How to Start a
Small Business
Business
Department, Brooklyn College C.U.N.Y.
It
is obvious that in today’s economy it may be difficult to find a job. Many
large corporations are downsizing and many workers are finding themselves
either underemployed or unemployed. This level of increasing frustration by
both the employed and the unemployed has led to searches by employers for
nontraditional alternatives for workers. One of these alternatives is to create
and form your own small business. This increasingly popular alternative has led
to a boom in the startup and creation of small business. However despite the
good intentions of these small businesses, a vast majority of these businesses
will fail within their first few years of operation. This article will describe
the potential reasons for the successes and failures of a small business, and
describe how a prospective small business owner can beat the odds and succeed
in small business.
The
first step prospective small business owners should ask themselves is if they
have the “correct” personality to succeed in a small business. A person who
needs direct leadership to succeed, a person who blames the “boss” for all
his/her problems, someone who thrives in a structured environment for a given
number of hours a week, and a person who depends on a fixed known salary is a
poor candidates for a small business. In a small business you have to motivate
and organize yourself. In addition, since you are your own boss, there
is no one to blame for any problems but yourself. The psychological ups and
downs of small business owners are severe; therefore to run a small business,
you must be very strong emotionally. The number of hours you may have to work
on a small business may be extreme, sometimes in excess of 50-60 hours a week
especially at the startup time of the business. In addition, you may not be
able to get a steady salary out of a small business for a protracted period of
time.
In
summary you have to make MAJOR sacrifices at first to get a small business to
succeed. However, despite the serious barriers to the establishment of a small
business, many people try to establish one. You should always ask yourself “Is
the sacrifice worth the potential rewards?” If the answer is yes (it was for
the author for over 20 years) then you may be an excellent candidate to form a
small business.
The
next step in the process is the type of organization you would like to choose
for your small business. The easiest type of organization to form is the sole
proprietorship. The advantages of such an organization is:
1. It is very easy and inexpensive to form. All
you have to do is say you are a business and file the appropriate paperwork.
2. You get to keep all of the profits. (You
absorb all of the losses too).
3. There are no legal restrictions. You have to
file license forms and meet other regulations.
4. It is easy to dissolve if the business ends.
5. There are tax advantages for the owner.
The
disadvantages of a sole proprietorship are:
1. You have unlimited personal liability and
you are personally responsible for all debts. You can lose EVERTHING if you are
sued. However there are ways to protect your assets. Small business insurance
is widely available for ALL types of organization at a minimal cost. This type
of insurance is a must and is highly recommended.
2. Skills and abilities are limited. You can
only use your own skills.
3. Capital is limited. You only have the
capital you have access to.
4. The business may end with the owner’s death
or disability.
Based
on these facts, I recommend against a sole proprietorship due to its serious
risk factors.
Another
type of organization is a partnership, which is an association of two or more
persons who own a business.
The
advantages of a partnership are:
1. It is extremely easy to establish. Just
obtain a license and fill out a few forms.
2. There is more than one set of skills.
3. There is a larger pool of available capital.
It is the pool of all the owners’ capital.
4. It is an extremely flexible method of
organization. The owners get favorable tax treatment--and significant tax
advantages.
The
disadvantages of a partnership are:
1.
There is unlimited liability on each of the partners. This is basically the
same unlimited liability in the sole proprietorship except it is an unlimited
liability by all of the partners in the partnership.
2.
There may be difficulties in dissolving the partnership. A partnership is like
a marriage, if it breaks up you may have to buy out the other partner.
3.
Difficulties could occur if one partner dies or is disabled. Partners may not
allow for a replacement of one partner is in this situation.
4.
There is a potential for conflicts of interest between partners.
Based
on these factors I also recommend against a partnership for a small business.
A
third form of organization is the corporation that is a formal legal form of
structure.
The
advantages of a corporation are:
1-
Stockholders have limited liability. Stockholders liability is limited to the
assets of the corporation.
2-
Attracting capital is easier. It is very easy to attract capital by issuing
stock (proportional ownership) to investors.
3-
The corporation has the ability to continue on indefinitely. A corporation can
continue on or beyond the death or disability of its owners or stockholders.
4-
It is easy to transfer ownership. All a corporation has to do to transfer
ownership is transfer or issue stock to prospective owners.
