Chapter 14

Starting and Running a Small Business

In This Chapter

Preparing to start your business

Figuring out how to finance your business

Deciding whether you should incorporate

Attracting and retaining customers

Finding and equipping your business space

Keeping track of the business’s money and taxes

After you research and evaluate the needs of your prospective business (see Chapter 13 for more information), at some point you need to decide whether to actually start your business. If you really want to, you can conduct and analyze market research and crunch numbers until the cows come home. Even if you’re a linear, logical, analytic, quantitative kind of person, you ultimately need to make a gut-level decision: Do you jump in the water and start swimming, or do you stay on the sidelines and remain a spectator? In my opinion, watching isn’t nearly as fun as doing. If you feel ready but have some trepidation, you’re normal — just go for it!

Starting Up: Your Preflight Checklist

When you take off into the world of small-business ownership, you need to make decisions about a number of important issues. Just like a pilot before he takes flight, you should make sure that all systems are in order and ready to do the job. If your fuel tanks aren’t adequately filled, your engines aren’t clean and in working order, and your wing flaps aren’t in the proper position, you may never get your business off the ground or be able to stay in business long enough to succeed.

Preparing to leave your job

You may never discover that you have the talent to run your own business, and perhaps have a good idea to boot, unless you prepare yourself financially and psychologically to leave your job. Financial and emotional issues cause many aspiring entrepreneurs to remain chained to their employers and cause those who do break free to soon return to bondage.

The money side of this self-exploration is easier to deal with than the emotional side, so I’ll focus on finances. Dealing with a net reduction in the income that you bring home from work — at least in the early years of your business — is a foregone conclusion for the vast majority of small-business opportunities that you may pursue. Accept this fact and plan accordingly.

Do all you can to reduce your expenses to a level that fits the entrepreneurial life that you want to lead. Examine your monthly spending patterns to make your budget lean, mean, and entrepreneurially friendly. Determine what you spend each month on your rent (or mortgage), groceries, eating out, phone calls, insurance, and so on. Unless you’re someone who keeps all this data detailed, you need to compile your checking and ATM transactions, credit card statements, and anything else that documents your spending habits. Don’t forget to estimate your cash purchases that don’t leave a trail, like when you eat lunch out.

Beyond the bare essentials of food, shelter, healthcare, and clothing, most of what you spend money on is discretionary — that is, you spend money on luxuries. Even the amount that you spend on the necessities, such as food and shelter, is probably only part necessity and may include a fair amount of luxury and waste. So make sure you question all expenditures! If you don’t, you’ll have to continue working as an employee, and you’ll never be able to pursue your entrepreneurial dream. If you need a helping hand and an analyst’s eye in preparing and developing strategies for reducing your spending, pick up a copy of the latest edition of my book Personal Finance For Dummies (Wiley).

In addition to reducing your spending before and during the period that you start your business, also figure out how to manage the income side of your personal finances. The following list gives you some proven strategies to ensure that you have sufficient income:

• Transition gradually. One way to pursue your entrepreneurial dreams (and not starve while doing so) is to continue working part time in a regular job while you work part time at your own business. If you have a job that allows you to work part time, seize the opportunity. Some employers may even allow you to maintain your benefits. In addition to ensuring a steady source of income, splitting your time allows you to adjust to a new way of making a living. Some people have a hard time adjusting to their new lifestyle if they quit their jobs cold turkey and plunge headfirst into full-time entrepreneurship.

  Another option is to completely leave your job but line up a chunk of work that provides a decent income for a portion of your weekly work hours. Consulting for your most recent employer is a time-tested first “entrepreneurial” option with low risk.

• Get (or stay) married. Actually, as long as you’re attached (married or not) to someone who maintains a regular job and you manage your spending so you can live on that person’s income alone, you’re golden! Just make sure you talk things through with the love of your life to minimize misunderstandings and resentment. Maybe someday you can return the favor — that’s what my wife and I did. She was working in education (no big bucks there!) when I started an entrepreneurial venture after business school. We lived a Spartan lifestyle and made do just fine on her income. Several years later, when things were going well for me, she left her job to work on her own business.

