11 Financial Mistakes – Part 2

By Trishan Arul    October 28, 2009

This is Part 2 of my post on Top 11 Mistakes that Ruin Entrepreneurs. Part 1 covered the first five items. “Ruin” may be overly dramatic but even businesses with solid underlying fundamentals can be ruined if you make enough of these mistakes.

6. Creating the wrong business structure – One of the first things you should do is to determine what business structure you need. Common choices are: sole proprietorship, partnership, LLC, and Corporation (both S-corp and C-corp). Take into consideration compliance work, cost, legal liability, employee issues, and taxation. There is no right form of business for every startup. In most cases you can switch forms down the road but the hassle and costs can be significant. I’ve spoken with many entrepreneurs who have spent thousands of scarce dollars to form a corporation which they didn’t need. This is a huge topic which I will address in the future but some resources can be found at my colleague Richard Greenberg’s Seedport website – he does that stuff for a living so if you want help, I recommend him!

7. Having employees without realizing it – Despite what some people say, there is no black & white line between being an employee and a contractor. The IRS provides some general information and even has Publication 1779 devoted to the topic. In general, the more control the business exerts over the work and finances of the person, the more likely they are to be classified as an employee. Penalties for incorrectly classifying an employee as a contractor are severe: the employer has to pay all of the payroll taxes (employer & employee portions), all of the income taxes that should have been withheld, and penalties. That can add up to 50% or more of what you paid the person. While classifying someone as a contractor may seem easy, it could cost you dearly down the road. Payroll is a huge headache which most people try to avoid but there are many inexpensive payroll solutions which can make it painless. So, no more excuses not to do it right.

8. Not opening business accounts – This ties in with #5 in Part 1 about Mixing Personal & Business Funds. At a minimum, you should have a separate bank account and credit card for your business. Most likely, you will have to personally guarantee the credit card but that shouldn’t prevent you from opening the account. Not only does it help you to separate business from personal transactions, it also allows your business to build a credit history. That will be important as you try to open accounts with various vendors for office supplies, cell phone service, computers, etc. Whenever you have the option, open an account under the name of the business so that when you need credit it will be available.

9. Funding the business with credit cards – Even after Congress acted to ban the most blatant abuses of the credit card industry, they are still a double edged sword. Credit cards are useful and often necessary to make many regular purchases, especially online but they also offer very expensive credit which is all too easy to abuse. If someone offer to lend you money at 20% interest, you’d probably consider that loan shark rates and immediately turn them down. Yet many small business owners pay more than that to their credit card companies without even thinking about it. Usually it starts out with small balances carried over so that you can meet payroll or conserve cash. But very quickly people end up reaching their limit, unable to pay off the balance, rolling it over month after month, and transferring balances to other cards. And when you depend on the credit card, it can really hurt if it gets cut off as many entrepreneurs have recently discovered.

10. Accounting without a shoebox – Handling your business finances with a shoebox isn’t recommended either! But many entrepreneurs don’t even bother to collect receipts, bills, statements, etc. in one place. They just ignore the accounting and money side of the business because its a hassle and there are so many other things to get done. Plus most people don’t like accounting so they avoid it as much as possible. Aside from never really knowing where your business stands financially, you will eventually have to figure it out. And when you finally try, it will be the nightmare you were dreading – we routinely spend months with new clients just trying to sort out their historical finances. If you’re separating your finances (Item #5) and keeping separate accounts (Item #8), then accounting doesn’t have to be difficult. Sign up for some of the free online services to make your life easier. Some websites that I recommend are Outright (which is designed with businesses in mind and can even sort expenditures by tax line) and Mint (which is geared to individuals but the importing and classifying features are great).  And if your business is large enough, then consider hiring a professional to handle the accounting – a good accountant will not only keep your books in order but they will become a financial partner and trusted advisor helping with many other business matters.

