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Startup Organization

How Risky is a Second Career Startup?

By Susan Schreter, Mg. Editor

Question I am planning to retire in 18 months and want to turn my furniture making hobby into a part-time business. My wife is concerned about losing our savings. What do you think?


There is a media image of entrepreneurship that seems to favor the work of eager, young innovators. Overlooked in the story are semi-retired, second career entrepreneurs who have finally earned the opportunity to work on creatively satisfying business opportunities. Now these retirees are developing businesses as writers, teachers, decorators, antique restoration experts, bakers, social entrepreneurs and more.

The reason I used the phrase "earned the right" is because their 30 or 40 years of salaried service have bought them social security and other forms of retirement income to help pay the bills while they pursue new entrepreneurial endeavors. I know a lot of 20 to 40- something prospective entrepreneurs who can't start their businesses because they don't have any other source of living while the business works toward a profit. You and your wife do which reduces some of the more stressful aspects of entrepreneurship.

While no one ever enjoys losing money in a startup there is another source of relief -- it's the U.S. tax code. While there are always restrictions, in general, businesses that create a loss may be able to deduct the loss against other earned income. Plus, the IRS may allow you to offset any excess losses by applying them against the prior two years income or carrying them forward to apply against future income. You and your husband should talk to your accountant about your specific tax situation.

Your use of the word "hobby" however caught my eye. There are a few words and types of business operations that tend to attract the attention of IRS agents. A hobby-oriented business is one of them.

If the IRS rules your side-line business is more of a hobby than a legitimate business then it will take away opportunities to carry-forward or carry-backward losses against income. IRS targets tend to include home-based animal breeders, collectible traders, and artists.

Network marketing sales reps who fill their garages with unsold inventory and generate losses year after year are other IRS targets. The IRS reasons that buying cosmetics and other home products for personal use is not the same as operating a business that routinely sells products to non-family members.

The best way to avoid IRS attention is to report a profit preferably in any three of five consecutive years. For companies that don't reach this desirable goal, then its wise to be cautious about describing the business as a hobby on sales literature of Web sites. It's also worthwhile to prepare monthly or quarterly financial statements throughout the year to demonstrate ongoing attention to business results. Your business should be more than a spring-time tally of tax deductions.

Now to the trickier issue of funding the startup. Frequent readers of this column know I'm rarely supportive of draining retirement accounts or taking out home equity loans to fund a new business. Here's why.

If you draw more money from an IRA, pension or 401K savings account than the IRS permits for your age, then you will have to pay cash penalties on these withdrawals. Actually, this cash cost may exceed the interest associated with securing a manageable small business loan.

Another problem associated with using retirement money, for entrepreneurs of any age, is the limitations of replacing tax deferred investment funds. I'd always rather have $1,000 in a tax deferred savings account than $1,000 in an ordinary savings account to let more of my money grow without paying annual income taxes on capital gains and dividends.

These accounts are also appropriately named "retirement" savings not "small business" savings accounts. If you can't afford to lose this money don't consider it as a business funding source. Period.

Next up on the funding source option list is home equity loans. Even though the nation is in the midst of a mortgage lending crisis, I still get press releases from firms that tout the advantages of older Americans taking out reverse mortgages or home equity loans to fund exciting "sunset businesses." The hyped up language makes me cringe.

Here's what you should keep in mind. To the extent you draw on home equity to fund a new business, you still will have to make the additional monthly mortgage payment in order to keep your home. Can you afford this extra debt without assuming any contribution from the new business?

Here are some other recommendations:

  • Cap your investment risk. Make an agreement with your wife of the total amount of money that will be invested in the business. And to double check your willingness to invest this money, calculate how many years it took you to save this money. Is the total a reasonable tradeoff?
  • Test! Test! Test! Take the time to thoroughly research customer demand for your proposed furniture product line before making big investments in advertising, inventory or machinery.
  • Limit business liabilities. Because you have developed a lifetime of assets, consider organizing your business as a Limited Liability Company or S-corporation so unpaid business debts and other liabilities don?t become your personal obligation.
  • Explore other funding sources early. Entrepreneurs who wait until they are desperate rarely raise money successfully from lenders or investors. Their impatience shows to investors who have a legitimate right to take their time.
  • Check out retirement savings loan provision. If you absolutely must, some retirement savings plans grant special-need loans without incurring withdrawal penalties. You will have to pay interest back into your retirement plan, which if documented appropriately, may be deductible as business interest expense.

Here's one last tip. I believe much can be gained when older entrepreneurs collaborate with younger minds for a different perspective. Equally, I encourage younger entrepreneurs to seek out the wisdom and experience of older entrepreneurs too.

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