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Where Startups Go Wrong

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Entrepreneurial missteps are inevitable, and chief among them is low-balling monthly expenses for startups.

In the Hiscox USA 2011 Small Business Survey, Bermuda-based Hiscox – a specialty insurer that also has operations in the U.S. – polled 501 small-business executives and identified the four most common mistakes among small-business owners:
  • Underestimating monthly expenses, cited by 32 percent;
  • Hiring the wrong people, cited by 20 percent;
  • Not knowing how to market or sell a product, cited by 18 percent; and
  • Not securing enough financing, cited by 18 percent.
The survey also shed light on knowledge gaps for understanding the impact of taxes, and financing and credit.  

Expense expectations
John McKearney, a counselor with the Springfield chapter of Score – Counselors to America’s Small Business, said he’s not surprised that that underestimating expenses is a common problem, even though those costs are a key component of a business plan.

“Always the major reason for business problems or failures is undercapitalization. They just don’t have enough money,” said McKearney, who has been a Score counselor for 13 years in Missouri, California and Nevada.

McKearney is a certified public accountant who worked in financial administration for several years and owned a San Francisco Bay-area commercial printing business for 13 years before coming to Missouri.

He said the reason for underestimation, he said, is a blend of too much optimism and overlooking expenses.

“People don’t spend enough time on a business plan, generally. Then, when they look at the number of expenses, they just don’t spend enough time trying to analyze what they’re really going to need, and they do make mistakes,” he said.

For example, salaries and wages are the biggest expense item for many businesses, but owners often fail to factor in payroll taxes.

“People will go through and say, ‘I need three people, and I’m going to pay $10 an hour, and factor that number in, and they’re off and running,” he said. “They forget that when you pay people, you have to pay the payroll taxes as well. Half are paid by the employee and half are paid by the business owner, so that’s a significant number.”

Other problem areas on the expense front are costs for advertising and promotion, accounts receivable, insurance and maintenance – particularly if a business relies on a lot of equipment, McKearney said.

He suggests a simple solution for entrepreneurs who want to more accurately gauge their anticipated expenses: Ask for help.

“I always recommend that people try to find someone in the business who they’re not going to be competing with – maybe a similar company in St. Louis, Kansas City or Joplin – and run some ideas by those people,” he said. “Generally, the successful ones will share information as long as they know you’re not going to be a competitor, and that’s always very helpful.”

The people factor
New entrepreneurs may fall prey to hiring mistakes because they feel pressure as the company owner to make perfect hires from Day 1, or because they’re rushing to fill a position, said Lynette Weatherford, owner of Human Resource Advantage and communications committee chairwoman for the Springfield Area Human Resources Association. “A lot of times, they let their emotions take over, and by doing this, they are overlooking, possibly, some of the warning signals that are coming out of the interview,” she said. “They try to find common traits, and think, ‘This person is so similar to me, they must be perfect for this job,’ and they’re putting a square peg into a round hole,” she said.

Entrepreneurs should put in place hiring processes complete with a formal application form and a questionnaire that can help determine whether an applicant is a good fit.

She recommends a simple questionnaire with 10 to 12 questions that accomplish goals such as determining applicants’ skill sets, exploring their backgrounds and outlining their future objectives.

She also recommends a job description of essential job functions, and allowing applicants to review it to see what skills they could bring to the job.

Weatherford said if an applicant completes all steps of the hiring process, but the owner still has some reservations, checking references can help entrepreneurs make the right decisions.

Her hiring advice to new entrepreneurs is simple: “Take your time. I know time is money, (but) listen to your heart and your gut. If something just does not appear to be right, follow your instincts.”

Customer connections
Paul Wannenmacher, owner of Wannenmacher Advertising Co. Inc., said the main roadblock for advertising and marketing is that owners don’t think long-term. “They open their doors, and run a grand opening advertising plan. They generate a few customers, but they have no sustaining marketing that keeps them growing,” he said.

Business owners also should be proactive in exploring new technology or social media and understand how it can be used to build a company.

“Every business can experience benefits of new technology, but new technology (used) without forethought can also lead to a drain on the business,” he said. “New technology and utilization of (it) is something that small business has to get on top of.”

One challenge with marketing and advertising – and a reason why entrepreneurs underestimate how much they’ll have to spend on it – is that the business owners are so passionate about what they have to offer that they assume everyone else will take notice, McKearney said.

“They don’t really think about how they have to communicate with their prospective customers to make them aware that they’re there and that they have the product or service,” he added. Wannenmacher said businesses also have to recognize that new sales come from one of three avenues – new customers, existing customers who buy additional products or moving more product by selling more at any given time, such as by switching to six-ounce packaging from four-ounce packaging  – and all sales aren’t created equally.

“The most expensive new sale is a new customer, as far as going out and trying to generate a sale, because generally, they don’t know much about your product,” he said. “There, you need more repetition of message for the customer to either accept or reject your premise.”

Financial pitfalls
Casey Pyle, vice president of commercial lending at Liberty Bank, said the bank doesn’t use set guidelines to determine financing parameters for small-business borrowers.

“Sometimes you’ll hear that you need to borrow or have available six months’ of operating expenses, as far as labor, rent, insurance and those types of overhead expenses,” Pyle said. “We don’t have a rule of thumb for that. We use a monthly cash flow formula for the first 12 months on a startup and critique it as much as we can to make sure that it’s realistic.” Liberty Bank is the No. 1 U.S. Small Business Administration lender in Missouri, and the top lender on Springfield Business Journal’s list of the area’s largest SBA lenders, with nearly $48 million in area loans in 2010.

Working with loans through SBA, and particularly its 7(a) program, allows Liberty to provide flexibility until borrowers get over the startup hump and get the business established, Pyle said.

“It’s a draw note, so every month that they have available funds, they can call and request – if they’ve been approved – that we advance to pay the rent or the utility bill. That monthly cash-flow formula for the first 12 months is pretty critical,” he said. “With the SBA program, we can build in working capital, borrowing to finance the months of negative cash flow while they’re ramping up, or if they’re seasonal, if they need to borrow because they don’t have enough equity in the company or need financing to make it through those months.”

Incremental access to loan funds helps borrowers keep interest expenses down, he said, but the bank still ensures that loan funds are used for eligible business purchases.

“A lot of times, we require receipts and invoices to document that it is for business purposes, especially for equipment purchases and real estate,” he said. “We might even do the same on paying utilities or rent, or insurance premiums.”When Liberty Bank declines to make a business loan, Pyle said it’s often because the borrower is asking the bank to finance too much of the project.

“They don’t have enough of their own sweat in the game. We like for them to have 20 percent of the total project invested. The SBA will allow us to do it with less, but they need to have a significant investment in their own company,” Pyle said.

Still, he cautions that even those businesses that can access funding should be careful with that money from the beginning.

“When they start up, they need to be as tedious with their dollars as they’re going to be in four or five years when they’re successful. They need to hang on to everything they can.”

Another financial hurdle, according to Score’s McKearney, is insurance, or more specifically, the lack of coverage.

“Usually, an individual policy does not cover business activity. If they plan on using their vehicles for their business, they become uninsured as a result, and that’s an area that’s often overlooked,” he said.

He recommends that before a business is launched, owners talk to an insurance broker to make sure adequate policies are in place for buildings, casualties and liabilities and specialty coverage, such as the errors and omissions coverage he carried as a commercial printer.[[In-content Ad]]

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