – a client of mine. He wanted to make the transition from worker to owner but needed to make sure that his family’s standard of living didn’t change. I find it so exciting to help clients see the possibilities of solopreneurship and then make the transition, ultimately creating the freedom to live the life they want.

So Lloyd and I started with a discussion of 7 areas of solopreneurship, as follows:

• Cash Flow
• Savings
• Retirement
• Risk Management
• Taxes
• Legal
• Support System

By walking through each area below, you’ll see what you need to assess in your personal and business finances to determine if you’re ready to make the transition from employee to solopreneur.

1. Cash Flow

Cash flow is a measurement of how much money moves into and out of your business during a specified period. And understanding your cash flow is critical to knowing whether or not your business is viable and sustainable. You need to know if you’re bringing in enough to cover operations, pay yourself, and make a profit.

Do you have the ability to create sufficient revenues? If you’re turning a side hustle into a small business, you’ll need to know if it can create enough revenue to replace your paycheck. If you have clients just waiting for you to go out on your own and start working with them, you should know what to charge to make your efforts worthwhile and cover your expenses.

You’ll need to get clear on the amount of revenue you can realistically expect to pull in versus your business and personal expenses. What are your current or estimated revenues for the next 12 months? What are your existing and estimated business and personal expenses for the next 12 months?

The question of cash flow will be your first test in the process. Can you make the transition from employee to solopreneur and have the revenues coming in to match or exceed your expenses? If yes, carry on and keep working through the process. If not, carry on, albeit a bit more carefully, because we don’t have enough information yet.
In the case of my client Lloyd, he did indeed have more revenues than his expenses. So we moved on to discuss the next item.

2. Emergency Savings

An emergency savings fund is a stash specifically used to cover or offset any expenses related to an unforeseen situation. Stuff happens, and when something unexpected comes up as a solopreneur, you can’t always depend on a regular paycheck. Deals fall through, clients take forever to pay an invoice, and meanwhile, your car breaks down and your kid’s tuition is due. You need enough savings to keep yourself afloat and cover costs when things don’t go as planned.

Take a close look at your personal and business cash reserves. How much emergency savings do you have in place in case ramping up your business takes longer than you expect or you have a down season? I recommend six to 12 months of living expenses, leaning more towards 12 to be safe.

Having access to credit can help too. When I left management in 2003, with my wife and oldest daughter at home and a second child on the way, I went to the bank and opened a line of credit just in case. Some other options include taking out a home equity line of credit or, as a last resort, using credit cards.

Lloyd had his emergency savings covered, so we moved on to the next step.

3. Retirement

Since Lloyd had a 401(k) with his employer, we talked about the retirement options available to him upon leaving and moving forward. We discussed the following options with his retirement assets and his goals regarding retirement planning.

• Option 1 – Leave it in the old plan. He had $500,000 in the 401(k), and he could leave it there with no issues.
• Option 2 – Roll it over to an IRA. This would allow him to move the funds from his old plan to an IRA with no taxes or penalties since it would be a trustee to trustee transfer – meaning from one account, the 401(k), to another account that is an IRA.
• Option 3 – Roll it over to his new business retirement plan. Here are the options:
  •  Simple IRA
  •  SEP IRA
  •  Solo 401(k)

Each one of them would work, and they each have different benefits that may or may not be of interest.

Since Lloyd wanted the ultimate flexibility and control, he went with the third option and chose the Solo 401(k). With this, there was a Roth 401(k) option that was a good fit for him. This allowed for the highest limits if his business were to be successful. Plus, he would have 401(k) loans available as an option just in case he ran into a major cash crunch.

As you’re exploring retirement options, keep in mind that these plans should not be a major expense for you. Be sure to ask your advisor about the annual expenses of having any of these plans in place. Still, the bottom line is, it’s essential to not neglect your retirement planning as you transition into self-employment.

Since Lloyd was on the right track, we moved on to the next step in the process.

4. Risk Management

When you go into business for yourself, a lot can happen to derail your progress. No matter how optimistic you are, it’s important to recognize and address potential threats proactively with appropriate risk management. In other words, you need to make sure you’re adequately insured. 

A critical expense you can’t afford to skip is health Insurance to protect your family from the financial ruin of excessive medical bills. If your spouse has employer-sponsored benefits, this is often the best choice. If not, there are other options.

You may be able to take advantage of COBRA, which can last up to 36 months in some circumstances. In simple terms, COBRA is the continuation of your plan from your employer, but at the full price that your employer was paying, which can be expensive. Keep in mind, if you’re considering COBRA, you need to elect it within 60 days of leaving your plan. Otherwise, you may need to find private insurance, and there are many relatively affordable options available in the marketplace. 

It’s also important to ensure you have adequate life insurance coverage in place. All too often, people let this slide when they become self-employed because they’re accustomed to having the employer-based policy.

As a rule of thumb, I recommend having five to 10 times your annual pay in life insurance before going out on your own. The policy you held through your job may be portable and easy to maintain. If not, get a policy in place and account for the cost in your budget. 

You’ll also want to make sure you have disability income insurance. If you become disabled while employed, the insurance can soften the blow; however, many solopreneurs neglect to get coverage, leaving themselves exposed to significant risk.