5-
There is known valuation. Because a corporation can sell stock to potential
investors, the price paid for this stock can provide a basis for valuation.
The
disadvantages of a corporation are as follows:
1. It is very expensive, difficult, and costly
to form a corporation. It is possible however to complete the forms to create a
corporation on-line at a reduced cost. Many sites such as www.incorporate.com perform this
service.
2. There is double taxation on net
income at the corporate tax rate and for the stockholder as dividends at the
personal tax rate.
3. There are complex legal and paperwork
requirements on corporations.
4. If enough stock is issued and transferred to
investors the original creators of a corporation may lose control of it.
There
are other types of corporations that can be formed that reduce the risks of
double taxation to the owners. One of these corporations is the Subchapter S
Structure. S corporations retain all of the advantages of a standard
corporation including unlimited liability. This is the case even though it is
limited to 75 shareholders and is not suitable for public underwriting. The
real advantage of a Subchapter S corporation is that all of the profits and
losses of this structure are passed through to the owners at the regular income
tax rate effectively ending “double taxation” problem for the corporation. This
makes the tax treatment for an S corporation the same as in a partnership.
There
is also another type of structure available called the Limited Liability
Company (LLC). This is a cross between a corporation and a partnership. Stock
ownership restrictions are not present and a LLC has similar tax treatment to a
Subchapter S corporation. However LLCs are difficult and expensive to set up,
and due to their complexity, are not for everyone.
Based
on the available choices for the structure of a small business, I recommend the
Subchapter S Corporation. It is relatively easy to set up, avoids double
taxation while offering limited liability to the owners and is well suited to a
small business.
The
next decision for the prospective small business owner is the choice of a type
of business to get involved in. Both product and service suppliers can be
adapted as a small business. However before you choose your product or service,
there are several items you should keep in mind. A prospective small business
owner should attempt to select a business that they have some degree of
knowledge in. Considering the substantial barriers that a small business owner
can face a lack of knowledge of your chosen area of business can be
insurmountable. Ideally a small business should be selected that is simple to
understand and inexpensive to run, and within the owners area of expertise.
However many small businesses are not.
The
next step in the creation of a small business is to put together, a
comprehensive and high quality business plan. A business plan is a summary of
the small business owners operational, financial and marketing plans as well as
a detailed description of the backgrounds of the key personnel that will form
the management team of the proposed business. The importance of this
document can not be understated. A well researched and thoughtfully created
business plan shows that the prospective owner is serious about their proposed
future venture. A poorly constructed or sloppy business plan reflects poorly on
the future owners and shows that they are either not well versed in their
business venture, or just too lazy to care about the venture. A good business
plan that is well researched and organized should act as a blueprint for the
future activities of the business, as well as a strategy of implementing of the
future goals of the business. The business plan should also include a
contingency strategy in the event the business must peruse alternative plans in
order to adapt or survive under uncertainty. A good business plan should be
like a magnet and should be able to attract venture capital from prospective
investors
The
business plan should be very comprehensive in scope and should include a
mission statement (what is the purpose of this company), the goals and
objectives of the business, as well as some financial information. The 4Ps of
marketing should also be described in detail, that is, Product, Place, Price
and Promotion as well as a detailed competitive analysis. Business owners
should always tailor the FINAL version of the business plan to their own
personality. A prospective small business owner may be requested to describe in
detail his/her business plan on various occasions. If you did not write your
own business plan or used a “off the shelf” program to create this plan you
will come across as either lazy or having a lack of concern or knowledge about
your business which can both be fatal errors when you present your plan to
“outsiders”.
The
first step of a comprehensive business plan is to state the mission of the
business. This can be as simple as saying “I would like to sell flowers in
Brooklyn for a profit”. This is a relatively basic and broad statement that
merely states the company’s purpose and future goals. In addition, it is
recommended that prospective small business owner should prepare a short
executive summary that clarifies and highlights the key points of the business
plan to prospective investors. Investors and financial groups that lend money
to small businesses have notoriously short attention spans; therefore an actual
business plan should not be too long or too short, ideally between 10-50 pages
in length, depending on the complexity and operating history of the proposed
business.