Image via Wikipedia

11. Not paying your taxes - I had a tax professor in university who used to say that you always have to pay your business partner… the government! Unfortunately, its true. This may seem simple but there are many layers of taxes that need to be paid: local property taxes, local payroll taxes, withholding taxes, FICA, income tax, etc. Its not uncommon to find businesses operating on a shoestring who decide not to pay some or all of them. This can lead to significant penalties down the road. One popular misconception is that you only have to pay income tax when you file your tax return. In reality, everyone has to pay income taxes throughout the year – employees get taxes withheld from paychecks but businesses need to make quarterly estimated tax payments. If you fail to pay the lesser of 90% of the taxes due or 100% of the prior year taxes by December 31, then you can be assessed penalties. And if you handle your own payroll, not remitting payroll taxes (employee withholding) is a serious crime with penalties to the INDIVIDUALS responsible (yes, even if it was a corporation) of up to 100%. Like credit cards, many businesses fall behind and think they will make it up later. If your business can’t afford to pay its taxes when due, you need to take drastic action now.

I’ve seen these mistakes made countless times by generally smart individuals. Avoiding these mistakes won’t necessarily make you successful but it will create a solid financial foundation for your business. Now, if you do end up making any of these mistakes, just don’t tell people you read our blog!

11 Financial Mistakes that Ruin Entrepreneurs!

By Trishan Arul    October 21, 2009

Image by Observe The Banana via Flickr

This post started out as a Top 5 list, but quickly grew from there as I thought about my experiences over the years. It wasn’t very hard to find 10 mistakes but since everyone does Top 10 lists, I decided to up the ante with 11! That’s 10% more useful, right? This is part of 1 of 2, the remainder will be in my next post. The list is intended to help first time entrepreneurs ensure that their business is on sound financial footing – its in the order that a typical entrepreneur would encounter each problem. If you’ve already made a mistake or two, I’d recommend fixing the problem before it becomes a real issue for your business.

1. 

   Image by Jon Newman via Flickr

   Computing financial viability – Most people don’t even know what this means but its not as complex as it sounds. You need to figure out if your nascent idea can be turned into a viable business. How much will customers pay (Revenue/Customer)? How many will you have (Qty) based on the market size? What do you need to run your business – product manufacturing cost or purchase price, servers, bandwidth, people, advertising, shipping, etc (Cost)? Is (Revenue/Customer * Quantity) – Cost > 0 ? If not, the idea is not financially viable and needs to be reworked. This is a simple “back of the envelope” calculation that everyone should do at the very beginning.

2. Not making a business plan – You may have heard the saying “those who fail to plan, plan to fail”… its true. I’m not saying you need to spend three months creating a 102 page business plan document with footnotes, appendices, and pie charts – though I am a fan of colored graphics . What you should do is think through all the basics – Customer Problem, Target Market, Product/Service Solution, Delivery Method, Employees, etc. On the financial side, that means creating a projection and budget for a few years (typically 3-5) with at least the first year in detail by month. This budget will be valuable to determine if you have enough money to survive, what big costs need to be paid, where you may be able to save money, how much investment you need, and so forth. Without a budget and plan, you’re just hoping that things work out.
3. Being overly optimistic with your budget – For financial matters, its usually better to take the conservative “glass half empty” approach. No one minds being surprised with extra money, but suddenly finding out you don’t have enough money is a bad thing. Assume it will take longer to make each sale, assume customers won’t pay right away, assume vendors will demand payment up front, if you’re doing development assume it will take 50% longer and cost twice as much… you get the idea.  Unexpected things always crop up, planning on everything going perfectly is the same as expecting to receive boxes filled with money – it won’t happen. And when reality is worse than your plan, you may find yourself out of money and time to complete the product, meet payroll, or other critical business needs.
4. Ignoring personal expenses – Most entrepreneurs have to save money and can do so very creatively. But you can’t live rent free holed up in your parents’ basement dining on Kraft Macaroni & Cheese and PBR while working 18 hours a day. Plan to spend a reasonable amount on your living expenses, including going out once in a while. Starting a business is stressful enough without turning yourself into a hermit. After making a business budget, make a personal budget to ensure that you have adequate money for both.
5. 

   Image by marsi via Flickr

   Mixing your personal & business funds – Keep your business money separate from your personal money and keep good records! The pain of sorting it out after the fact will make you wonder why you didn’t take the extra few seconds each time to do it right. You WILL need to sort it out for tax purposes, financial reporting, bringing on other investors, and budgeting purposes.  Its also easy to do, open a separate bank account, use one credit card just for business expenses (even if its in your name), minimize cash transactions, and always ask for a receipt. Its not easier to mix everything up and sort it out later since you’re creating a bigger headache down the road.

Next week I’ll finish the list but you can start fixing, or avoiding, these mistakes right now.

