Given that an individual has what they believe is a unique product or service to offer the marketplace and a strong desire to be their own boss, how do they proceed to establish themselves as the head of a business enterprise?
What are the major factors to consider if the business venture is not to end in failure and bankruptcy as nine out of ten do? What sources of information and outside help are available?
Is there a better chance of success from acquiring an ongoing business or buying into a franchise chain, rather than starting a new business from the ground up?
In this article, the pitfalls to avoid in starting a business are discussed by Maury Delman, who also addresses the major reasons for business failures and lists sources of help in making the initial decisions.
Delman’s suggestions underscore the necessity of thoroughly understanding the operational and financial considerations involved in starting one’s own business.
The entrepreneur will usually experience severe difficulties during the first two years in business. Delivery dates must be met, products must be reliable, and bills and employees must be paid.
But mainly, the entrepreneur must convince potential customers that their product is better and less costly and that their business has a long life expectancy.
An obvious requirement is that the entrepreneur must have confidence in their entrepreneurial abilities and be committed to the successful exploitation of their product concept.
To repeat, both their abilities and strategies must be documented in a business plan that is used as a tool in establishing financial support for the new venture and as a reference framework with which to compare the future status of the business.
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Avoiding Common Pitfalls in Starting an Agricultural Business
U.S. Department of Commerce studies show that about half of new small businesses never make the third year. Retailing suffers the most, with only 29% surviving three-and-a-half years. Wholesales show the best, with a 48% survival rate after the same period.
Nevertheless, Dun & Bradstreet figures suggest that more than 400,000 firms are started annually, with about an equal number being discontinued.
Survival depends upon a variety of factors. Dun & Bradstreet has pinpointed nine major reasons for the failure of new businesses.
1. Lack of Managerial Experience
Topping the list is simply lack of managerial experience. Even those who have managed other businesses successfully have come quickly to bankruptcy when operating businesses they knew little about. For example, take the case of a young Pennsylvanian who went into the building business after nine years as an insurance agent.
With cash tied up in real estate and “receivables,” suppliers were willing to sell to him on a cash basis only. He couldn’t buy enough to keep going. After four years, he filed a voluntary petition in bankruptcy with liabilities twice the size of his assets.
A “receivable” is simply money owed that cannot yet be accessed. Experience in selling insurance is hardly good training for another business that requires buy-sell judgment and heavy day-to-day expenses before profits roll in.
But even with specific experience in some lines, there is no assurance of success. The importance of experience is not the time spent but what is learned. Successful business owners underscore the need for balanced experience, which includes knowledge of the product, financial handling, and buying and selling.
2. Insufficient Starting Capital
Insufficient starting capital ranks just under lack of experience as a cause of all business failures. The notion that a few thousand dollars and very hard work will bring success has held very little validity since the 1930s.
An experienced women’s-wear retailer says, “Anyone going into business now without plenty of capital in back of them should have their head examined.” Even if a new business venture survives its first year with limited capital, this disadvantage takes many years to overcome.
Borrowing the needed capital often seems an easier solution than it is. Those who don’t calculate exactly how much the interest on borrowed money will eat into their expected profits often come to grief discovering too late that they’ve only been working for the bank.
An individual who earns 9% “clear profit” on capital borrowed at 9% can have a great time running their own business until they starve to death.
Yet the attractions of being “independent” have been known to induce new business owners to close their eyes to the hard fact that they won’t earn a cent for themselves until all operating costs and interest are met.
Today, anyone starting a new business must first figure their normal operating expenses plus their salary. For safety, the expense figure should be adjusted upward from 25% to 50%. There are always unforeseen costs. Then, the volume of business needed to cover these expenses must be determined.
The cost of supplies, merchandise, etc., to produce this volume must be figured. Finally, what fixtures are needed, and what receivables will have to be carried if credit is granted to customers?
In essence, what capital is needed to produce income enough for a reasonable net profit after expenses? A surprising number of people go into business without doing this hard arithmetic.
3. Choosing the Wrong Location
The third business pitfall is the wrong location. Inexperienced people are prone to look for inexpensive locations. Good locations are bound to cost money, but the volume realized from a good location can more than offset the higher rent.
4. Inventory Mismanagement
Once a business is underway, it can readily fall victim to the fourth pitfall—inventory mismanagement. The common warning, “don’t get too much inventory,” should be modified to, “don’t buy too much of the wrong merchandise.”
