Transitioning from employee to consultant isn’t easy no matter how you get there. Some make a conscious decision to start up a business on their own, others shift into the role of consultant after a job loss. Regardless, if not planned out carefully, the migration from employee to consultant can lead to unexpected personal debts as it did for one of our Kitchener clients.
Peter (not his real name) relocated his family several years ago to Waterloo to take a position at Blackberry (called RIM at the time). During the good years, Peter was able to capitalize on this opportunity by gaining experience and growing business connections within the community. Unfortunately with the decline of Blackberry, Peter eventually found himself in his late 40’s and unemployed. With two children connected to a local school, sports teams, and friends, Peter and his wife (Susan) wanted to remain in Waterloo. Since Peter worked in a specialized field and had developed a long list of contacts in the area, he made the decision to start his own consulting business.
During the start-up period, Peter and his family relied on his severance pay and Susan’s part time income to keep up with date with household bills and their modest debt payments. His consulting business started off well enough, gaining his first contract right away. To grow his client base, Peter was required to spend a couple of months traveling through the US and Europe. Not having available cash to pay for the flights, hotel and other travel expenses, Peter paid for these business expenses with personal debt -- his credit cards and a personal line of credit he had set up prior to being let go from Blackberry. And as Peter’s severance ran out, these same credit cards became the primary means to pay for their living costs while the business got going.
Advancing forward 18 months, Peter now has several solid business contracts. His monthly average income from consulting is around $4,500 after business expenses and income tax instalments. They should be doing well.
Unfortunately, the family still seemed to be experiencing a cash crunch each month due to two primary factors; first, Peter’s income varied each month, some months only $2,000, while others were $10,000, and second, their personal debts during the initial setup stages of Peter’s business had increased to $75,000.
They were making all the debt payments on their personal debts, but seemed to be using one debt to pay the other in lower income months. In the larger income months, Peter was playing catch up but inevitably found that the balances were increasing, not decreasing. To improve his cash flow, Peter held back on HST and income tax installment payments in poor months, catching up when his consulting revenue picked up. To date Peter was current with his tax debts but he worried it was just a matter of time before his tax installment fell permanently behind.
Common financial problems for start-ups
Peter fell victim to some very typical financial problems faced by all new business start-ups:
- Insufficient financing for his business which often leads to the over-use of personal debts;
- Poor cash management to help level cash flow needs when income fluctuates;
- No formal business plan or budget to help manage money needs and expectations.
Getting rid of debt
When I met with Peter and Susan, their stress level was taking a toll on them. The varying monthly business income and personal debt levels seemed to make balancing their budget impossible.
At our initial meeting, we focused first on determining what it would take to balance their personal budget. It was fairly obvious that $75,000 in personal debts was too much for them to handle going forward even with the business now doing well. To make their situation better, we had to fix their budget and this meant Peter and Susan had to deal with their debts.
The debt solution they decided on was a consumer proposal which allowed them to pay $450 per month for 60 months, totalling $27,000 to deal with the $75,000 in credit cards and the line of credit debt.
Separating business and personal finances
Next we advised Peter to separate his business and personal finances. We recommended that Peter open two new bank accounts. One account was for his business and the second account was for their family. Peter started to treat himself like an employee giving himself a steady pay cheque from his business. He withdrew the same amount each month from the business account to put into the family account. By doing this, Peter was able to manage his irregular income by only taking out what was needed and leaving any excess for those months when his income was down.
In the end, we were able to help Peter not only eliminate his debts through a consumer proposal, but create a better strategy to manage their consulting and personal finances.