Where’s the Money?

By Trishan Arul    August 27, 2009

Image via Wikipedia

Among the many things needed to start a business, the one most often cited as a roadblock is money. Especially for young people who have the energy, passion, ideas, and other key ingredients to become entrepreneurs, money is scarce. Some businesses, notably personal services such as consulting, require very little money to start but others such as a retail store require significant upfront investment before any money comes in the door. Below I’ll discuss various common funding options for entrepreneurs.

Personal Funds: This is the most common source of startup funds for businesses. Many people who have worked for years have significant retirement and regular savings. I don’t recommend tapping your retirement funds to start a business no matter how good you think the idea is – you’ll not only pay penalties in most scenarios but you’re jeopardizing your future financial security. If you’ve planned to become an entrepreneur for some time, then you can live frugally and save money for a few years to fund your dream. While it may seem like a long time to wait, you can use the time wisely by planning, researching, and laying the groundwork to make your business a success in the long run.

Image by The Library of Congress via Flickr

Friends & Family: More than just a cell phone plan feature, this is the second most common source of funds for new businesses. You can draw from a larger pool of people who can each can invest less money to reach your overall funding target. People with self directed IRA’s can even tap into some of those funds to invest in your business. The good thing is that these people are investing primarily in you & your idea. The bad thing is that they are then relying on you to execute well, work hard, and make the business a success. Be aware that there is a non-monetary cost to taking this type of investment – the dynamic of your friendship could change and many relationships have been ruined because of money. If you go this route, ensure you set expectations properly, that no one is investing money they can’t afford to lose, and that you comply with any relevant securities laws (consult an attorney).

Image via Wikipedia

Loans: The recent stimulus package includes incentives for small business lending and many people believe this is a ready source of capital for starting a new business. Programs through the Small Business Administration do help many small businesses however they are administered through traditional banks and geared towards operating businesses with a financial history. If you don’t think a bank would loan you money based on the 5 C’s (Character or Credit History, Capacity or Cash Flow, Collateral, Capitalization, Conditions), then the SBA guarantee won’t change that situation. If you plan to invest a significant amount of money in the business (20-50% of total capital required), will have assets that can serve as collateral, and can personally guarantee the loan then this is a viable source of additional funding.

Angel Investors: Angels are professional investors, often former entrepreneurs and other wealthy individuals who invest in new businesses. Many do it to help entrepreneurs get off the ground but they are also seeking a financial return. They will thoroughly vet you, your team, and business so you need to be prepared for that level of scrutiny.  Some want to get involved in the business (i.e. a Board seat) but most are happy to invest in the background and let the team run with the business. But in either case, having a professional investor WILL change what you have to do. You will have to manage the business more formally, produce timely & accurate financial statements, and regularly report to the investors. Unfortunately, angel investment has become harder to find in the current economic environment.

Image via Wikipedia

Venture Capital: Being in Silicon Valley, this is the first thing everyone thinks of when raising money for a business. The truth is very few companies are appropriate for venture financing. Venture capitalists are looking for “home runs”, they don’t want to earn a 10% return, they shoot for a 10X or 100X or more return with each investment. They need a few stellar investments to compensate for all the investments that don’t make any money. VC’s  have large pools of capital which need to be invested and limited time/resources to invest that capital. A company that needs $1M and will never need any more money, isn’t as compelling as a company raising $20M which will eventually need $50M in funding before a liquidity event. That’s just how the business models of large funds work. As an entrepreneur, you will also give up a significant portion of your company (at least 20%) along with some control. Entrepreneur stories & complaints about dealing with VC’s are common and sometimes fodder for comic relief. That said, there are very good VC’s and this source of funding is quite valuable to many startups however unless you need a large amount of capital, VC’s are normally not the best funding option for a new business. If you do want to seek professional investment, reading Joe Beninato’s Raising Capital presentation is a great start.

Image via Wikipedia

Bootstrapping: Bootstrapping entails raising funds through operating a business with paying customers. In my opinion, this is the best path of funding for businesses which can use this approach since it minimizes the upfront investment while providing additional business benefits. Software and services businesses are the best candidates for growth through bootstrapping. A good example is a software company that starts out doing consulting. The company generates revenue while it gains expertise in understanding the customer’s problems, tailoring a solution, and creating code that will eventually become a piece of software that can be sold on its own. This also increases the company’s chances of success since it has learned firsthand from people who would eventually become its customers.