The
next step is describing the company history. Many prospective companies will be
startups and therefore will not have much of an operating history. It is OK to
be in a startup as long as the rest of the business plan is strong and focused.
If the company is not a startup then a description of past history, operational
as well as financial, future goals, and the method of implementation is
warranted.
The
next item that must be considered while constructing a small business plan is
product. Typically as easy as this sounds there can be a great difficulty in
selecting a product. One of the primary difficulties a small business faces is
the type of product or service they will be selling to the public. In the case
of a service you certainly do not want to be in an area where many different
companies offer the same service as you do. This type of over saturation can
lead to cutthroat competition and increased costs to remain competitive. As we
will describe later, an in depth and comprehensive competitive analysis must be
performed before deciding on the choice of a service or product for your
company. As far as the choice of a product a prospective small business owner
may choose to market a common product under a license from a third party or may
want to become a distributor of one or more existing products. If possible a
prospective small business owner should choose a product or service that they
are familiar with or have experience with and they should attempt to select as
simple a product or service as is possible. When problems arise is often where
the product being offered is new or completely unique to the marketplace. Most
small business owners seek to protect a new product against potential theft by
competitors. A common but at times misguided way of accomplishing this task is
to seek a patent from the U. S. Government. A patent is an expensive and time
consuming process that more often than not requires the help of an attorney to
accomplish. In addition, ALL patents require a detailed description of the
product and how it operates (product descriptions are public information that
is available at the website www.uspto.gov).
As a matter of law, patents are protected for only 20 years and a new patent
can be issued for a similar product that has a “material change” from your
product. What is a material change? It depends on what a judge thinks. In
addition, the cost of defending your patent if it is infringed upon is yours.
Many smaller businesses may not have the capital to go through a protracted
defense of a patent especially against a gigantic company. A better and far
more workable idea may be to seek a non disclosure non-compete contract from
your current employees. What this states is that all the employees that sign
this agreement are bound to keep the companies designs confidential and if they
leave the company they cannot compete against your company in your industry for
a reasonable period of time. This type of agreement is easier to enforce and
can be easily drawn up and executed. If a company has a catchy logo, it can
seek a trademark for this logo. If the company has a nice jingle or a song that
can be used to advertise this product then the company can seek copy write
protection for this song or jingle. As a rule this is easier and cheaper to get
than a patent and the protection is much longer (at least 75 years).
Another
common problem that occurs with a product for a small business is “How do I
produce this item?” If it is a small business that only needs a small amount of
this product then it may be able to produce this amount on premises. However,
if larger quantities of this product are needed then it may be necessary to
find a way to manufacture this product in another location. As a general rule
strangely, small businesses usually seek foreign producers for these goods.
Many assume that it is cheaper to produce abroad. This may be true, but the
overall quality of foreign goods, along with the additional cost of
transportation must be considered. In addition if there is a problem in a
foreign country with the production of your goods how will you solve this
problem? A better idea is to produce these goods domestically, and, if
possible, locally. The advantages of this are many. The quality of the finished
good is usually higher domestically. Transportation costs will be significantly
less and if there is a problem it can be corrected more easily than in a foreign
nation. However the best advantage to the small business may be in part
psychological. Post 9/11 customers perceive that products “Made in the U.S.A”.
Are better than goods produced in a foreign country. This bolsters a feeling of
patriotism and helps protect domestic jobs. In addition, if possible, it may be
advantageous to produce these goods as locally as possible to your
headquarters. This is socially responsible behavior in that you are employing
people from, and supporting your local community.
However
the first question a small business owner would ask is how do I get a potential
manufacturer locally? In that regard it is a good idea is to contact the union
that covers the area that your product is in. Due to the fact that many jobs
are being exported overseas, unions will bend over backwards to help a
potential customer find the right manufacturer. If that does not work then a
trade association in the area of your product can be helpful in getting you
started. A small business owner may also find that there may be significant
incentives available to produce products locally. In NY as well as other areas
there are Economic Development Zones available. These EDZ are economically
disadvantaged areas in and usually around an inner city. Doing business in an
EDZ can create significant advantages for your business. Companies that move to
or expand in one of 10 EDZ (Empire Zones) in New York City (among those
available are Far Rockaway and South Jamaica
in Queens, East New York, The Brooklyn Navy Yard and Southwest Brooklyn)
may be eligible for significant incentives. Among these incentives are wage,
sales, investment and real property tax credits as well as discounted rates on
utilities. In order to qualify for these incentives a business must either net new
investment or job growth in New York State. Further information on this
worthwhile program is available at http://home.nyc.gov./html/sbs/html/ez.html.
