Minimizing Your Risk When Starting a New Business
Jumping into a new business with both feet may be too risky for some people. In fact, most people believe it is best to stick one toe in to test the waters first, and most new businesses start on a part-time basis, while the owner is still working elsewhere.
To reduce your risk, you may want to consider the following options.
- First, operating a family-owned business may make a lot of sense in certain instances, but you must always look at more than just the dollar decisions when involving family.
- Second, franchising is a way to increase visibility and reduce the failure rate of your new business.
- Third, hiring a manager may enable you to keep your current job, but this alternative is only as good as the manager that you hire. Fourth, a home office may reduce the risks in your new business, keeping your startup and shutdown costs lower.
- Fifth, a part-time operation can be the answer in certain situations, but part-time operations usually make only part-time profits. It is important to know when to cut your losses by determining the cap on how much you're willing to spend to make your dream a reality. We'll explore all of these tactics in detail.
Remember that there is always a risk-reward tradeoff. Usually, when you reduce your new business risk, you also reduce the potential reward of your new business. For example, the new business may not generate as much income as you had expected.
Hiring Family Members Lowers Startup Costs and Risks
The majority of new small businesses involve the owner's family in some way. This involvement may range from having a spouse do the bookkeeping to having the children work part-time after school.
Getting help from family members can be a great, not to mention inexpensive, way to help you get through the startup phase of your new business. Family members can also help alleviate the additional time and frustration aspects of your new business.
A consideration when hiring family members is how the hiring might affect family relations. If your spouse works with you on a full-time basis in the business, how will that affect your home life? Are you willing to or capable of firing a family member, if necessary? If your child or spouse is not capable of doing the job adequately, what will you do?
Another consideration is how it will affect non-family employees, if you have any. When it is time to promote an employee, will it automatically be the family member? These decisions will affect all of your employee-employer relations with the other employees.
On the positive side, a family member will be more willing to step into your shoes when needed. For example, if you are unavailable, a family member usually makes a reliable fill-in.
See this article for more information on the tax benefits of hiring family members.
Franchise Businesses Have Better Startup Success
A good way to reduce your risk of failure is to purchase a franchise. Franchises typically have a higher success rate than other types of small businesses. Conventional wisdom holds that franchises have a failure rate of about five percent, compared to a 50 percent failure rate of independent entrepreneurs. Note, however, that the five percent rate doesn't take into account that franchise failure rates vary widely by type of business. It's best to do some research into the particular type of business before drawing much comfort from this conventional wisdom.
You should be aware of studies that question the five percent rate. For example, a study by Dr. Timothy Bates, a professor at Wayne State University in Detroit, found that the franchise failure rate actually exceeded 30 percent and that franchises made lower profits than independent entrepreneurs. Dr. Bates's study also found that the average capital investment of franchisees was $500,000, compared to $100,000 for independent entrepreneurs.
Blue MauMau, an online franchise news journal, compiled statistics on franchisee failures based on the amount of SBA loan defaults, sorted by franchisor. While failure to repay a loan doesn't indicate that an individual franchisee has gone out of business, it is an indicator. The failure rate varied from a low of zero percent for almost a hundred franchises, to a high of 86 percent. Of the 505 franchises listed, 133 had default rates of five percent or lower.
Successful franchisors have developed "formulas" for starting a new business. The good franchisors want your new business to succeed. If you fail, they fail.
Normally, when you purchase a franchise, you must follow guidelines on what you have to do as a franchisee. These guidelines will decrease your new business startup errors. The franchisor will provide you with guidelines on site specifications, the maximum that you should pay for your location, and other useful information.
The franchisor will also provide you with lists of equipment and fixture requirements for your new business, which might keep you from purchasing too much equipment. For example, if you are going to open a franchise sub sandwich shop, the franchisor will provide the exact type and size requirements for all your refrigeration and baking equipment needs.
An experienced franchisor with a long track record will be able to provide you with the failure rate of the specific business. This will give you a much clearer idea of your chances for success when making the decision to start a new business.
On the negative side, a franchised operation will typically be more expensive than other types of startups. Also, some franchises will require you to purchase supplies and various items through the franchisor that may cost you more.
For more detailed analysis, see purchasing a franchise.
Hiring a Professional Manager Can Improve Operations
If you're uncertain about your ability to run a small business, one good way to offset that concern is to hire someone to run the business for you. This accomplishes two purposes. First, the manager can bring instant experience to the new business. Second, if you have another job, you'll be able to continue with your current employment, and you'll have something to fall back on if your new business fails.
