by Beth Laurence, J.D.
Save as much money as possible before starting. People too often go into business with no savings, using loan money from friends, banks, or the SBA. They expect to start paying the loans back right away with their profits. What they don’t realize is that it can take months or years to make a profit. And once a lender discovers a business isn’t as profitable as expected, the lender is likely to call in the loan or refuse to renew it for another year. Often business owners then have to take out home equity loans or use credit cards to pay off the loans (putting their home and credit rating at risk). For more on this, see Nolo’s Business Financing FAQ.
A better plan is to save up as much of the needed investment money as possible, including living expenses for the first year, or even two. Odds are that your business won’t be profitable for one to two years. Even if you get plenty of business and your customers pay you on time (which isn’t always a sure thing) you’ll want to be able to invest that money back in the business for space, equipment, advertising, and insurance needs.
Start on a shoestring. Think small. Don’t rent space if you can work somewhere else. Don’t hire employees until you can keep them busy. You can hire independent contractors or temps in the meantime. People who start their business cheaply, often in a garage, den, or some other scavenged space, and create their first goods or services with more sweat than cash, have the luxury of making their inevitable rookie mistakes on a small scale. Because their early screw-ups don’t bury them in debt, they are able to learn and recover from them.
Protect your personal assets. When you go into business for yourself, you are usually personally liable for all judgments and debts the business incurs. This includes business loans, taxes, money owed to suppliers and landlords, and any lawsuit judgments against the business. If you don’t protect yourself, a creditor can go after your personal assets, such as your car and your house, to pay these debts. While you can protect yourself against lawsuits by buying business liability insurance, this won’t help you with business debts. If you plan to run up big debts, consider forming a corporation or limited liability company (LLC). An individual can form either type of business. See Nolo’s article Choosing the Best Ownership Structure for Your Business.
Understand how—and if—you will make a profit. You should be able to state in a few sentences how your business will make a substantial profit. For starters, you need to know your costs: how much you’ll spend on inventory, the rent, employee compensation, and a surprisingly long list of other costs. Then you can figure out exactly how much you need to sell each month at what price, to cover those expenses and have an adequate profit. These numbers are key to a “break-even analysis.” See Will My Business Make Money?
Make a business plan, no matter how short. Understanding your profit numbers and creating a break-even analysis is the first step in making a business plan. For most small companies, the key portions of a business plan are the break-even analysis, a profit-and-loss forecast, and a cash flow projection. (Projecting your cash flow is key and will make or break your company: Even if your business is getting plenty of work or selling its products if you’re not getting paid for 90-180 days, you’re not going to survive unless you’ve planned for it.) With a cash flow spreadsheet and a profit-and-loss forecast, you can tinker with and improve your business idea before you start. Creating a business plan also allows you to determine your projected start-up costs and your marketing strategies. If you can’t make the numbers work on paper, you won’t be able to make them work in real life. For more information, see Nolo’s Business Plan Basics.
Get and keep a competitive edge. Giving your business a competitive edge is crucially important to long-term success. Some ways to get this edge are by knowing more than your competitors, making a product that is hard or impossible to imitate, producing or distributing your product more efficiently, having a better location, or offering superior customer service. One way to hold on to your competitive edge is to protect your trade secrets, confidential information that gives you a competitive advantage in the marketplace. Examples of trade secrets include customer lists, survey methods, marketing strategies, and manufacturing techniques. To protect your trade secrets under the law, you need to take steps to keep the information confidential. This includes marking documents “Confidential,” using passwords to protect computer information, using nondisclosure and/or non-compete agreements, and limiting access to employees with a reasonable need to know the trade secrets. It is also important to patent those that are patentable. (Nolo’s Trade Secret Basics FAQ.) Another way to keep your competitive edge is to react quickly to bad news. When you see that your business faces adversity, come up with a plan to deal with it immediately. This may involve moving your offices, introducing a new product or service, or developing a better way to reach customers.
Put all agreements in writing. The laws of your state require you to put some contracts and agreements in writing: contracts that will last longer than a year; contracts that involve the sale of goods worth $500 or more; contracts that transfer the ownership of copyrights or real estate. (To learn more, see Make a Legally Valid Contract.) Even if not legally required, it’s wise to put almost everything in writing. Oral agreements can be difficult or impossible to prove. This includes leases or rental agreements, storage agreements, contracts for services (such as consulting or electrical work), purchase orders or contracts for goods worth more than a few hundred dollars, offer letters of employment, and employment policies. Get in the habit of getting and giving receipts for all goods, services, and deposits, regardless of the amount.
Hire and keep good people. Your goal should be to hire and retain truly excellent employees, not just reasonably competent ones. A highly competent and truly enthusiastic employee is at least two and sometimes three times as valuable as a person of average skills. To create a stable and happy workforce, it’s essential not only that your employees (and independent contractors) believe they are being fairly treated, but that your business is worthy of respect. Employees and contractors who like their work will represent you well on and off the job. And customers will be loyal to an upbeat business and more likely to recommend it to their friends. See the Human Resources area of Nolo’s website.
Pay attention to the legal status of your workers. When you hire workers as independent contractors, make sure they shouldn’t really be taxed as employees. The IRS can impose substantial penalties for not withholding taxes and paying taxes for a worker who is really an employee. The IRS and other agencies are likely to think that a worker is an employee rather than an independent contractor under any of these conditions:
The worker works full-time or nearly full-time for you.
The worker doesn’t work for anyone else.
The worker provides services that are an integral part of your operations.
You control how the worker does the job and provide detailed instructions and training for the worker.
One way to help avoid trouble is to have the worker sign a written service contract, or independent contractor agreement. Most employees you hire will be “at-will” employees, subject to termination at any time and for any reason, It’s important to preserve your at-will rights because they protect you from having to prove that you have a valid business-related reason to terminate an employee. Don’t make any promises to prospective or current employees that you are offering a permanent job or that they will lose their job only if they perform poorly. That will limit your ability to terminate them for other reasons, like personality conflicts or finances. When hiring an at-will employee, have the employee sign an offer letter that makes it clear that the employment relationship is at will. Except for high-level executives, you shouldn’t have employees sign an employment contract.
Pay your bills early and your taxes on time. In the real world, a reputation for keeping one’s word is a hugely important asset. A good strategy is either to pay your bills upfront or pay them early. You gain trust, build a positive credit profile, and have a built-in safety net if things go badly. These benefits outweigh any interest you might earn by holding onto your money until the last possible minute. Most importantly, pay your payroll taxes on time, especially the portion that you withhold from your employees’ paychecks. The IRS and state tax authorities can hold you personally liable for these taxes, plus stiff penalties if they’re not paid, even if you operate your business as a corporation or LLC or if your business goes bankrupt. (If you find yourself having trouble paying the bills, see Nolo’s articles for Financially Troubled Businesses.)
Ms. Laurence works for Nolo, a wholly owned subsidiary of Internet Brands, responsible for the integration of some of the Internet’s first legal sites, including Nolo.com, Divorcenet.com, and AllLaw.com. These sites were combined with the ExpertHub technology platform in 2011 to form the Nolo Network.