By Michael Hanks, Esq.
In my last column, I discussed the proper use of outside professionals by the small businessman. In this article, I want to talk about the most common mistakes made by persons starting a business. In my years as an attorney, I have seen businesses fail for each of these reasons, or for a combination of these reasons. Nonetheless, almost without exception, whenever I counsel someone starting a new business, the following mistakes are made by the fledgling entrepreneurs:
- This business idea is so good it cannot possibly fail. This misconception is usually the product of wishful thinking, coupled with a failure to properly survey the market. In the typical case, the client has received input from “friendly” sources, such as a spouse, friends or casual strangers, no one of which is eager to pour cold water on his enthusiasm. He therefore gains a distorted view of how novel and creative his idea is.
- We can start this business for peanuts. If we need more money in the future, I’m certain we can find it somewhere. This error is perhaps the most frequent and the most deadly. It’s source is usually the strong desire to be self-employed coupled with very limited access to capital. The client will force his minimal business plan to fit the available resources, and hope for the best. While this may be the only way he can start his business, the reality of the market place will eventually prevail. Further, the idea that he can find capital when necessary is usually a fallacy. Even if he does find it, it will usually be far more expensive than he anticipated. The cost of capital (whether debt or equity) is a function of risk, and any investor will charge more if his capital is going into a shaky or new business. At that point, the business owner may have no choice but to accept whatever terms are dictated by the market.
- Who needs a business plan? In my last article, I talked about the advantages of brainstorming as a business tool. A business plan is really nothing more than a refined and expanded brainstorming session. Most persons starting a new business fail to prepare even the most rudimentary budgets and revenue projections, let alone a full scale business plan, discussing such things as advertising, marketing, demographics, competitors, government regulation (if any) and so forth. While the failure to prepare a business plan is not necessarily fatal, a proper plan can help avoid potentially fatal problems in the future.
- My brother-in-law will work for free until the business gets going. Any potentially successful business owner will realize that no one works for free. Further, anyone who does work for free usually is either unreliable or has a hidden agenda. This is merely an aspect of the undercapitalization problem. If you have to rely on free labor, you don’t have enough money in the business. Moreover, if someone is willing to work for free what does that tell you about the value of his services to begin with?
- This business will cost less to run and will generate more income than I think. This again relates to wishful thinking. Generally, the entrepreneur should realistically estimate both revenue and expenses as accurately as possible, and then increase expenses by 25% and decrease revenue by 25% at a minimum. If the numbers still work, the business may work. If the numbers do not work, reconsider or increase your starting capital. The worst that will happen if your figures are too conservative is that you will end up making more money than you predicted.
- If I get into trouble with the IRS, I am sure they will understand. The most common tax problem that kills small business is failure to withhold and remit payroll tax trust funds. The IRS is remarkably intolerant of this problem, since a portion of the withheld funds do not even belong to the business owner to begin with, but rather represent money withheld from employees’ paychecks. The IRS’s ability to collect payroll tax delinquencies is quite impressive. It exceeds that of even the most diligent creditor. For most small business owners, issues relating to state and federal taxes are usually the most perplexing. If you fail to get on top of these problems at the outset and establish reliable systems for compliance, your business is doomed.
- We’ll work out of a shoe box at first and establish our bookkeeping and account systems later. Without accurate financial feed-back, the new business owner will soon be uncertain whether the business is making money or losing it. Moreover, he will be unable to foresee trends and make adjustments. Adequate budgeting for reliable bookkeeping and accounting help from the start is essential.Thankfully, the budding entrepreneur has resources available to address each of these problems, starting with a diligent and realistic approach. In life, both the strong and the weak survive. The only difference is that the strong live better. In business, only the strong survive, especially in the 90’s. For a new business, that strength will come from preparation and planning.
To speak directly with Attorney Michael Hanks about a business, real estate, estate planning, elder law or prenuptial agreement matter, contact the Law Offices of Michael Hanks at (916) 635-0302.