It’s important to define the nature of your involvement, in both depth and scope, in the business you are founding. An entrepreneur’s involvement in his own business can range from being a full-time manager/employee (active ownership) to that of a hands-off investor (passive ownership).
An active owner materially participates in the day-to-day activities of the business. Most business owners and entrepreneurs actively participate in their businesses in some way, shape or form. Many work full-time in their businesses as employee/managers, drawing both a paycheck and profits (if there are any).
The definition of a passive owner is a little trickier to nail down. A passive business owner does not participate in the day-to-day activities of the business he or she owns. The IRS states that passive income can only come from two possible sources: rental activities or “trade or business activities in which you do not materially participate.” Within the context of entrepreneurial endeavors some examples of passive income are:
Receiving passive income is delightful. The hard part is usually accumulating enough assets in the first place to begin receiving passive income from them (rents or passive business activities). Examples where an entrepreneur can derive passive income from her investments are:
Most entrepreneurs who start businesses have one of two basic plans for their involvement in their enterprises.
1. The entrepreneur(s) plan to be heavily involved in the business startup and operations over a period of a couple of years. Then, at some undetermined point in the future, they plan to hire a manager and then run the company as a passive investment.
2. The entrepreneur(s) are essentially creating a job for themselves. They plan on working in the enterprise as an open-ended, long-term committment.