In This Chapter

Too often small businesses fail simply because the owner didn’t do upfront planning and carefully map out details about the business or the environment in which it will be operating. Questions you’ll need to consider include: Why do you think your idea is a good one? Who else is in your vicinity doing the same thing you want to do? What do you bring to the business that someone else does not?

People want to go into business for themselves for a variety of reasons. Some people simply want to be their own boss. Others want to earn more money. And some people want to have the freedom to come and go as they please. These are all valid reasons for starting a business, but don’t jump in assuming it is going to be easy; it most assuredly will not be!

This chapter covers the diverse best practices essential for starting a business. It helps you ensure you have considered all the planning essentials prior to jumping in and launching your own business.

What is the purpose of your business? Will you manufacture products, sell consulting services, open a local diner, or embrace any of a million other ideas? Regardless of what your business will be, you need to spend significant time refining your initial business idea to ensure the business you launch meets a need in the marketplace.

As a best practice, start by asking yourself the following questions:

Do you have money set aside for emergencies? What will you do if your business doesn’t make money immediately? It is unlikely you’ll be profitable in the first year, and maybe not even for a couple of years—how will you pay your bills during that time?

What excites you? Think about what you like to do. If you could do anything and not worry about money, what would you do? Maybe there is an idea in there. Do you love to travel? Maybe you could open a small travel agency. Do you love dogs? Maybe you could open a doggie day care or a pet shop.

Are you self-motivated? You need to be a self-starter. No one will be telling you what to do and when to do it; you’ll need the discipline to do the work that needs to be done in the time it needs to be done.

Do you have the time needed to invest in starting a business? We aren’t talking about a 40-hour work week; you’ll be spending a significant amount of time working on your business. Where are you now with your family and other commitments? Given where you are right now in your life, does it make sense to branch out on your own and start a business?

Starting a business is not easy. It requires a significant amount of planning and commitment on your end. While starting a small business means you are your own boss and make your own decisions, it also means you bear the risk for whatever might go wrong in the business, including poor decisions. You’ll need a lot of knowledge in many areas, including human resources, basic legal issues, contracts, negotiating, and technology. Of course you can (and will) call on experts to help you; but the broader your knowledge base, the less risk you’ll face—you won’t have to rely as much on others to do things that will have an impact on your business and its future.

Once you have settled upon an idea for starting a business, you’ll need to take some time up front to refine that idea to increase the likelihood of your business’s success. Let’s look at an example.

Assume you are considering opening a small deli. You’ll need to think through whether your idea is a good one based on factors such as:

The following sections consider each of these issues in turn.

What’s so special about your idea to open a deli? Why would someone come to you for their breakfast or lunch? What can you bring to the deli business that would make your deli stand out from others and draw in customers?

Maybe your deli will offer a make-your-own-sandwich station where customers are provided a setup similar to a salad bar. Perhaps your deli will offer a variety of ethnic sandwiches or sandwiches named after local celebrities. Or maybe you will cater to a growing Muslim population in your area by offering halal meat for your sandwiches.

The point is that your idea must have something special about it. Your business has to stand out!

It is very unlikely you will come up with a business idea that doesn’t already exist somewhere. The key is to ensure that no one located nearby is doing exactly the same thing you want to do. Consider who your competition might be and how you would compete effectively against them.

Let’s assume that your competition for the local deli is a pizza shop that also sells sub sandwiches. You’ll need to differentiate yourself from the pizza shop. You might decide to do so by offering a variety of sandwiches they don’t offer along with soups and salads for lunch and pastries for breakfast. Additionally, while they are strictly a take-out joint, you might offer seating for customers along with wireless Internet access and small meeting areas. Now there’s a reason to visit your shop rather than grab a piece of pizza.

Don’t assume you already know everything there is to know about the competition. When analyzing other businesses that do some or all of what you want to do, take the following issues into account:

Study the businesses that compete with you. Purchase their products. How is the quality? How do they interact with customers? Do they seem to know customers personally? If you bought something from them, would you want to buy again?

Your work is not done just because you know who the competition is and how you are different from them. One powerful best practice for small business planning is to answer these questions on paper:

At this stage, of course, you are only creating initial draft answers, but it’s important that you get them down in black and white. Your answers may well change as you build your business plan (which we discuss in Chapter 4), but you should begin writing these ideas down now.

