Many people dream of starting their own business and be their own boss. However, they ignore the harsh realities of starting a small business. They often fall prey to the myths and legends of entrepreneurship. So, what are the realities of starting a small enterprise? Let’s find out.
”When you own a business, your responsibility is a lot more than that of an employee. Your business can fail even if only one aspect of it is not being handled well.
BUSTING 6 MYTHS OF STARTING A SMALL ENTERPRISE
1. Buying at a distress sale is always a good deal
This is the biggest myth. Seller is in the market to sell a business because of his own needs. On the other hand, you are in the market to buy a business which satisfies your requirements. If it happens that your and sellers’ needs are aligned, you will have a transaction. I usually make a Pro-forma statement which shows profitability under my ownership. Based on that, I make an offer. Let’s consider these two scenarios:
- Let’s say, a business with revenue of $500K has a payroll of $50K and profits of $100K. If most employees of that business are the seller’s family members who work for no wages, or minimum wages, it will have an impact on your net profit. When you hire new employees to replace the seller’s family, your payroll may increase from $50K to $110K, and so your net profit will come down from $100K to barely $40K.
- In the reverse scenario, consider another business that pays $50K more in payroll than the market rate. Once you purchase this business and hire new employees at market rate salaries, your net profit will increase from $100K to $150K as you no longer have to pay this excessive payroll.
Thus it is more profitable to buy the second business if both are available for sale at the same price. In fact, purchasing the second business may still be the better choice at a slightly higher price if the Pro-forma statement makes sense.
2. Having a broker is always good for the business
The broker is paid on the successful sale of the business and not on how the business performs under the new ownership. The broker is not responsible for the financial performance of the seller. You have to do your due diligence on that front to avoid any issues following the purchase.
3. Starting a new franchise vs buying an established location of the same brand
Most small businesses fail within the first one or two years of business. If a business survives the beginning, chances of its success increase considerably. Starting a new location can be overwhelming because of a variety of reasons including, lease of space, construction, buying inventory. It also takes 1-2 years before a business breaks even. This period can be very challenging. An existing location may cost more money but will be profitable from the very beginning. For example:
- Scenario A: You can start a new franchise for a UPS Store for about $150K, but have to lose another $100K in the next two years before you start making a profit. Thus, in reality, it will cost you $250K before you make your first-year profit of, say, $75K.
- Scenario B: You can purchase an existing franchise for about $250K which will start making you $75K profit from the first year.
So, in scenario A, you invested $250K and did not make money for the first two years. You also paid a much higher emotional toll by buying a new franchise. In scenario B, you spent the same amount of money but earned an additional $150K over two years.
4. You are your own boss, so you can work as you please.
This myth can cost you quite a bit of money. No business is simple enough to be run by the get-go.
When you own a business, your responsibility is a lot more than that of an employee. Your business can fail even if only one aspect of it is not being handled well. For example, marketing, sales revenue, net profit, HR issues, demographic changes or just cash flow. You may have to work long hours, in the beginning, to make sure that all aspects of the business are dealt with appropriately. As you gain experience, you can indeed become your own boss and delegate work to your employees.
5. If you invest in a franchise, you have a high chance of succeeding.
Plenty of franchises fail every year. Being a franchise is no guarantee that a business is going to be fail-proof. Chances of success are higher only if you purchase a franchise or independent location which has been in business for a few years.
6. Revenue is the most important metric.
Everyone wants to own a business to be more profitable. However, if expenses are more than the sales, then the business is running at a loss, and sooner or later it will shut down.
Let us compare a business A with $10M in sales to business B with $500K in sales. Consider they both have the same profit of $200K. Thus for business A, the profit is 2% of the sales whereas for business B the profit is 40% of the sales. However, if things go wrong or a recession hits, business A will be in a loss in no time. On the other hand, business B will continue to make a profit even if sales decrease or expenses increase. Thus I will definitely pick business B over business A, even if the purchase price is higher.
When it comes to starting a small enterprise, hearsay or preconceived notions such as above can significantly hamper your decision making. Always do your due diligence in separating facts from myths to make the right moves for your new business.