Based on the available incentives and the other advantages I listed before, I
strongly recommend that a small business consider producing its products
domestically, and if possible locally.
Once
this is settled, the next decision that the prospective small business owner
faces is the place for the company’s physical location. This is at times a
difficult and emotionally charged decision process. Most business owners do not
conduct enough competitive analysis to correctly determine the place they would
like to open in. Most small business owners look for the most glamorous and
densely populated areas to open in. In New York Manhattan is a favorite of new
small business owners even though it may be prohibit ally expensive to open
there. In addition the competition in Manhattan may be much greater than the
outlying areas. I have found that business is like a battle, it is best to
establish a safe beachhead before you move out into more dangerous territory.
Small business owners would be better off starting up operations in an area
that they are familiar with. In a “home” area owners may have contacts in the
local community and they will be known to their customer base. In addition if
there are problems with the business they can adjust operations more quickly in
a known than an unknown environment. There is no shame in starting off small in
your home area and considering expansion later if the business is successful.
Many small businesses are also dependent upon a steady flow of traffic through
the area of the business to provide prospective customers. For those types of
businesses it is vital to conduct a headcount analysis that gives the owners a
good idea of the amount of people that move through a given area at a
particular time of day. Therefore it may be important to place this type of
business in a heavily trafficked area that can provide the necessary customer
base.
Another
consideration for the selection of a product or service is potential barriers
to entry into the marketplace. Do you need a high degree of specialized
training and knowledge to use the product such as with some high tech
electronics? Do you need a specialized license to do business that may require
years of training such as with a doctor or lawyer? If you are involved with
food preparation you and your employees must take a food preparation training
course before you can open. Almost all businesses require licenses to operate
and there no quicker way to fail then not applying for and getting the
necessary paperwork completed with the city and state before you open up. There
are some businesses that not only require a license but may require expensive
insurance (such as a car service) before they can open for business. Many
businesses will have to have some form of insurance in order to start up not
only for legal but also for protective purposes. Before you start up a small
business you MUST research the barriers to entry, determine the costs of these
barriers and make sure you are compliant with all of the regulations that
govern your proposed business or face the prospect of being closed down due to
non compliance.
One
of the more important factors involved in selecting a location for the business
is a through competitive analysis. Most small business owners might say “it is
too time consuming and expensive for me to perform a competitive analysis”. In
reality a good competitive analysis can be conducted inexpensively and quickly
if the owner knew the right steps to perform. The first and easiest step is to
survey the area you intend opening the business in. A good walk around this area
may yield excellent results. In addition you may talk to other non-competitive
business owners to see their opinions on your business. An excellent forum for
this is to join the local Chamber of Commerce for that area. This allows you
gather information from other business owners in the area in an informal and
relaxed setting. The Chamber of Commerce also allows you to network with other
business owners for ideas and to create possible strategic networking with
other business owners (students looking for a job with a small business may
benefit from joining there local chamber of commerce too).In addition many
Chambers of Commerce are organizing together to offer group insurance policies
to their members. This may be an excellent way to get a group policy such as
health insurance at a reduced cost. A prospective business owner can also
gather data on competitors by acting as a secret shopper and shopping at a
competitor.
There
are many sources that are publicly available that can be used to generate reliable
data on potential competitors (or all Businesses) in a particular area.