Valuing and replacing your benefits

For many people, walking away from their employer’s benefits, including insurance, retirement funds, and paid days off, is both financially and emotionally challenging. Benefits are valuable, but you may be surprised by how efficiently you can replicate them in your own business.

Health insurance

Some prospective entrepreneurs fret over finding new health insurance. However, unless you have a significant existing medical problem (known as a preexisting condition), getting health insurance as an individual isn’t difficult. If you have such a condition, many states have high-risk pools that offer coverage options. You also have new protections under the 2010 federal healthcare bill (also known as Obamacare). This bill includes numerous provisions affecting small businesses. However, as of this writing, it’s unclear exactly when some of the small business provisions will take effect. For updated information on this topic, visit my website at www.erictyson.com.

When you’re seeking health insurance, first explore whether you can convert your existing coverage through your employer’s group plan into individual coverage. Just don’t act on this potentially attractive option until you’ve explored other health plans on your own, which may offer similar benefits at lower cost. Also, get proposals for individual coverage from major health plans in your area.

Take a high deductible, if available, to keep costs down. Having a high-deductible health plan, which is defined as an individual plan with a deductible of at least $1,250 or a family plan with a minimum $2,500 deductible for tax year 2011 (this amount increases over time with inflation), qualifies you to contribute money into a Health Savings Account (HSA). The contribution limits are up to $3,300 for individuals and $6,550 for families for tax year 2014, and these amounts increase over time with inflation. (Folks age 55 or older can put away an extra $1,000 per year.) Contributions to an HSA reduce your current year’s taxable income, and the money compounds without taxation over time. Withdrawals aren’t taxed so long as you use the money for qualified healthcare expenses, which are fairly broadly defined and include traditional out-of-pocket medical expenses (doctors and hospital care) as well as dental care, prescription drugs, psychologist expenses, vision care, vitamins, and so on.

Government regulations called COBRA require an employer with 20 or more employees to continue health insurance coverage (at your own expense) for up to 18 months after terminating employment. Moreover, if you have or develop a health problem while covered under COBRA, the law enables you to purchase an individual policy at the same price that a healthy individual can. These laws create a nice buffer zone for the budding entrepreneur, but don’t get lazy and wait until the last minute of the 18th month to start shopping for your individual plan — COBRA plans can be costly. Shopping around and locking in an individual plan as soon as possible can save money and prevent headaches.

Long-term disability insurance

For most working people, their greatest asset is their ability to earn money. If you suffer a disability and can’t work, how would you manage financially? Long-term disability insurance protects your income in the event of a disability.

Before you leave your job, secure an individual long-term disability policy. After you leave your job and are no longer earning steady income, you won’t qualify for a policy. Most insurers want to see at least six months of self-employment income before they’ll write you a policy. If you become disabled during this time, you’re uninsured and out of luck — that’s a big risk to take!

Check with any professional associations that you belong to or could join to see whether they offer long-term disability plans. Association plans are sometimes less expensive because of the group’s purchasing power.

Life insurance

If you have dependents who count on your income, you need life insurance. And unlike with disability insurance, you can generally purchase a life insurance policy at a lower cost than you can purchase additional coverage through your employer.

Retirement plans

If your employer offers retirement savings programs, such as a 401(k) plan or a pension plan, don’t despair about not having these in the future. (Of course, what you’ve already earned and accumulated while employed is yours.) One of the best benefits of self-employment is the availability of retirement savings plans — SEP-IRAs (Simplified Employee Pension Individual Retirement Accounts) and Keoghs — that allow you to sock away a hefty chunk of your earnings on a tax-deductible basis.

Retirement plans are a terrific way for you and your employees to shield a sizeable portion of earnings from taxation. If you don’t have employees, regularly contributing to one of these plans is usually a no-brainer. With employees, the decision is a bit more complicated but often still a great idea. Small businesses with a number of employees can also consider 401(k) plans. I explain retirement plans in more detail in Chapter 3.

