When Is a Business a Failure?

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By Paul J. Christopher

It may seem odd to discuss failure before you have even begun. No one starts out to fail. Understanding the word “failure” is important. Much of the data about failure comes from tax records or census information, and in that context a failure is simply a business that disappeared. But a business can be abandoned—no longer needed or wanted—even though it is still viable and productive. Maybe the owner took a full-time job with a large employer; or no longer needed the extra income from the part-time business; or simply did not like the business and the accompanying lifestyle. Someone unemployed might start a service business as a temporary stopgap, knowing that as soon as he finds full-time employment he will return to the corporate world. This often is the case for highly compensated executives, whose vast experience can be parlayed into lucrative temporary service contracts. These executives know that it will take a year, perhaps more, to find similar senior management positions. Thus, not every “failure” is a financial one.

All the same, it is the financial failure that is most common and should be of the greatest concern. Someone’s hard-earned money went into starting this business—yours, the bank’s, or investors’— and when it shuts down, at the very least, someone has to be paid off. As noted earlier, it basically takes five years before you know that your business is a going concern. Thus, you must enter your new endeavor with a good understanding of financial risks and ways to control them. We address this in detail in later chapters, but one basic and important rule of thumb is to reduce risk at all costs. Unless you are extremely well capitalized, the best strategy is to start slowly, spending as little as possible in the early stages, because it is going to be some time before cash flows with any consistency. In fact, you may find that you never bring in cash with the same consistency as when you received a paycheck.

The first financial rule of new entrepreneurship is to live without:

Do without the best and latest iPad, laptop, printer/ scanner, cell phone, and office furniture. What you have now will do for a while.

Phone, fax, and e-mail rather than travel when possible. Learn to solve your own computer and e-mail problems rather than calling in a service.

If possible, avoid taking on fixed costs such as rent and utilities. If you truly lack viable office space in your home, basement, or garage, look for a short-term lease on a shared office suite or unused space behind or above a retail store as potential low-cost locations.

This list could go on and on, but for the moment its purpose is to set the tone for your business. We will say much more about financial control, personal discipline, and overall strategy as this discussion progresses.

Lost Opportunity

Another kind of risk, often not thought about in the excitement of the moment, is that of lost opportunity. Often people begin businesses or buy an existing business because of a sense of impend- ing doom: your industry is doing poorly, your company seems to be on the verge of downsizing or being bought out, and you have real concerns about your job and your future. (It seems contrary, but more businesses are founded during hard economic times than when the economy generally is prospering.)

What many entrepreneurs fail to realize is that not all companies and industries are doomed to decline or eventual failure. Consider IBM, once strictly a manufacturer of typewriters and mainframe computers, which transitioned to PCs and servers and has now morphed into a service company offering business and systems management consulting. There were times when it looked like IBM was in serious trouble, but instead of failing, it changed with the times.

Or examine the history of American automobile manufacturing; several of these companies have come back from the grave more than once, only to emerge stronger and more competitive. Your present company may be in trouble, but it also may have fantastic potential as a downsized and reenergized organization. By leav- ing your employer and starting your own business, you may miss out on an opportunity to retool or retrain, find a new place in your company or a similar one, weather the storm, and possibly see substantial advancement in your career and salary—including health insurance, bonuses, 401(k) plans, stock options, and other fantastic benefits that larger organizations often provide.

Instead, because you have chosen to go out on your own, you can miss years of full income and benefits, and it will take a hugely successful start-up to make up for all of the salary and perks you might have had if you stayed in the corporate world. Exhibit 1-1 looks at a the case of Kathryn D, a marketing manager of a Fortune 1000 company, and what she could expect in salary, retirement, and other benefits versus what she could expect in the first five years of running her own business. Kathryn had been concerned about her employment situation for some time. Her company is a major manufacturer of industrial coatings, and her main accounts are heavy manufacturers, whose business has been very uneven in the past three years. She searched for other employment, but because she does not have an MBA she found it difficult to get attention from prospective employers.

Her job was eliminated, and thus she did not receive her full salary of $77,000 for that year; instead, she earned $50,000 in 2011 and received a severance of $20,000, making her nearly whole for the year. Because she was well liked and highly respected, Kathryn had substantial contacts within her industry and the local professional marketing association, with which she had been active for the past five years.

In response to her job loss, her strategy was to finish her MBA degree part-time and start her own marketing firm. Rather than continue to look for employment or move to an area with a stron- ger business environment, she used her $20,000 severance as seed money to set up her company, Marketers Associates, LLC. Her motivation was primarily economic; she and her company had gone through several slow periods, but none as bad as the cur- rent environment. Kathryn was convinced that this was the only recourse; she assumed that the industry and her field would be mired economically for years.

But who can predict economic upturns and downturns? This particular downturn was short. Kathryn probably would have found comparable employment the next year, 2012, and her new MBA would allow her to reach a senior-level marketing position and, over the next four years, earn a salary of $96,000 plus benefits, for a total five-year income (with benefits) of $518,700.