Obviously if you are opening up a Pizza shop in Brooklyn you can expect
competition, obviously it is unwise to open up in an area with 10 other Pizza
shops within walking range of your business. The site of the US Census report
at www.census.gov is extremely helpful in
finding demographic data. Inside of this site on the left hand side is a link
to American Fact finder that offers micro based demographics that can be
helpful to a small business owner. Another helpful site is www.melissadata.com where under free
lookups on the home page there is a link to the zip code level demographics
that are available from the U.S. Government. With these zip code level
demographics you can determine, among other items the age, racial composition
and income of a specific area. Another even more helpful site is available at
the Brooklyn Public Library website at www.brooklynpubliclibrary.org
Under “Electronic Resources” on the home page then go to Alphabetic List of
resources (you must have a Brooklyn Public Library card to use the site). The
next step is to go to a resource called Reference USA. This resource
under its business database listings has some information on almost every
company even private companies. All a user has to do is find the name of a
business (it does not have to be competitive) in an area. Once this name is
entered into the business database finder the database will come up with
information on that company. At the bottom of the information page a user can
get the names and descriptions of EVERY business within a certain distance from
the chosen business (from 1/10 of a mile to 5 miles). This can obviously be
helpful in determine both competitors and other businesses in your chosen area.
Any small business owner who uses these methods can create an excellent
competitive analysis at a minimal cost, and by implementing the results of this
analysis can avoid a serious and costly mistake.
Another
problem for a prospective small business owner is deciding where to locate the
business. Many small business owners prefer to operate their businesses from
their homes. This method has both several negatives and positives. Among the
positives are that there is little or no commute, you can work at literally any
time and there are significant tax advantages to running a small business from
your home. However among the negatives are the fact that you can be expected to
work continually without separation from your business. There is something to
be said for leaving the office and getting away from work. In a home-based
business other distractions can occur such as children, pets, friends etc.
Another significant problem is that most potential customers look down at small
home based businesses as being too minor to meet their needs. It may be fine to
run a small, service business from your home but a manufacturing or larger
business should seek an actual place of operation. It is relatively inexpensive
to run a small business from a local space and in many cases may be to your
advantage in the long run.
Another
rather touchy problem that faces a small business owner is “How much do I
charge for a good or service?” As a rule most small business owners think that
they must discount their goods or services dramatically in order to get
customers to “try them out”. This may not be true in all instances since that
type of philosophy can lead to a cutthroat competition war with a
better-capitalized competitor. In fact most of your companies’ competitors are
probably better capitalized and established than your business. Pricing a
product should net a small business a profit, however most small businesses
must assume for cash management purposes little or no revenue for the first
year of operation (even though this assumption may not be true). A possible
effective strategy is to give out a free trial or free sample to the product or
service you carry for a limited period of time. This will give a prospective
customer a chance to “try it out” and give your business a chance to gain a
prospective customer. Once you gain a reliable customer base it will become
easier to generate an effective pricing strategy. This strategy should be based
on several factors including the income of your target market and the total
amount of market share that you would like to have in the marketplace.
Obviously the market strategy must also take into account the cost of the goods
(so you can make a profit) and the prices that the market will bear (those
charged by your competitors).
Another
problem that is faced by a small business owner is how to promote your business
to your customer base. Most small businesses do not have a great amount of
resources that can be used to promote your business. One of the most effective
methods of promoting a product or service is by positive word of mouth. If you
have a good product or service is quite probable that there will be a positive
“buzz” on your business. However the real trick is getting a prospective
customer to try your product or service. This may be very difficult considering
the lack of money available to promote your business. A small business owner
must realize that some forms of promotion are very expensive and therefore out
of there reach. Nationally based advertising such as TV or magazines is very
expensive. Major celebrity endorsements are also probably out of reach. However
if the small business owner tries to operate on a local basis instead of a
national one these methods of promotion may be unnecessary. It is possible to
get prospective customers to try your product or service without spending a
fortune. For a budget of about $5000 a small business owner can get an
effective promotional campaign that gives them some real bang for the buck.
My
sample $5000 promotional budget would include the following items:
I
would spend about $750 dollars on promotional giveaways that would have my companies
name prominently listed on the item. Such items as calculators, pens, mugs,
calendars and other commonly used items can be purchased relatively cheaply and
can create brand recognition for your business. These items are available at www.quill.com or www.staples.com among other sites that cater
specifically to a small business.
Another
$1000 would be spent on a locally based campaign that would use such local
newspapers such as the Penny Saver, or local TV guide or Welcome Wagon
Publications. This type of campaign is inexpensive and very locally targeted.
