It never ceases to amaze business owners how some seemingly simple decisions, made during the early years of their business startup, can become fatal errors down the road. After meeting with many business owners across a broad spectrum of industries it’s common to find them enduring the consequences of the same, or similar, errors over and over again. In most cases these early errors become very costly. In some cases they are fatal. Below are the 5 most common errors to avoid when starting a business.
- The most common error to avoid is not doing the math.
While successful business owners need not have a PhD in Mathematics, they do need to know how to use the basic functions of a calculator. Every fourth grade student has learned the basic math skills of addition, subtraction, multiplication and division. It’s surprising to see how infrequently they are applied. Not doing the math can be the root cause of long term financial difficulties for business owners. Here are a few of the many ways:
- Offering an employee a salary without considering all of the associated costs of employment. Such costs include employer federal, state and local taxes, unemployment taxes, worker’s compensation insurance, healthcare and other insurance premiums, retirement and incentive compensation, vacation and other forms of paid leave and benefits.
- Signing a lease for retail or office space without considering all of the associated costs of the lease and/or understanding what the relative market price per square foot is in the community. It is somewhat difficult to compare commercial rental space unless you break it down to the cost per square foot “fully loaded.” This analysis requires addition, multiplication and division. However, it’s important to understand that it is necessary to add up all of the costs associated with the rental space on a monthly basis (not just monthly rent), multiplying that figure by twelve and then dividing it by the number of square feet to obtain the “fully loaded cost per square foot.” Armed with this information, the entrepreneur is able to compare apples-to-apples.
- Ignoring the total costs required to deliver the product or services offered by the business. If all the costs are not considered, the likelihood of a business being able to set the price for its product or services at a level that permits the business to earn a profit is a gamble at best. Pencil, paper, and the addition function on the calculator are what the entrepreneur needs to avoid this fatal error. It’s really simple. Just do the math!
- The second fatal error is offering equity without risk to friends and family members in an effort to entice them to become the business owner’s partner.
While many friends and family may have proven to be loyal and responsible people, not all of them prove to be great entrepreneurs. And most of them make lousy partners. Not really nice to say, but true in most cases, nonetheless.
When starting out, many entrepreneurs find the journey frightening and feel that they “need” a partner to pull it off. In some cases, this is true. They recognize their own talents but understand they need the skills and talents of others to succeed in the long term. Where the business owner runs into trouble is when they find it comforting to search for that complementary talent among their lifelong friends, college roommates, or sister or brother-in-law.
And it creates an even more complicated situation when a business owner offers their friends and family the promise of equity without requiring them to assume risk. Risk comes in many forms. Risk may include cash to start and/or sustain the business, bank or lease personal guarantees, cash for payroll, working more than the typical 40 hours, and in some cases contributing sweat equity without compensation in any amount whatsoever until the company makes a profit.
If one partner is assuming such risks and other “partners” are not willing to do the same, then the unwilling partners are not partners at all. By offering them rights to company ownership, you are giving them equity without risk. If such an arrangement does not bother the entrepreneur initially, it will some day in the future. When it does, the feelings of frustration, disappointment, anger and betrayal will become a problem. It is better not to form partner relationships with others unwilling to share your risk.
- The third fatal error is ignoring the Exit.
Most entrepreneurs learn and understand that when they start a business, it is in their best interest to protect their non-business assets such as their home, other real estate, and investments from potential creditors of their business. In the early days of forming a new business, it is typical for the business owner to meet with their attorney and form some type of entity to shelter this risk.
It is an exciting time for the entrepreneur. The days go by quickly as many hours are devoted mentally to the development of the business plan, name, logo, new relationships, etc. Much like the honeymoon for many newlyweds, the entrepreneur doesn’t see how the exit should be carefully planned now. Not later.
If a “partner” has been brought into the business in the form of a shareholder in the case of a corporation, a partner in the case of a limited or general partnership, or a member in the case of a Limited Liability Company (LLC), now is the time to plan for the departure of the “partner.” If the plan is to wait to negotiate the terms of departure until the time when it is needed, the experience will prove to be difficult, stressful, very expensive, and in some cases impossible to accomplish.