Every aspect of starting a business is hard work but finding the right sources of funding is something that should be done upfront with a lot of careful thought. Every business is different so you should determine the best combination of funding that works for your business. And don’t be afraid to get creative by bartering, giving equity or a percentage of future revenue, or anything else you can think of – one local couple even used their wedding registry!

Why Outsource?

By Trishan Arul    March 18, 2009

Full disclosure upfront, this is somewhat of a self-serving post since my company provides outsourced accounting services. However, having been on both sides of the coin, I do think I have a good perspective on the pro’s and con’s of outsourcing. Additionally, I think it is especially important for smaller companies to proactively consider how things get done – it’s too easy in the daily rush of things to end up with the wrong people doing the wrong tasks which can, over time, balloon into bigger problems.

Let’s start with the potential drawbacks:

• Loss of control: You have to rely on another person to accomplish tasks and in some cases they are remote so you can’t “see” them.
• Increased communication: The nature of the relationship requires that you spend more time defining projects up front. You’ll need to keep in contact on an ongoing basis, even if it’s just to check in.
• In-house talent: Using an outsourced provider means that your own staff isn’t developing the necessary skills to perform certain job functions.
• Cost: This is normally a benefit but hiring a good, experienced provider may cost more in the short term than having one of your staff take on more work

I would argue that many of the oft perceived drawbacks are actually beneficial in the long term. For example, losing some control and having to clearly define processes will often result in improved internal control & work flow. Even the cost issue is a misnomer. Many companies I’ve worked with made the mistake of having someone with no accounting experience fumbling around in Quickbooks. This results in many weeks of work to clean up months or years of errors. In those cases, doing it right the first time would have been much cheaper in the long run.

Let’s also take a look at the direct benefits:

• Expertise: An experienced professional will be able to offer specialized skills that would otherwise be unavailable to your business. They can stay up to date in their field (critical for fast moving areas like IT), will be able to oversee/mentor junior staff, are more efficient, and have probably seen & solved your current problems in the past.
• Cost: If you only need a part time person, an outsourced provider can provide that service at a comparable or cheaper cost because they have greater efficiencies of scale. And tying into the previous point, you can get an experienced person that you would otherwise have not been able to afford. Further, you can avoid one time capital costs such as buying software or servers.
• Scaling: Some businesses, especially project based, need to scale up & down rapidly to meet changing business conditions. Outsourcers can handle this variable level of work which eliminates the need to hire, train, or use temporary workers which could result in poor performance and potential layoffs.
• Focus: In my opinion, this is the most important reason to outsource. It allows your company to focus on the skills that set you apart in the market. A successful business does something far better than its competitors and whatever that is needs to be you team’s core focus. Let someone else handle the tertiary tasks involved in running a business while you keep a strategic view of the company and build on the key competencies that make your business unique & successful.

That’s a high-level rundown of the pro’s and con’s of outsourcing. At the end of the day, what really matters is that you spend time to choose the RIGHT outsourced provider which can make all the difference in your company’s success..

Look for a provider:

• with deep experience in their specialty
• who has worked with similar types & sizes of business
• with the infrastructure necessary to service your business
• whom you trust and have a good rapport with

For small business, it usually comes down to the person that you will be working with on a daily basis. Don’t be afraid to ask probing questions and speak with references. Make sure that person fits in to your company culture and shares your long term goals for the company. That will lay the groundwork for a successful outsourcing relationship.

Start-Up Basics

By Trishan Arul    March 5, 2009

These are the notes from a session where myself and others offered advice to people who were considering starting their own business. This was a session on Tuesday at LaidOffCamp SF, the first OST style conference in what will probably be a series of conferences around the country. Many people were blogging and making videos of this unique concept. It was a great event and I hope all the attendees found the information useful. A lot of it is straightforward information which is helpful for anyone who has not started a business before. And yes, for those of you who watch KRON 4 TV evening news, that was me speaking for 5 seconds during the story about LaidOffCamp.

Please feel free to add more suggested resources in the comments section. I will occasionally update the PDF to include that information. If you attended our session, please feel free to email me with feedback – what was good, bad, helpful, confusing, or even tips on dressing better!

Click Here for Start-Up Basics Session Notes