Most small businesses fail within the first five years, often from a lack of planning at the outset. There are a number of financial pitfalls that new businesses must avoid in order to survive. You can improve your new business' chance of succeeding by learning about, and taking steps to avoid, the top ten mistakes new business owners make.
1) Starting Your Business With a Large Loan
Many small business owners make the mistake of borrowing large amounts -- either from banks, credit card companies, home equity loans, or friends and family -- to start their businesses. Because these business owners start off owing so much money, they feel pressured to make a profit immediately -- and they may have to make high monthly payments on the loans. A wiser approach is to save a good amount of money and to rely mostly on those savings when you begin your business.
2) Planning on Making a Profit Right Away
Most small businesses are not profitable within their first year or two. You should have a reliable source of income from something other than your new business to sustain yourself during your start-up period.
3) Spending Too Much Money at the Beginning
Many small businesses spend too much money "setting up shop," buying equipment and furniture, and investing in business cards and brochures. Plan to start on a shoestring. And remember, if you spend a lot of money, that's more money you can lose if the business fails. (For information on what to do if your business falls into debt, read Nolo's article When You Can't Pay Your Business Debts: Personal Liability and Bankruptcy Options.)
4) Hiring Employees You Don't Need
Hiring employees subjects you to registration and record keeping requirements and can be very expensive. You'll have to pay unemployment taxes, withhold state and federal income taxes (as well as Medicare and Social Security taxes), pay for workers' compensation insurance, and comply with safety regulations to avoid injury to your workers. (To learn more about your obligations as an employer, read Nolo's article Hiring Your First Employee: 13 Things You Must Do.)
You may face severe penalties -- and may even be found to be personally liable -- if you don't comply with all of these requirements. If you need help with your business, consider hiring an independent contractor or a worker from a temp agency rather than a permanent employee.
5)Renting Space You Don't Need
Renting space is usually not necessary when you're just starting out. Often times, you can work from home. Running your business from home can save you tax dollars too. (To learn more about tax savings for home businesses, read Nolo's article The Home Office Tax Deduction.)
Renting commercial space is expensive, and if you need to make modifications to the space, can be even more so. If your business doesn't work out or you can't afford to rent and have to move, you'll probably owe the landlord rent until your lease runs out. You will most likely be personally liable for these payments because most landlords require small business owners to sign personal guarantees, even if the business is officially an LLC or a corporation. (To learn more, see Nolo's Business Space & Commercial Lease area.)
6) Not Developing a Business Plan
Even if you're not soliciting money from investors, business plans are useful. Come up with a financial forecast to see if your business can make money and will have money year-round. Among other things, consider:
- what your initial financing needs are
- what challenges your business will face (in terms of competition and marketing), and
- how your business will survive and grow past the initial start-up period.
Your business plan should include a break-even analysis, profit-and-loss forecast, and a cash flow analysis. (For more detailed instructions on business plans, read Nolo's article Business Plan FAQ.)
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