Instead, her own business began to grow nicely, but it took until 2014 to really allow Kathryn to pay herself a salary even close to her past income. And it is not until the fifth year that she could fully rationalize compensation and benefits comparable to what she would have made as a marketing manager in a larger firm. Her earnings for the five years as an entrepreneur are $172,850.

There may have been other, positive reasons for starting her company, but these results clearly show that Kathryn would have been financially better off to continue her graduate program and look for employment in the short run rather than try to earn a living from her own business.

Did Kathryn make a bad decision? You have to assume that her personal balance sheet is much less robust after five years of being an entrepreneur; no doubt she used savings and her retire- ment money to live on while building the business. What is clear is that she got past the so-called five-year stage and that the business showed good growth throughout the period. She seems to have the potential to grow the business, thus justifying the risk and the short-term loss of income.

Many individuals find themselves in similar situations; they are outsourced or have lost their long-term employment, and they think that going into business for themselves or buying a franchise is the solution. It may, in fact, turn out to make matters worse. It is not uncommon that the money from buy-out packages or severance agreements is used to buy a franchise in an industry in which the buyer has little or no experience. Future earnings are much lower than expected and the cost of the franchise is much higher than anticipated, thus leaving someone in middle age in a real bind.

One solution is to test the franchise or new business concept while you are still employed. Chapter 6 covers this subject and the need to plan for small business ownership before you are forced by circumstances to plunge ahead prematurely.

Why Take the Chance? It’s Your Life(style)

If the rate of failure is so high, why take the chance? Why plan, look for financing, make personal sacrifices—including financial and lifestyle changes—to start up a business? Many potential busi- ness owners would rightly say that with the odds stacked so high it just may not be worth it. Why endure what can be an exhausting and frustrating experience in the best of circumstances, only to see your scheme collapse like a house of cards?

The ultimate reason for taking the chance is that, if you are suc- cessful (however you define it), chances are you are going to have the very advantages you are seeking:

  • financial independence
  • flexibility in work and personal lifestyle
  • control over your time and talents
  • creative and innovative work environment
  • chance to grow personally and professionally    

Many people feel strongly that some or all of these results are well worth the risks and costs.

The important thing to recognize is that business is more than making (or losing) money; it is a lifestyle. Consider someone in her early sixties who is planning on retiring from full-time employ- ment in two years. Assuming good health, she has many choices, from volunteering to traveling, but are these all that meaningful to someone who has spent a lifetime accumulating job-related skills and knowledge?

Consider the former school superintendent whose district paid him well and whose state provided a handsome retirement pack- age. His children are grown; his wife is working part-time, and the house is paid for. The family’s financial picture is not that of millionaires, but they are secure because of years of careful planning and saving. Is his goal necessarily to make money to pay bills and keep food on the table? Does he have a long-range plan for a business other than the opportunity to improve his income during retirement and keep active and current in his field? The answer to both is probably no. Nevertheless, there is a real entrepreneurial drive behind his decision to build a small consulting and educational practice. In this case, the financial structure and ultimate financial goals may not be the most important part of his decision to write a business plan and start a company; he is likely evaluating his opportunities for success differently now than he would have at an earlier time in his life.

The business is a vehicle to stay in his field, a reason to get up in the morning that is meaningful for him and continues to use his skills and experience. The fact that he can supplement his retire- ment income is also a plus, but not necessarily the driving factor for being a late-blooming entrepreneur. The superintendent knows that this gig is limited; he wants to retire gradually, and a small consulting business gives him the freedom to work as much or as little for as long as he wants.

If You Still Plan to Go Ahead

Is entrepreneurship for you? Exhibit 1-2 lists assessment questions designed to help you better understand and evaluate your readiness for starting a small business. How many of these questions can you answer “yes” to?

 

Resources

Small Business Administration

The Small Business Administration has excellent resources that can be used to help you sort through the myriad questions and problems you will face when you are planning a new business. Visit the SBA website and use the navigation bar at the top to locate and click on Starting & Managing a Business. There you will find tools and templates to help you get started.

About.com

The website About.com is a rich resource with several excellent short articles and tips. Use the links on the Starting a Small Business 101 page.

Internal Revenue Service

The IRS has all of the essentials a small-business owner needs to understand and manage tax liabilities. Its page  be very useful, especially for starting, operating, and closing a business. From this page, you can also find information particular to small businesses by clicking on “Small Business/Self-Employed” on the navigation bar at the top.

SCORE

SCORE is a nonprofit associated with the Small Business Administration. Its volunteers offer free business counseling.

 

 

book cover: How to Get a Great Job: A Library How-To HandbookThis article is excerpted from the book The Entrepreneur's Starter Kit:50 Things to Know Before Starting a Business by Paul J. Christopher (2012, Huron Street Press, an imprint ALA Editions).

 Please note that unlike the majority of content on the @ your library website, The Entrepreneur's Starter Kit:50 Things to Know Before Starting a Business is copyrighted material and is not available for reuse under Creative Commons license.

 

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