Other benefits

Besides insurance and retirement plans, employers offer other benefits that you may value. But don’t get too bummed yet. These benefits aren’t true benefits, so you won’t miss much if you branch out on your own. For example, you seem to get paid holidays and vacations. In reality, though, your employer simply spreads your salary over 52 weeks, thus paying you for actually working the other 47 weeks or so out of the year. You can do the same by building the cost of this paid time off into your product and service pricing.

Another “benefit” of working for an employer is that the employer pays for half of your Social Security and Medicare taxes. Although you must pay the entire tax when you’re self-employed, the IRS allows you to take half of this amount as a tax deduction on your annual tax Form 1040. So, really, this tax isn’t as painful as you think. As with vacations and holidays, you can simply build the cost of this tax into your product and service pricing. Just think: Your employer could pay you a higher salary if it weren’t paying half of these taxes as a benefit.

Some employers offer other insurance plans, such as dental or vision care plans. Ultimately, these plans only cover small out-of-pocket expenditures that aren’t worth insuring. Don’t waste your money purchasing such policies when you’re self-employed. (Note: One of the reasons that Obamacare-compliant health insurance plans are costly is the mandated pediatric dental and vision coverage.)

Financing Your Business

When you create your business plan (which I explain how to do in Chapter 13), you should estimate your startup and development costs. Luckily, you can start many worthwhile small businesses with little capital. The following sections explain methods for financing your business.

Going it alone by bootstrapping

Making do with a small amount of capital and spending only what you can afford is known as bootstrapping. Bootstrapping is just a fancy way of saying that a business lives within its own means and without external support. This strategy forces a business to be more resourceful and less wasteful. Bootstrapping is also a great training mechanism for producing cost-effective products and services. It offers you the advantage of getting into business with little capital.

Millions of successful small companies were bootstrapped at one time or another. Like small redwood saplings that grow into towering trees, small companies that had to bootstrap in the past can eventually grow into hundred million–dollar (and even multi-billion-dollar) companies. For example, Hewlett-Packard’s founders started their company out of a garage in Palo Alto, California. Microsoft, Motorola, Sony, and Disney were all bootstrapped, too.

Whether you want to maintain a small shop that employs just yourself, hire a few employees, or dream about building a large company, you need capital. However, misconceptions abound about how much money a company needs to achieve its goals and sources of funding.

“There’s an illusion that most companies need tons of money to get established and grow,” says James Collins, former lecturer at the Stanford Graduate School of Business and coauthor of the bestsellers Built to Last and Good to Great: Why Some Companies Make the Leap … and Others Don’t. “The Silicon Valley success stories of companies that raise gobs of venture capital and grow 4,000 percent are very rare. They are statistically insignificant but catch all sorts of attention,” he adds.

Studies show that the vast majority of small businesses obtain their initial capital from personal savings and family and friends rather than outside sources, such as banks and venture capital firms. A Harvard Business School study of the Inc. 500 (500 large, fast-growing private companies) found that more than 80 percent of the successful companies started with funds from the founder’s personal savings. The median startup capital was a modest $10,000, and these are successful, fast-growing companies! Slower-growing companies tend to require even less capital.

With the initial infusion of capital, many small businesses can propel themselves for years after they develop a service or product that brings in more cash flow. Jim Gentes, the founder of Giro, the bike helmet manufacturer, raised $35,000 from personal savings and loans from family and friends to make and distribute his first product. He then used the cash flow from the first product for future products.

Eventually, a successful, growing company may want outside financing to expand faster. Raising money from investors or lenders is much easier after you demonstrate that you know what you’re doing and that a market exists for your product or service. (Check out the following section for info on getting a bank loan.)

As I explain in the earlier section “Preparing to leave your job,” aspiring entrepreneurs must examine their personal finances for opportunities to reduce their own spending. If you want to start a company, the best time for you to examine your finances is years before you want to hit the entrepreneurial path. As with other financial goals, advance preparation can go a long way toward helping start a business. The best funding source and easiest investor to please is you.

Alan Tripp, founder and CEO of Score Learning, a chain of storefront interactive learning centers, planned for seven years before he took the entrepreneurial plunge. He funded his first retail center fully from personal savings. He and his wife lived frugally to save the necessary money. Tripp’s first center proved the success of his business concept: retail learning centers where kids can use computers to improve their reading, math, and science skills. With a business plan crafted over time and hard numbers to demonstrate the financial viability of his operation, Tripp then successfully raised funds from investors to open many more centers. (Kaplan Inc. ultimately bought his company.)

