The Risks Of Starting Your Own Business
Small Business Preparation
Perhaps my nature was that of an entrepreneur at heart, or perhaps it was born out of the frustration of working under a large group of “yes men” in multinational conglomerates. However for many years I wished to work for myself. After years of research and 15 years working as a financial planner and investment advisor I opted to pursue forming my own firm in 2011. Fortunately things have gone quite well. Perhaps as a result of the type of work that I do I was inherently more prepared to form a new business. Yet in reality the best form of preparation I made was to prepare for the unexpected. Below are a series of considerations that each person should think about before starting their own company as a means to provide for themselves. In reality, most of these were hardly shocking for me as I have aided many small business owners over the years. Yet for many of you, you may be shocked.
Employee’s and the Tax Burden
Most of you that have only signed the back of the paycheck your entire lives may not truly appreciate the full cost of an employee. For example, every week when you get your paycheck you’ll take note that on top of your federal and state income taxes due, you are also responsible for payroll taxes. This is what funds programs like Medicare and Social Security. Yet most employees don’t realize that each dollar you pay towards these programs must be matched by your employer, which will now be your responsibility. That’s about 7.5% of each employee’s compensation. If you plan to draw a salary, which you will eventually do if your business produces a positive cash flow, that number will be the full 15+% on your income.
How about unemployment compensation ??? With all of those citizens currently on unemployment in such harsh times, someone must pay for these benefits. Whether you realize it or not, your employer carries an unemployment insurance policy on you typically required through the state you reside in. Even if you operate a sole proprietorship, the state will typically require that you pay unemployment insurance on yourself should your business entity fail. That responsibility is now yours.
Workers compensation is another insurance that is required for anyone one who has employees in most states. If you don’t have any employees you may not be required to have such coverage on yourself. However it’s best not to get injured at work because your ordinary medical coverage will not cover your treatment for work related incidents.
Clearly you’ll be required to provide for your own coverage unless your spouse has coverage on your behalf. Most often purchasing group insurance is less expensive, yet under Federal law you’ll be required to offer the same coverage to each employee under the same terms as you provide to yourself.
Once your business entity is operational and you have a positive cash flow you may want to consider putting some money away towards retirement for yourself. Again, if you have employees that can get complicated. You can’t simply fund your own retirement and ignore theirs. There are specific formulas on what you must contribute to the cost of each employee. Depending on the type of business entity you’ve established you may want to view various small business plans explained here.
Depending on how business friendly your state is, you may incur various other taxes that you’ve never heard of before you where self employed. For example, in the State of New York if you declare more than a 50k salary you’re subject to an additional 3% tax for the Metropolitan Transit Authority (MTA). It doesn’t matter if you never use MTA services or that when you do you already pay the train fare. You’re still subject to the tax. In the city of New York there is also an interesting tax known as the “Labor Mobility Tax” based on the size of your payroll. This is basically a quasi commuter tax even if your employees work from home. Be sure and check with your local tax advisor to prepare for what other additional expenses you may incur in your area.
Regulatory and Compliance
Assuming you can overcome the expenses of taxes and employee benefits, you must then be prepared for the regulatory burden. Depending on the type of business you are in, this can be quite cumbersome. In many fields such as the financial, medical & engineering industry you may having various licensing and registration requirements. This can vary greatly from field to field and state to state. However do not under estimate this cost. You don’t want to buy a building to open up a restaurant and find out that you can’t get a liquor license in your area of zoning. Of all the obstacles you’ll be required to overcome, this very likely will be the most difficult. This is also likely an ongoing complication that will require substantial man hours that is in some fields best outsourced. It’s important to try and evaluate the value of your time in comparison to the cost of outsourcing such requirements.
Clearly before you go into any business you want to evaluate the need for your service or product and how it will stack up against the competition. Starting your own company should be preceded with some form of market analysis to see if the public is actually interested in what you offer. You may have felt as the employee that you brought a certain degree of value to the table when compared to your co-workers. Your assumptions may or may not have been accurate. Yet once you start your own company, it may be harder to convince your customers of this value you offer. Be sure you’re actually worth what you think before you make the personal and financial commitment.