A few words of caution about hiring a manager:
- First, your new business will be only as good as your new manager. If you hire a bad manager, your new business may never recover from it.
- Second, hiring a new manager can be expensive, especially if you want one with experience in the field. Make sure that the benefits outweigh the costs.
- Third, there really isn't such a thing as a part-time small business. Even if you hire a competent manager, you'll be amazed at how much time your small business will demand of you. Be prepared to work long hours in addition to those you put in on your other job.
Using a Home Office Can Lower Costs
Operating a small business from your home is a nice, cost-saving alternative for some people. If a home office makes sense for you, this option will reduce the risk and cost of starting a new business in many cases.
You can save on rent and other costs associated with opening a business outside the home. In some instances, home office startup costs will be next to nothing, thus minimizing your financial risk in starting the new business.
If your new business is not a success, the shut-down costs should be minimal. For example, if you were renting outside space on a five-year lease, you would be potentially responsible for five years of lease payments even after your business shut down. But if you work from home, you won't have any additional obligations to third parties, at least as far as your facility is concerned.
Launching a Part-Time Business as a Test
For those who are unsure about whether they can make a go of a new business, starting out on a part-time basis is a viable alternative. A part-time business will reduce your new financial risk significantly while you gain the experience you need. And, of course, if the business fails, you can fall back on your full-time job.
An example of a part-time business is doing paid work for friends or family on the weekends or in your spare time. Others choose to start with only a single client or customer and use vacation time to provide the service.
Going into a part-time new business will also enable you to get the kinks worked out of your new business before operating on a full-time basis. Remember that a part-time business will usually not generate a large profit. In some instances, a person may be able to live off of a part-time business, but this is not usually the case.
You should also remember that there is really no such thing as a part-time small business. You'll be surprised how much time a "part-time" business will take, even if you have only one client or customer. If you decide to work part-time, be prepared to work long hours.
If you feel that you lack business experience and you're not sure that you're capable of running even a part-time small business, get the experience any way you can. If you have to, volunteer your services or work for next to nothing at a business that's similar to the one you want to start.
Just because you consider your new business part-time, the related costs of doing business do not necessarily go down.
Suppose you're planning to open a home-based business. The office will require a complete separate set of office equipment. If your business is part-time, that means only that you are willing to generate income on a part-time basis; it doesn't mean that your office expenses will be smaller. A desk and chair cost the same if you sit in it for 10 hours a day or two hours a day.
Knowing When To Cut Your Losses and Close Your New Business
How much money are you willing to lose in your new business venture? You should set a maximum dollar amount that you're willing to commit.
If you don't decide the financial commitment to your new business in advance, you may regret it in the future. For example, suppose you have $50,000 in cash and investments that you have accumulated from past saving. You're going to open a new business that you're willing to limit to a $10,000 cash commitment of your own money. The business is losing money and needs additional funding. What will you do? Will you increase your cash commitment or will you consider it time to cut your losses? If your business has lost the $10,000 commitment, stop at that amount.
Don't start throwing money into a sinking ship. Make sure you've made the appropriate changes to your new business to make it a successful operation. Don't just presume the business will get better
How long are you willing to commit to an operation that will barely support itself? Would your time be better spent starting another new business that is related to your current idea, or would you be better off becoming an employee for someone else? Before you start your new business, it's good to have time commitment goals as well. For example, if you're willing to develop your business for three years and then expect a livable profit, what will you do if you don't meet your profit objectives? You need to answer that question before you start your new business.
If your new business does fail, your goal will be to get out of business with the least amount of financial pain.
The following are different ways to cut your losses if your business is failing or has failed. Some options will work better than others, but just remember that there is no ideal way to get out of a failing business.
- Sale of the business. A voluntary sale may be the least painful way to get out of your business. A voluntary sale usually will allow you to sell your business for the most amount of money. Most potential buyers are willing to spend more on a business that is still in operation and has some ongoing business value.
- Forced liquidation of the business. This occurs when your creditors force the sale of company assets. This can be an expensive option because the price received may be substantially less than you would get in a voluntary sale of the business as a going concern. In some instances, it may make sense to sell parts of the business and to wait until you find the best buyer for each business part. For example, you may be able to sell your office equipment to one buyer and your manufacturing equipment to another.
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