Some small-business founders put the cart before the horse and don’t plan and save for starting their business the way Tripp did. And in many cases, small-business owners want capital but don’t have a clear plan or need for it.

Taking loans from banks and other outside sources

If you’re starting a new business or have been in business for just a few years, borrowing, particularly from banks, may be difficult. Borrowing money is easier when you don’t really need to do so. No one knows this fact better than small-business owners.

Small-business owners who successfully obtain bank loans do their homework. To borrow money from a bank, you generally need a business plan, three years of financial statements and tax returns for the business and its owner, and projections for the business. Seek out banks that are committed to and understand the small-business marketplace.

The Small Business Administration (SBA) guarantees some small-business loans that banks originate. Because many small businesses lack collateral and pose a higher loan risk, banks wouldn’t otherwise make many of these loans. The SBA, in addition to guaranteeing loans for existing businesses, grants about 20 percent of its loans to startup businesses, which must have founders who put up at least a third of the funds needed and demonstrate a thorough understanding of the business, ideally through prior related industry experience.

The SBA offers a number of workshops and counseling services for small-business owners. Its SCORE (Service Corps of Retired Executives) consulting services provide free advice and critiques of business plans as well as advice on raising money for your business (www.score.org; 800-634-0245). The SBA charges a nominal fee for seminars. To get more information on SBA’s services and how to contact a local office, call 800-827-5722 or visit its website at www.sba.gov.

If you don’t have luck with banks or the SBA, consider the following:

• Credit unions can be a source of financial help. They’re often more willing to make personal loans to individuals.
• Borrowing against the equity in your home or other real estate is advantageous. This strategy is helpful because real estate loans generally entail lower and tax-deductible interest.
• Retirement savings plans can bridge the gap. You may be able to borrow against your investment balance, and such loans are usually available at competitive rates through employer-based plans. Just make sure you don’t take on too much debt and jeopardize your retirement savings.
• Credit cards may be useful as a last resort. If you’ve got the itch to get your business going but can’t wait to save the necessary money and lack other ways to borrow, the plastic in your wallet may be your ticket to operation. You can acquire some credit cards at interest rates of 10 percent or less. Remember: Because credit cards are unsecured loans, if your business fails and you can’t pay back your debt, your home equity and assets in retirement accounts aren’t at risk.

No matter what type of business you have in mind and how much money you think you need to make it succeed, be patient. Start small enough that you don’t need outside capital (unless you’re in an unusual situation where your window of opportunity is now and will close if you don’t get funding quickly). Starting your business without outside capital instills the discipline required for building a business piece by piece over time. The longer you can wait to get a loan or an equity investment, the better the terms generally are for you and your business because the risk is lower for the lender or investor.

Borrowing from family and friends

Because they know you and hopefully like and trust you, your family and friends may seem like good sources of investment money for your small business. They also likely have the added advantage of offering you better terms than a banker, wealthy investor, or a venture capitalist.

However, before you solicit and accept money from those you love, consider the following pitfalls:

• Defaulting on a loan can cause hard feelings. If your business hits the skids, defaulting on a loan made by a large, anonymous lender is one thing, but defaulting on a loan from your dear relatives can make future Thanksgiving meals mighty uncomfortable!
• Most entrepreneurs receive surprisingly little encouragement from the people they’re close to. Your parents, for example, may think that you’ve severed some of your cerebral synapses if you announce your intention to quit your job, which provides a lofty job title, decent pay, and benefits. The lack of emotional support may discourage you more than the lack of financial support.
• You lose out on the experience of a seasoned investor. Family and friends may lack important practical experience with similar ventures and may be unable to provide the type of guidance that a seasoned investor could.