You’ll need to do additional research about your particular industry and understand its potential. Is it a growing industry? (If it is shrinking instead of growing, you will face higher levels of competition.) What changes are likely to occur in the short and long term? Does it make sense to have another company—yours—offer products or services in that particular industry? If so, why?

Let’s look at another example. Assume that you want to open a business that helps companies develop and optimize their websites. As part of the IT industry, you would want to consider the size of this industry. Certainly an increasing number of companies are developing websites and doing business over the web. Given that, is there room for additional entrants? How will you compete effectively in a business where it doesn’t matter if you are local? Companies will hire others to do this work regardless of location. You may well be competing with companies in Manhattan, Mumbai, or somewhere in between. Where will you fit in? Many small companies and individuals already provide this service locally; what makes you exceptional? What value will you bring to the industry and the customers?

In order to start your business and run it effectively, you’ll need to know some basic business economics. In-depth information on economics is beyond the scope of this book, but we cover some basics for you to consider when starting your own business.

One factor that will have a huge effect on your business is, of course, the behavior of your customer. Customers control supply and demand in the marketplace.

Let’s look at an example. You own a small fruit and vegetable store that sells only organic products from local farmers. Recently there have been reports in the news that show that eating organic produce is healthier. Since those reports have come out, demand for organic fruits and vegetables has increased. This is great for your business, but it also means an increase in competition—chain supermarkets are now offering more organic produce than ever before. In addition, because of increased demand for your products, you can’t keep enough organic produce on your shelves for your customers, so you must adjust your inventory to meet customer needs.

You can increase your pricing because there is a stronger demand for the product and less supply. However, as new entrants begin to sell the same product and therefore increase supply in the marketplace, you will have to drop your prices.

Supply and demand is an economic model that explains pricing equilibrium in the marketplace. To get a sense of how this pricing equilibrium works, let’s assume that this year Florida was hit with severe frost in the winter months that damaged half of the state’s orange crop. While the demand for orange juice has not changed, the supply has been drastically affected by the frost and damaged crops. Due to the limited supply of orange juice, the price will increase. The same number of people are competing for a dramatically smaller number of oranges. If we reverse this example and assume this year was the best year ever for orange production and there were very few damaged oranges, the demand remains static, but the supply of oranges increases. In this scenario, there is likely to be a glut in the market of oranges, effectively lowering the price of orange juice in the marketplace.

As the preceding graph shows, as supply increases, demand will decrease; when price increases, demand will decrease. The intersection of supply and demand shows the balance, or pricing equilibrium, in the marketplace.

Going back to our example of the organic local food store, as customers realize there is more supply of organic produce, they will begin to demand lower prices. In other words, if customers can now find organic produce at several markets, they will begin to shop based on price. If, as a smaller business, you are able to order produce specifically to meet your customer’s needs and to ensure you have the highest quality product, you may be able to retain your higher price structure and effectively compete against the chain supermarkets. Alternatively, you might find another differentiator that a larger supermarket cannot provide: maybe you’ll offer cooking classes for your customers, provide organic ready-made meals, or offer other product lines (such as organic cosmetics and local handmade food gifts such as jams and jellies).

Some businesses are more affected by supply and demand than others because of their particular product or service. For instance, let’s say you want to run a small company that delivers training for Microsoft certification using Microsoft Official Curriculum. There are a number of potential challenges to consider, including:

Your problems stem from the fact that the customer is indifferent about where they purchase this training since the goal of the training is simply to obtain certification. Because everyone is using Microsoft’s Official Curriculum, there is no difference in material. Trainers must be certified, and while some trainers are more competent than others, it is difficult to sell the customer on the value of having a better trainer. Additionally, there are many e-learning offerings that help people get certified. So where does this leave you? Competing with countless other trainers with few, if any, ways to differentiate yourself!

In some situations, government policies and licensing requirements affects your ability to offer a product or service as a small business. For example, to start a radio station, the Federal Communications Commission requires a license, and it would be difficult, given the large barrier to entry into the marketplace from current radio stations, for a smaller business to obtain such a license. Many larger stations may work together to keep you out of the marketplace and, in some industries (such as this one), they may have the power to do so.