Because most employer policies are not portable, and because disability insurance companies will want to see two years of tax returns before writing a policy to someone who is self-employed, you should apply for benefits before quitting your job. So my advice is to explore your options before going out on your own.

Look at the total monthly cost for health, life, and disability insurance, and be sure to include these costs in your transition expenses.

Lloyd and I made sure he was adequately covered with insurance and moved on to the next step in the process.

5. Taxes

I spend a fair share of my time helping my clients reduce their tax burdens and bills. I find that most people don’t mind paying what they owe but do not want to leave the IRS a tip.

My advice is always to hire a good CPA or accountant. Find someone who specializes in working with small business owners, and even better if you can find one that works specifically with solopreneurs.

You’ll also need to know about self-employment taxes. You may already have some familiarity with it, but you should be aware that you’re responsible for the full 15.3% self-employment tax on your bottom line if you’re a sole proprietor.

Even if you’re organized as an S-Corp, you’ll still have to pay the 15.3% total; it will just be split between the corporate payroll taxes and then the amount to be taken out of your paychecks. You’ll also be paying ordinary income taxes, which you’re already paying, in addition to your self-employment tax.

You might be thinking, “holy crap, that is a lot!” Yes, it is, but if you work with a good CPA in conjunction with tax planning with your financial advisor, you’ll be able to reduce taxes as much as possible. Still, it’s important to take your overall liability into account. 

One last thing regarding taxes: when you become a solopreneur, be sure to set up a special tax account. Make regular deposits to it so that it doesn’t hurt so bad when it comes time to pay your taxes. I have seen many great businesses shut down because of poor money management around taxes. 

I hooked Lloyd up with my CPA, and we were ready to move on to the next step.

6. Legal 

I am a big fan of filing taxes as an S-Corporation for solopreneurs, especially successful ones. This means you’re going to want to organize your business in one of the following manners.

I personally am set up as an S-Corp and have been ever since 2008, when I formed Gabe Nelson Financial, Inc. I knew that is the type of firm that I wanted to be from the very beginning.

Like a lot of things in business, especially when starting a new one or making a transition from W-2 to solo, you’ll want to begin with the end in mind. I wanted to have the ability to take advantage of paying myself a salary and then taking distributions to help reduce my tax liability each year.

In simple terms, with an S-Corp or an LLC filing as an S-Corp, you have the ability to pay yourself a salary – let’s say $100,000, of which you’ll then be subject to payroll taxes and ordinary income taxes. But let’s say you’re planning to pay yourself another $100,000 in distributions. That amount is only subject to ordinary income taxes. The $100,000 distribution would not be subject to payroll taxes and would provide additional income to your household free of payroll taxes.

The options to you are as follows:

• Sole Proprietor – This option may require a business license or a “Doing Business As (DBA)” in your state. The good of this option is it’s simple. The bad is that you do not have any personal liability protection from your business activities, and all of your earnings are subject to self-employment tax plus ordinary income taxes.
• LLC – Limited Liability Company – This option you can do yourself or hire a good attorney to put together and file with your state. The good is you now have personal liability protection from business activities. The bad is you’re still subject to self-employment taxes. You can form an LLC and then file taxes as an S-Corp, which has become the norm since I started my firm 12 years ago.
•  S-Corporation – For this option, you’ll want your attorney to draw up the S-Corporation and file it with your state. You’ll benefit from personal liability protection from business activities and the ability to reduce your taxes by how you pay yourself. 

You’ll also want to make sure you have your Last Will and Testament and Powers of Attorney in place. I have an attorney that I send most of my clients to who does a fantastic job with the formation of companies and estate planning. I shared her name with Lloyd, and we moved on to the last item.

7. Support System

If you’re serious about making the transition from employee to solopreneur, you will need a support system. These are the people who will cheer you on and keep you going when things get crazy. And they will.

One of my clients just made the transition from employee to solopreneur. He started to tell people what he was doing and, sure enough, someone got in his head. As he shared his plan, he got pushback from those who don’t have what it takes to go out on their own. I called him to check in on his transition, and he told me about the concerns people were bringing up and how he was starting to doubt himself. I assured him that those concerns were just their opinion, and they were most likely projecting their fears onto him. He needed to find a way to get past it. 

Like this client, I told Lloyd to find his people, and I recommend you do the same. Seek out mentors who have been there and done that and model what they do to be successful.

Your Turn

Now it’s your turn to take the next step! To make this transition simple for you, I created a worksheet to help walk you through the seven steps I went through with Lloyd. 

This worksheet will help you understand and dig into your Cash Flow, Savings, Retirement, Risk Management, Taxes, Legal, and Support System. You can download it now at gabenelsonfinancial.com/resources.

If you need help mastering your finances so that you can create the freedom to build the life you want, schedule a consultation appointment with me here.

Gabe Nelson, CFP®, is the principal and founder Gabe Nelson Financial, Inc. (GNF) is a Registered Investment Advisory firm based in Sioux Falls, SD. GNF offers fee-based financial planning and investment advisory services to solopreneurs and self-employed professionals. Clients receive personal attention from a financial planner dedicated to helping them reach short and long term financial goals with specialized insight into the particular challenges and opportunities that arise in entrepreneurship. Gabe can be reached at 605.553.9180, via email at ga**@ga*****************.com, or on the web at gabenelsonfinancial.com.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.