Family investments in a small business work best under the following conditions:

• You prepare and sign a letter of agreement that spells out the terms of the investment or loan. In other words, you act as if you’re doing business with a banker or some other investor you know for business purposes only. I also recommend clearly disclosing in writing the risk of losing one’s entire investment. As time goes on, people have selective recall. Putting things in writing reminds everyone what was agreed to and what’s at risk.
• You’re quite certain that you can repay the loan. Otherwise, you run into the issue I discuss earlier: You default on the loan and burn bridges with your closest loved ones. No business is worth losing your family or friends.
• You can start your business with an equity investment. With an equity investment, a person is willing and able to lose all the money invested but hopes to hit a home run while helping you with your dream. (Check out the next section for more on equity investments.)

Courting investors and selling equity

Beyond family members and friends, private individuals with sufficient funds — also known as wealthy individuals — are your next best source of capital if you want an equity investor (and not a loan from a lender). However, before you approach wealthy people, you must have a solid business plan, which I explain how to prepare in Chapter 13.

A worthwhile angel investor (a wealthy individual who invests in small companies) has a track record of success with somewhat similar businesses that she’s funded and brings other things to the table besides money, such as strategic advice, helpful business contacts, and so on.

Although you want an investor to care about your business, it’s best if his investment in your business is no more than 5 to 10 percent of his total investment portfolio. No one wants to lose money, but doing so is less painful when you diversify well. A $50,000 investment from an investor with a $5 million portfolio is risking just 1 percent of his portfolio.

Finding people who may be interested in investing requires persistence and creativity. Consider these approaches:

• Consult tax advisors and attorneys you know who may have contacts.
• Network with successful entrepreneurs in similar fields.
• Think about customers or suppliers who like your business and believe in its potential.

One friend of mine sent hundreds of letters to people who lived in upscale neighborhoods in the city where he lived. The letter, a one-page summary of his investment opportunity, got an astounding 5 percent response for interest in receiving a business plan. Ultimately through this search method, he found one wealthy investor who funded his entire deal.

Here’s how to determine how much of the business you’re selling for the amount invested. Basically, the equity percentage should hinge on what the whole business is worth (see Chapter 15 for details on valuing a business). If your whole business is worth $500,000 and you’re seeking $100,000 from investors, that $100,000 should buy 20 percent of the business.

New businesses are the hardest to value — yet another reason you’re best off trying to raise money after you demonstrate some success. The further along you are, the lower the risk to an investor and the lower the cost to you (in terms of how much equity you must give up) to raise money.

Deciding Whether to Incorporate

Most businesses operate as sole proprietorships, a status limited to one owner or a married couple. If you run a sole proprietorship, you report your business income and costs on your tax return on Schedule C (Profit or Loss From Business), which you attach to your personal income tax return, Form 1040.

Incorporating, which establishes a distinct legal entity under which you do business, takes time and costs money. Therefore, incorporation must offer some benefits. Here are two main benefits of going through the process:

• Because corporations are legal entities distinct from their owners, they offer features that a proprietorship or partnership doesn’t. For example, corporations can have shareholders who own a piece or percentage of the company. These shares can be sold or transferred to other owners, subject to any restrictions in the shareholder’s agreement.
• Corporations offer continuity of life. In other words, corporations can continue to exist despite an owner’s death or the owner’s transfer of her stock in the company.

In the following sections, I detail the other benefits, along with possible drawbacks, of incorporating so you can decide whether it’s the right choice for you.

Don’t waste your money incorporating if you simply want to maintain a corporate-sounding name. If you operate as a sole proprietor, you can choose to operate under a different business name (“doing business as,” or d.b.a.) without the cost and hassles of incorporating.

Looking for liability protection

A major reason to consider incorporation is liability protection. Incorporation effectively separates your business from your personal finances, thereby better protecting your personal assets from lawsuits that may arise from your business.

Before you incorporate, ask yourself (and perhaps others in your line of business or advisors — legal, tax, and so on — who work with businesses like yours) what can cause someone to sue you. Then see whether you can purchase insurance to protect against these potential liabilities. Insurance is superior to incorporation because it pays claims, and people can still sue you if you’re incorporated. If you incorporate and someone successfully sues you, your company must cough up the money for the claim, and doing so may sink your business. Only insurance can cover such financially destructive claims.