Another potential barrier to entering an industry as a new player in the market is the competition. More established firms have a brand name and have built up their reputation in the marketplace. It may be difficult for new companies to enter that market and gain some of that market share. It doesn’t mean you shouldn’t try—we are not trying to discourage you! But these are all things to consider as you think about starting your own business. If you are entering an industry with heavy competition from big players, make sure you have a niche for your business—something that will make you stand out from the others and intrigue and draw customers.

An additional component of success for any business is understanding your cost structure—specifically fixed costs and variable costs. We have seen too many businesses led by individuals who don’t have a grasp of the costs involved in running their business.

Without a complete understanding of your cost structure, you will find it difficult to obtain financing and investment in your business, control costs, and effectively manage your business.

Let’s look at an example. Your business produces engines for lawn mowers and other such equipment. Your variable costs have increased by 20 percent over the last year, mainly due to the increase in demand and shortage of supply of a particular component for the engines you produce. You need to reduce costs overall. You cannot lower your fixed costs as business is increasing, and you need the employees you have as well as the manufacturing facilities. You’ll need to review your variable costs. Your options include:

These are the kinds of issues you’ll need to be familiar with, and be ready to address, long before you launch your business. (See Chapter 12 for more ways to cut costs in your business.)

According to the U.S. Census Bureau report in 2007, there were more than 27 million businesses registered in the United States. Of these, only 5.75 million have paid employees. The balance—the vast majority—are sole proprietorships with no paid employees.

Small businesses operating within the United States can form a variety of different types of partnerships and corporations. Your decision on how to legally organize your business will be based on many factors, including …

Sole proprietorships are not an official form of legal ownership, as they do not require any special forms or filings to be completed with either state or federal government. However, you might still have to obtain business licenses or permits, depending on your particular business (such as if you are running a daycare business). Depending on state and local zoning board requirements, you might also be required to register your business as a sole proprietorship if you are running a business out of your home.

When people pay for the products or services of a sole proprietor, they write a check out to the individual directly rather than to a company name, and the business owner can deposit this check in a personal checking account.

A sole proprietorship is certainly the simplest way to run your small business. When filing tax returns, all income can be reported as personal income, along with any deductions for your small business, on Schedule C. Therefore, taxes are certainly much simpler in a sole proprietorship.

A disadvantage to a sole proprietorship is that your assets—even your personal assets such as your home—are unprotected if you are unable to pay your debts. There is no difference between you personally and your sole proprietorship. If your business runs into debt that you cannot get out from under, you are personally responsible for that debt as the individual owner. In such situations, if you file bankruptcy, you would need to file personal bankruptcy as the sole proprietor of the business, a step that would, of course, affect your personal assets.

While a sole proprietorship may be a good option initially in starting off your business, as you grow and hire employees, look to expand your business with investment money, or want to take advantage of deductions permitted other businesses, you may want to consider other legal ownership options.

Two or more individuals are able to form partnerships; however, one individual can form a limited liability company (LLC). Depending on the type of partnership entity you select, you have total liability to limited liability.

In a general partnership, all parties are liable based on the percentage of the business they own. For example, if you own 40 percent of a business and your partner owns 60 percent, you are responsible for 40 percent of the debt and your partner is responsible for 60 percent.

An LLC provides more protections under the law than a general partnership but is more flexible than a corporation (less record-keeping and administrative requirements). Therefore, registering as an LLC is frequently a good choice for smaller businesses.

Professional limited liability partnership (PLLP), limited liability partnership (LLP), or professional limited liability company (PLLC) are usually reserved for licensed professionals such as a doctors, lawyers, accountants, architects, or engineers. A small law firm may have five partners who have formed a PLLP, LLP, or PLLC.

Corporations are much more formal entities that offer more protections for its members (stockholders) under the law. Corporations are a separate legal entity from its stockholders and can enter into agreements and contracts without the members personally entering into those agreements. The members (or stockholders) of the corporation have very limited liability—only to the extent of their initial monetary contribution into the corporation. For example, a stockholder who has paid $30 per share for 1,000 shares of stock is only liable for $30,000, the initial amount paid per share.

Corporations pay higher taxes than any other business entity. In many cases, corporations have an easier time obtaining investment money because there is a sense of security in dealing with a formal entity on the part of investors.