The management of inventory is an art, if what is being done is selling something kept in stock. Its ABCs are simply put, even if its XYZs are not. The dollars invested in inventory must earn money at a desirable rate.
Fast turnover will earn money on goods priced at a small profit margin. Goods that turn over slowly only pay well if the markup is large. The great inventory tragedy is found in goods that sit on shelves without buyers.
They represent dollars invested that are not earning anything in short, precious capital that’s tied up. This is all just as obvious as it can be, but, oh, the businesses that go on the rocks because of ill-judged inventory.
In big, successful retail stores, there is no love, humanity, sentiment, or personal whim in the matter of inventory. The hard questions are: “What sells, at how fast a turnover, for what markup?” and buyers of stock succeed or fail in their ability to solve that equation most profitably.
By contrast, a successful man quit his profession to invest his all in a store selling a “cultural” product that he thought people “ought to” have. It bankrupted him because people buy what they want, not what one thinks they “ought to.”
5. Excessive Investment in Fixed Assets
Pitfall five is too much capital going into fixed assets. Any money invested in fixtures or real estate will most likely come from working capital or will be borrowed. Money tied up in frozen assets that aren’t necessary to the business is working capital that may not be available when needed for either a crisis or an opportunity.
6. Poor Credit-Granting Practices
The sixth pitfall is poor credit-granting practices. The temptation to let customers “put it on the books” can be very strong, particularly if competition is coming from low-margin, big-volume cash competitors.
If easy credit is offered to get the business, some customers may be so slow to pay that they’ll give “the business.” When credit is forced on people, there is a danger of attracting poorer payers.
One of the shocks lying in wait for new business owners is that well-heeled customers are very often the slowest to pay their debts.
In granting credit, two fundamental questions must be answered: Is there enough capital? Is there knowledge of how to collect? A general rule is that additional capital equal to one-and-a-half months’ credit sales must be on hand to give customers 30 days to pay. Credit granting and collecting takes skill. Many people just don’t have it.
One retailer with 25 years’ experience commented, “When I first started, I also tried to sell on credit but found that I wasn’t a good collector, so after several months, I made all sales for cash and have since conducted a cash-and-carry business.”
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7. Excessive Personal Withdrawals
Pitfall number seven is taking too much out for oneself. It’s an easy habit to fall into. Many new business starters pledge to themselves, “We are not going to take anything out of the business.” And of course, they can’t stick to it. What’s the purpose of going into business if nothing is taken out? The approach to what is taken out for oneself should be flexible and realistic. When profits decline, owners must curtail their withdrawals.
8. Unplanned Expansion
The eighth pitfall can come from too much success. Business is so good that a decision to expand is made, but unplanned expansion can be ruinous. Generally, businesses grow in two ways: slow and steady from within—marked by increased sales and profits—or by rapid expansion through addition or acquisition.
Rapid expansion must be carefully planned since it requires skills to manage new people, and more must be hired as additional capital is acquired. One storekeeper found out the hard way that two stores weren’t twice as profitable for him as one. With one store going well, he opened another across town.
But the managerial help in his second store failed to grasp his successful methods. The owner had to supervise both stores, with his wife helping out. When she got sick, the load was too much. Eventually, physical and capital strain forced him to sell the second store. Today, he operates one store profitably and without undue headaches.
9. Wrong Attitude
Pitfall number nine the wrong attitud ruins many. Some businesses fail to prosper or come to grief because of the wrong attitudes of their owners. Being in business is plain hard work, demanding full diligence. Some owners figure that since the business is theirs, they’ll work hours only to suit themselves.
Others get involved in outside interests to an excessive extent. They may even tell themselves that social and civic interests help promote the business when all they do is take the owner away from affairs that need tending. Greed kills off others. When products are misrepresented or shoddy, it is always found out.
A well-known chain of fine restaurants had to be sold off because their owner evaded income taxes. The penalties levied by the Internal Revenue Service, in addition to a jail sentence, forced the sale of that restaurant chain.
Resources for Overcoming Start-Up Challenges
But, even with all the hazards, the dream of having one’s own business can be realized. There are ways to overcome the obstacles and succeed. A prime source of help lies with the federal government through its agency, the Small Business Administration, set up in 1953 to aid small businesses.
The S.B.A., with field offices in principal cities, as well as in Guam and Puerto Rico, is available to assist new business hopefuls as well as established small businesses.