People can also sue you if, for example, they slip and suffer an injury while on your property. To cover these types of claims, you can purchase a property or premises liability policy from an insurer.

Accountants, doctors, and a number of other professionals can buy liability insurance. A good place to start searching for liability insurance is through the associations for your profession. Even if you’re not a current member, check out the associations anyway — you may be able to access the insurance without membership, or you can join the association long enough to sign up. (Associations also sometimes offer competitive rates on disability insurance.)

Taking advantage of tax-deductible insurance and other benefits

A variety of insurance and related benefits are tax-deductible for all employees of an incorporated business. These benefits include the full cost of health and disability insurance as well as up to $50,000 in term life insurance per employee.

A new health insurance premium tax credit is available to qualifying small employers. Among other requirements, employers must have fewer than 25 full-time employees, and the annual employee wages must average less than $50,000. For tax year 2014 and beyond, the credit is 50 percent of the employer’s qualifying health insurance premium expenses. The credit is calculated and claimed on IRS Form 8941.

In addition to insurance, incorporated companies can also hold dependent-care plans in which up to $5,000 per employee may be put away on a tax-deductible basis for childcare and care for elderly parents. Corporations can also offer cafeteria or flexible spending plans that allow employees to pick and choose which benefits they spend their benefit dollars on.

If your business isn’t incorporated, you and the other business owners can’t deduct the cost of insurance plans for yourselves. However, you can deduct these costs for your employees as well as your health insurance costs for yourself and covered family members.

Cashing in on corporate taxes

Aside from the tax treatment of insurance and other benefits, another difference between operating as a sole proprietor and as a corporation is that the government taxes a corporation’s profits differently from those realized in a sole proprietorship. Which is better for your business depends on your situation.

Suppose that your business performs well and makes lots of money. If your business isn’t incorporated, the government taxes all profits from your business on your personal tax return in the year that your company earns those profits. If you intend to use these profits to reinvest in your business and expand, incorporating can potentially save you some tax dollars. (However, this tax-reducing tactic doesn’t work for personal service corporations, such as accounting, legal, and medical firms, which pay a higher tax rate.)

Resist the short-term temptation to incorporate just so you can have money left in the corporation taxed at a lower rate. If you want to pay yourself the profits in the future, you can end up paying more taxes. Why? Because you first pay taxes at the corporate tax rate in the year that your company earns the money, and then you pay taxes again on your personal income tax return when the corporation pays you.

Another reason not to incorporate, especially in the early months of a business, is that you can’t immediately claim the losses for an incorporated business on your personal tax return. Because most businesses produce little revenue in their early years and have all sorts of startup expenditures, losses are common.

Making the decision to incorporate

If you’re totally confused about whether to incorporate because your business is undergoing major financial changes, it’s worth getting competent professional help. The hard part is knowing where to turn, because finding one advisor who can put together all the pieces of the puzzle (including the financial, legal, and tax-related aspects) is challenging. Also be aware that you may get wrong or biased advice.

Although most attorneys and tax advisors don’t understand the business side of business, some do. So try to find one who does. You may need to hire a business advisor along with your attorney or tax advisor. Attorneys who specialize in advising small businesses can help explain the legal issues. Tax advisors who perform a lot of work with business owners can help explain the tax considerations.

If you’ve weighed the factors and you still can’t decide, my advice is to keep your business simple — don’t incorporate. Why? Because after you incorporate, unincorporating takes time and money. Start off your business as a sole proprietorship and then take it from there. Wait until the benefits of incorporating your business clearly outweigh the costs and drawbacks.

Finding and Keeping Customers

When you write your business plan (see Chapter 13), you need to think about your business’s customers. Just as the sun is the center of the solar system, everything in your business revolves around your customers. If you take care of your customers, they’ll take care of you and your business for many years.

Obtaining a following

When you’re ready to attract customers, put together a mailing list of people you know who may be interested in what you’re offering. Draft and mail an upbeat, one-page letter that provides an overview of what your business offers. As you have news to report — successes, new products and services, and so on — do another mailing.

Short letters are read more than glossy advertising newsletters. Most people are busy and don’t care about your business enough to read a lengthy piece of mail. E-mail lists may work as well and are attractive due to their lower costs. Use a service like Constant Contact, which enables you to track how many people actually open and click on links in your e-mails.