Your business will have certain unique requirements for getting started. If you are going to be selling homemade products such as soaps, candles, or jams and jellies, you will want to do some or all of the following as part of the launch of your business:

You need to understand the core needs of your particular business in order to have a successful launch. If you are selling photographs, a website presence alone may be sufficient to get started, with a long-term goal of opening a storefront location when you have more profits to invest back into the business. If you are opening a dry-cleaning business, you’ll need a storefront location but might not need a website initially.

Now let’s look in more depth at some of the specifics you will want to consider prior to launching your business.

Every business will have some cash requirements. Consider the cash requirements for your particular business and how to obtain that cash if you don’t already have it on hand. You’ll need cash on hand to …

Think carefully about your cash requirements. Consider every possibility and then add a bit extra on top of it, just in case. Ideally, you will want enough cash to keep your business running for 12 to 18 weeks while you work to make your business profitable. This provides you the security you need to keep moving forward and get through the rough patches.

Let’s look at an example. You want to open a dry-cleaning business. Here are the costs you’ll need to cover to get the business off the ground:

In addition, you’ll need money to live on for at least a year. You estimate you’ll need $350,000 set aside for the business for the first year.

As a best practice when starting a new business, check with a number of sources for information on costs associated with starting that particular business. Your local Chamber of Commerce, business and industry associations, and the U.S. Small Business Administration (SBA) are all sources of information on business start-up costs. Additionally, speak with a proprietor of the type of business you are starting to get his perspective on what it takes to start a business. By being well-prepared for what is involved, you increase your chances of success, and you’ll be much more relaxed when the inevitable hiccups occur.

Now that you have an idea of how much money you’ll need to invest in your business, and how much you’ll need to hold on to in order to stay afloat while your business is getting off the ground, you’ll need to determine where you’re going to get that money. Chapter 4 includes information on funding your start-up; in this section we help you decide whether to invest your own money and how to decide how much to invest.

Let’s start by assuming you will need to invest some of your own money to start your business. This will show investors that you are serious and committed to making the business a success. However, before you jump in and invest your own finances, think about how much you need to live on while your business gets going. If you have a spouse who is bringing in a regular paycheck, or you plan to work full time and start your business on the side, you’ll likely need less (or nothing) set aside to pay yourself. However, if you won’t have any income outside of your new business, you need to be sure you can cover your expenses.

Here’s an example. You are opening a store that sells handmade crafts, and you need $200,000 to get started. You have $150,000 in savings. You will have no other income once you start your new business except for what the new business generates. Given that, you decide to invest $50,000, apply for financing for the balance of $150,000 and hold $100,000 to live on during the first year.

Your decision to invest your own money will be based on a variety of factors, including …

Many entrepreneurs choose not to relinquish control of their business by selling stock or seeking venture capital (VC). For some companies, such as the analytics software giant SAS, the price of such financing is simply too high. If retaining control over all timelines and decision-making processes is important to you, you may want to go it alone, financing the business out of your own savings or out of the company’s cash flow. This is not necessarily an easy path, but it has proved to be the best one for some businesses.

Another major decision you’ll need to make for your business is whether to lease space, buy property and a building, or have a virtual business where everything is done online. Your choice will be based on the type of business you are opening and the amount of money you have for investment. Some businesses are more conducive than others to being completely virtual.

Let’s look at a few examples.

Own: You are interested in opening a small gift shop in an area with high tourist traffic. You notice that there is a small gift shop for sale in your town. The owner of the gift shop owns the building in which the shop is located and is selling both the business and the building. You decide to pursue the option of purchasing the business since it has been operating for over five years and seems to do quite well. Additionally, you have significant money of your own to invest in the business and are willing to take more risks.

Lease: You are interested in opening a hardware business. The previous one closed about a year and a half ago, and the building it was in has remained empty for that time period. The owner of the building is willing to either sell or lease you the building. The shop requires little retrofitting since it was previously a hardware store. You decide to pursue the option of leasing the business as it will be easier for you to manage financially and you are concerned about taking on too much risk.

Virtual: You are interested in starting a business doing event photography. You have no need for a storefront location and will instead run the business out of your home for at least the first year. You decide to launch your business with a website. You have money to invest in building a website and marketing your business, which will cost no more than $20,000.

In your initial planning for your business, consider your options for leasing, buying, or running your business solely online. What are your competitors doing? Does one path work better for you initially? Can you expand as you start to make a profit?