Another $500 would be spent on an opening day (or days) party that would
introduce my business to my local target market. I would spend another $1000 on billboard and other advertising
that is placed on my local areas OUTGOING bus and train stations. Many
potential local based customers spend time waiting for transportation. What
better time to send out your message then to this captive audience. I would
spend another $250 on flyers that would be locally distributed that would
describe my product or service.The last $1000 would be spent on giving out
coupons and samples of my product or service to my potential clients.
I
believe that this promotional campaign can be effective in promoting a new
business to target market. This campaign can be changed to suit any small
business and is just being presented as a sample of a type of inexpensive
campaign that can create positive results.
Another
very important concern of potential small business owners is getting sufficient
funding to be able to operate a business for at least a year or two without any
significant revenue. Many small businesses will have very limited revenue for
the first two years of operation. Most small businesses will not make a real
profit for at least two to three years. Money in a business is like blood in a
human being, both will die without enough. It is very difficult to raise
venture capital for a small business unless you have an established operating
history. Many small businesses go to a bank seeking capital. This method is
especially fruitless and frustrating since most banks will not loan money to
small businesses without collateral. Another method that is popular is to seek
out a financial “angel” (a person or group that invests in small businesses)
that can loan you money. This method is also ineffective since most financial
angels get a multitude of business plans and tend to only invest in a “sure thing”.
This leaves the potential small business owner with only a few options they can
use to raise capital. One of the most popular ones is raising the money
yourself through credit cards, savings or a potential mortgage on your house.
This method is rather expensive and can create a multitude of problems for the
small business owner if the business fails. The problem can be even worse if
the prospective small business owner raises money from family and friends.
Family and friends may give you money but what price will you pay if the
business fails? Another interesting method of raising money is to determine who
will benefit from your business being in operation. An example of this is if
you own a gasoline station a local tanker company would benefit from your
operation since you would probably have to use them to get gasoline to your
business. It is possible to ask a potential suppler to help fund your business
since this type of strategic partnership can be beneficial to both parties. You
can find a local supplier through a local chamber of commerce, a trade
association or by using Reference USA (the procedure for use of this database
can be found earlier in this article). Also a local chamber of commerce or a
trade association can help a prospective small business owner find a connection
for venture capital. Another totally untapped source of venture capital contact
is a union that could benefit from your operation. Most trade unions have good
contacts with larger companies that can help you network and get venture
capital for your business. Another widely used method of raising venture
capital is to contact the SBA at www.sba.com
and seek a loan from the government. This method is difficult for several
reason among them the fact that the government requires a very complex business
plan to even consider your application. In addition government is notoriously
slow in clearing their loans and it appears that the SBA may now be under
funded leading to even more problems securing potential financing for your
business.
Most
small business have other concerns that may create problems down the road. One
of these problems is keeping accurate records about your business. All
organizations require accurate business records including the licensing and tax
bureaus. In order to correctly run your business you will need a computer, some
good analysis and tax software (you should hire a CPA to do taxes) and a good
filing system. Failure to keep accurate records can create grave consequences
for your business.
Another
concern for a small business is costing and inventory control. Many an
excellent small business has failed due to a misinterpretation of their costs
and inventory. A small business owner must eventually make a profit or eventually
face failure. A small business owner must have an excellent idea of their costs
and inventory so that costs can both be minimized and inventory controlled.
There are several good off the shelf software programs that can help such as
QuickBooks or Quicken that are both inexpensive and useful.
There
are many available resources that can help a small business owner. Among the
available resources are:
www.inc.com The homepage of Inc magazine that
includes a great set or resources for small business owners.
www.entrepreneur.com the home page of
entrepreneur magazine. This magazine has many resources that can be of great
use to a small business owner.
http://mel.lib.mi.us/business/BU-smallbiz.html
This is a list of resources that can help small business owner find information
that can help them operate.
www.smallbusinessresources.com.
This is a useful commercial site with many useful links.
www.allbusiness.com. This is another
good commercial site that offers useful resources for a small business owner.
http://smallbusiness.yahoo.com. Most
major portals such as Yahoo and MSN among others offer useful resources that
can help a prospective small business owner.
I
hope that this article has been informative and useful. The author of this
article Prof. Eric Popkoff can be contacted at Brooklyn College through the
Economics Department at 1-718-951-5000 or by e-mail at epopkoff@pipeline.com. I would welcome
any comments on this article.