In addition to mailings, other successful ways to get the word out and attract customers are limited only to your imagination and resourcefulness. Consider the following ideas:

• If your business idea is innovative or somehow different, or if you have grand expansion plans, add some local media people to your mailing list. Newspaper, radio, and even television business reporters are always looking for story ideas. So include them in your mailings, and send them the one-page updates as well. Just remember to make your press releases information pieces and not advertisements.
• If your business seeks customers in a specific geographic area, blanket that area by mailing your one-page letter or delivering it door to door. You can include a coupon that offers your products or services at a reduced cost (perhaps at the cost you pay) to get people to try them. Make sure that people know this deal is a special opening-for-business bargain.

Providing solid customer service

After you attract customers, treat them as you would like to be treated by a business. If customers like your products and services, not only do they come back to buy more when the need arises, but they also tell others. (However, keep in mind that they’re even more likely to tell others when they have a bad experience!) Satisfied customers are every business’s best cost-effective marketers.

I never cease to be amazed by how many businesses have mediocre or poor customer service. One reason for poor service is that as your business grows, your employees are on the customer service front lines. If you don’t hire good people and give them the proper incentives to serve customers, many of them won’t do it. For most employees on a salary, the day-to-day task of assisting customers may be just an annoyance for them.

One way to make your staff care about customer service is to base part of their pay on the satisfaction of the customers they work with. Tie bonuses and increases at review time to this issue. You can easily measure customer satisfaction with a simple survey form.

Treating the customer right starts the moment that the selling process begins. Honesty is an often-underused business tool. More than a few salespeople mislead and lie in order to close a sale. Many customers discover after their purchase that they’ve been deceived, and they get angry. These unethical businesses likely lose not only future business from customers but also surely — and justifiably — referrals.

If your business doesn’t perform well for a customer, apologize and bend over backward to make the customer happy. Offer a discount on the problem purchase or, if possible, a refund on product purchases. Also, make sure you have a clear return-and-refund policy. Bend that policy if doing so helps you satisfy an unhappy customer or rids you of a difficult customer.

Setting Up Shop

No matter what type of business you have in mind, you need space to work from, whether it’s a spare room in your home, shared office space, or a small factory. You also need to outfit that space with tools of your trade. This section explains how to tackle these tasks.

Finding business space and negotiating a lease

Unless you can run your business from your home, you may be in the market for office or retail space. Finding good space and buying or leasing it both take plenty of time if done right.

In the early years of your business, buying an office or a retail building generally doesn’t make sense. The down payment consumes important capital, and you may end up spending lots of time and money on a real estate transaction for a location that may not interest you in the long term. Buying this type of real estate rarely makes sense unless you plan to stay put for five or more years. Leasing a space for your business is far more practical.

Renting office space is simpler than renting retail space because a building owner worries less about your business and its financial health. Your business needs more credibility to rent a retail building because your retail business affects the nature of the strip mall or shopping center where you lease. Owners of such properties don’t want to move in quick failures or someone who does a poor job of running his business.

If you and your business don’t have a track record with renting space, getting references is useful. If you seek well-located retail space, you must compete with national chains like Walgreens, so you better have a top-notch credit rating and track record. Consider subletting — circulate flyers to businesses that may have some extra space in the area in which you want to locate your business. Also prepare financial statements that show your personal and business creditworthiness.

Brokers list most spaces for lease. Working with a broker can be useful, but the same conflicts exist as with residential brokers (see Chapter 12). So also examine spaces for lease without a broker, and deal with the landlord directly. Such landlords may give you a better deal, and they don’t worry about recouping a brokerage commission.

The biggest headaches with leasing space are understanding and negotiating the lease contract. Odds are that the lessor presents you with a standard, preprinted lease contract that she says is fair and is the same lease that everyone else signs. Don’t sign it! This contract is the lessor’s first offer. Have an expert review it and help you modify it. Find yourself an attorney who regularly deals with such contracts.