Have some kind of a plan to alert the public of what you offer. You could be the best at what you do, but nobody has heard of you. Marketing is an expense that can be costly. Depending on the industry this can be local TV or radio marketing. It could be in some instances the type of business entity that may utilize centers of influence in larger numbers as a means to produce referrals. But don’t simply sit back and expect the phone to ring. When you own the company, especially at the beginning...you must be all things. One of the most important of those is the rainmaker.
Make sure you have a reasonable set of assumptions on what your expenses will be in the first few years. Be sure to put these expenses to paper and overstate them by a good 15-20%. You can be sure that there will be numerous unexpected costs that will develop. You want to make sure you’re properly capitalized and have the liquidity to deal with these obstacles. One minor example of an unexpected expense that I simply overlooked was the notice of formation costs. When you establish any legal entity, you must file a public notice in the local newspapers. Usually more than one paper is required by state law. Even though virtually nobody reads these filings, they are required. They typically must run for a week or two. The total costs was an additional $500.00. In reality this was a minor oversight in the grand scheme. Yet there are various minor oversights and they can add up over time.
It’s generally not the best idea to pursue self employment in a field that you have little experience with. Another major reason why many new entities fail is that the individual pursues a field that they had never been affiliated with. They’re learning curve is increased substantially as a new business owner. I once knew an attorney who decided to open a nightclub without ever having worked in the industry. He was one to enjoy the nightlife. He made the mistake of assuming that socializing in nightclubs nearly every night made him an expert on running them. He learned a very costly lesson.
Be cautious in entering into any venture with another. Make sure you’re not just on the same page, but so are the spouses of both partners. They may have substantial input and can be disruptive if not in agreement. Preferably a partner is someone whom you’ve worked with on a daily basis in the past. Perhaps a former colleague from the same field.
Depending on the type of business you establish and the expected tax treatment, the best option may differ. Consult with your tax advisor and attorney as to what option makes the most sense from the standpoint of taxation and legal protection. Most often you’ll form one of the following
S-Corporation, LLC, LLP, or Sole Proprietorship (DBA)
Make the commitment
Don’t start your own company on the basis of a fleeting thought. Starting your own business requires great sacrifice. That means you don’t take days off, you’re really working 24 hours a day on call. If the alarm goes off on Sunday night you have to be there. If you’re going to make the commitment, then do it 100%. That may mean that if you fail, you lose everything. Your savings, your time, maybe even your home. But that is often what is required. Half hearted efforts will get you nothing but a pile of regrets.
These are just some basic considerations of going to work for yourself. Many people have the idealistic view of being self employed as some form of a utopia. In reality the majority of new small business entities fail within the first 1-3 years. Very often this is a result of a lack of planning or realistic business expectations. Should your business do well enough to stay viable and prosper it can be rewarding. Yet a few myths that should be addressed immediately are…
You’ll work harder and more hours...NOT less. You will be the LAST person to get paid. First comes the employees, vendors, suppliers, insurance, taxes and everything else you can imagine. The more successful you are, the more of your time and commitment will likely be required, NOT less. At NO point will you sit back and turn over the company’s operations to your top employees to keep an eye on things while you take prolonged vacations. Your employee’s DON’T CARE !!! They did not make the sacrifice, invest everything they had and risk all to make this work. They are thinking about getting to Friday just as you did when you where the employee. They very often think they’re just as valuable as you without such a sacrifice. As a result of human nature they will put their own interest above all else. If you have a tough year and lose money, the employees are NOT going to take up a collection for you. They probably won't even believe that you're losing money, and will complain about not getting a big enough raise.
When and if you are successful, the additional financial rewards may breed contempt from others. Often it’s your employees as they overstate their value. Sometimes it can even be friends and family that will look at what you’ve achieved with jealousy. Yet they themselves are unwilling to take the risks that you have borne. Unfortunately in society there are many who look at those of wealth and means as someone who is privileged. Rarely do they consider the sacrifice that it took along the road to success. Most people will choose to simply apply for work from someone else. While there is nothing wrong with taking the safer path for those who choose it, it rarely gives the proper perspective on what it takes to be a successful business owner. Most successful business owners are simply workaholics. When that is coupled with innovation and commitment, it can produce just the right outcome. With the sacrifice may come the reward’s. It’s not for everybody. Yet you will rarely get rich working for someone else.
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