Mistakes Made by New Businesses: The Top Ten
by Bethany K. Laurence
Learn about the most common mistakes that new business owners make and how to avoid them.
Most small businesses fail within the first five years, often from a lack of planning at the outset. There are a number of financial pitfalls that new businesses must avoid in order to survive. You can improve your new business’ chance of succeeding by learning about, and taking steps to avoid, the top ten mistakes new business owners make.
1) Starting Your Business With a Large Loan
Many small business owners make the mistake of borrowing large amounts -- either from banks, credit card companies, home equity loans, or friends and family -- to start their businesses. Because these business owners start off owing so much money, they feel pressured to make a profit immediately -- and they may have to make high monthly payments on the loans. A wiser approach is to save a good amount of money and to rely mostly on those savings when you begin your business.
2) Planning on Making a Profit Right Away
Most small businesses are not profitable within their first year or two. You should have a reliable source of income from something other than your new business to sustain yourself during your start-up period.
3) Spending Too Much Money at the Beginning
Many small businesses spend too much money “setting up shop,” buying equipment and furniture, and investing in business cards and brochures. Plan to start on a shoestring. And remember, if you spend a lot of money, that’s more money you can lose if the business fails.
4) Hiring Employees You Don’t Need
Hiring employees subjects you to registration and record keeping requirements and can be very expensive. You'll have to pay unemployment taxes, withhold state and federal income taxes (as well as Medicare and Social Security taxes), pay for workers' compensation insurance, and comply with safety regulations to avoid injury to your workers.
You may face severe penalties -- and may even be found to be personally liable -- if you don't comply with all of these requirements. If you need help with your business, consider hiring an independent contractor or a worker from a temp agency rather than a permanent employee.
5) Renting Space You Don’t Need
Renting space is usually not necessary when you're just starting out. Often times, you can work from home. Running your business from home can save you tax dollars too.
Renting commercial space is expensive, and if you need to make modifications to the space, can be even more so. If your business doesn't work out or you can't afford to rent and have to move, you’ll probably owe the landlord rent until your lease runs out. You will most likely be personally liable for these payments because most landlords require small business owners to sign personal guarantees, even if the business is officially an LLC or a corporation.
6) Not Developing a Business Plan
Even if you’re not soliciting money from investors, business plans are useful. Come up with a financial forecast to see if your business can make money and will have money year-round. Among other things, consider:
- what your initial financing needs are
- what challenges your business will face (in terms of competition and marketing), and
- how your business will survive and grow past the initial start-up period.
Your business plan should include a break-even analysis, profit-and-loss forecast, and a cash flow analysis.
7) Not Knowing How to Collect Bills
One of biggest problems new small businesses face is collecting bills. You should be aware that some clients may not pay their invoices on time. So plan to spend some time collecting what is owed to you -- you might need to re-bill clients or to contact them personally when they are late in paying you.
8) Not Planning for Cash Flow Problems
There may be times when your business runs low on cash, either because business is slow or because your clients or customers are late in paying you. You should either apply for a credit line with a bank or develop some other emergency plan for how you are going to pay your bills when you don’t have enough cash to do so.
9) Not Planning to Protect Personal Assets
You don't want your business debts to endanger your personal assets, such as your home or your savings account. Some options for protecting your personal assets include purchasing liability insurance for your business, and structuring your business as a corporation or an LLC.
10) Choosing the Wrong Ownership Structure
Choosing an ownership structure is one of the most important decisions you’ll make for your new business.
Consider your specific needs. The following factors can help in making your decision:
- What are the potential risks and liabilities of your business? (For instance, building houses, making edible goods, fixing cars, and selling alcohol carry inherent risks.)
- How willing are you to spend the money it takes to set up and maintain the records for a separate business structure (such as an LLC or a corporation)?
- What are your expected profits or losses in the first couple of years? Unincorporated business structures let you deduct business losses from your other income, but corporations do not.
- What are your plans for seeking investors? Sophisticated investors often prefer the stock structure of a corporation.
Consider your potential liability. Here is a summary of the amount of liability you may face depending on how you structure your business:
- Sole proprietors. Because sole proprietors are personally liable for all business debts, you could potentially lose everything you own if your business debts are not paid.
- Partnerships. Because your partners can make commitments that bind the entire business, your liability may be even greater than in a sole proprietorship. Make sure you can trust your partners to protect your interests.
- Limited Liability Companies (LLCs). LLCs are often subject to annual taxes or annual reporting fees. The amounts vary by state, but can be as high as $500-$800 per year, whether or not you turn a profit.
- Corporations. Corporations are required to keep many different records, including recording every major decision and holding annual formal meetings. If you fail to do so and are sued, a judge can find that the corporation was a sham (this is often called "piercing the corporate veil"). Investors can also sue you if they think you're not operating the business in their best interests.
Consider what most people do. For most people starting a one-person business, operating as a sole proprietor at the outset makes sense. But, if your business is especially likely to be sued, is funded by outside investors, or might be profitable right from the start, consider forming an LLC instead.
For most people starting a business with more than one owner, an LLC is preferable to a partnership -- you get limited liability but need to do less record-keeping than a corporation, and the same taxation as a partnership.
For more information on San Diego
business law or starting you own business, you may e-mail Shaun Boss
To steer clear of mistakes that can sink your business, get The Small Business Start-Up Kit: A Step-by-Step Legal Guide, by Peri H. Pakroo (Nolo).