Office leases are usually simpler than retail leases. About the most complicated issue you face with office leases is that they can be full service, which includes janitorial benefits. Retail leases, however, are usually triple-net, which means that you as the tenant pay for maintenance (for example, resurfacing the parking lot, cleaning, and gardening), utilities, and property taxes. You’re correct to worry about a triple-net retail lease because you can’t control many of these expenses. For example, if the property is sold, property taxes can jump.

Here are provisions to keep in mind when dealing with a triple-net lease:

• Compare your site’s costs to other sites to evaluate the deal that the lessor offers you.
• Your lease contract needs to include a cap for the triple-net costs at a specified limit per square foot.
• Try to make sure that the lease contract doesn’t make you responsible for removal costs for any toxic waste you may discover during your occupation. Also exclude increased property taxes that the sale of the property may cause.
• If feasible, get your landlord to pay for remodeling. It’s cheaper for the landlord to do it and entails fewer hassles for you.
• With retail leases, get an option for renewal. This renewal option is critical in retail, where location is important. The option should specify the cost — for example, something like 5 percent below market, as determined by arbitration.
• Get an option that the lease can be transferred to a new owner if you sell the business.

If you really think you want to purchase (not lease) because you can see yourself staying in the same place for at least five years, head to Chapter 11.

Equipping your business space

You can easily go overboard spending money when leasing or buying office space and outfitting that space. The most common reason that small-business owners spend more than they should is to attempt to project a professional, upscale image. You can have an office or retail location that works for you and your customers without spending a fortune if you observe some simple rules:

• Buy — don’t lease or finance — equipment. Unless you’re running a manufacturing outfit where the cost of buying equipment is prohibitive, try to avoid borrowing and leasing. If you can’t buy office furniture, computers, cash registers, and so on with cash, you probably can’t afford them! Buying such things on credit or leasing them — leasing is invariably the most expensive way to go — encourages you to spend beyond your means.

  Consider buying used equipment, especially furniture, which takes longer to become obsolete. The more popular a piece of equipment, the more beneficial it is for you to purchase rather than lease: If many other businesses would be willing to buy the equipment, you’ll have an easier time unloading it if you ever want to sell it. Leasing may make more sense with oddball-type equipment that is more of a hassle and costly for you to unload after a short usage period.

• Don’t get carried away with technological and marketing gadgets. Some small-business owners spend excessively on the latest tech gadgets that they don’t really need because they feel the need to be “competitive” and “current.” Don’t forget the virtues of picking up the phone or meeting in person — these forms of communication are much more personal ways of doing business.

Bootstrap-equipping your office makes sense within certain limits (see “Going it alone by bootstrapping,” earlier in this chapter). If customers come to you, of course, you don’t want a shabby-looking store or office. However, you don’t have to purchase the Rolls-Royce equivalent of everything that you need for your office.

Accounting for the Money

One of the less glamorous aspects of running your own business is dealing with accounting. Unlike when you work for an employer, you must track your business’s income, expenses, and taxes (for you and your employees). Although you may be able to afford to hire others to help with these dreary tasks, you still must know the inner workings of your business to keep control of your company, to stay out of trouble with the tax authorities, and to minimize your taxes. The following sections explain how to handle the accounting aspect of your business.

Maintaining tax records and payments

With revenue hopefully flowing into your business and expenses surely heading out, you must keep records to help satisfy your tax obligations and keep a handle on the financial status and success of your business. You can’t accurately complete the necessary tax forms for your business if you don’t properly track your income and expenses. And should the IRS audit you (the probability of being audited as a small-business owner is about four times higher than when you’re an employee at a company), you may need to prove some or even all of your expenses and income.

In order to keep your sanity, and keep the IRS at bay, make sure you do the following:

• Pay your taxes each quarter and on time. When you’re self-employed, you’re responsible for the accurate and timely filing of all taxes that you owe on your income on a quarterly basis. You must pay taxes by the 15th of January, April, June, and September. (If the 15th falls on the weekend, payment is due the Monday that follows the 15th.) Call the IRS at 800-TAX-FORM (800-829-3676) and ask for Form 1040-ES (Estimated Tax for Individuals), or download this form from www.irs.gov. This form comes with an easy-to-use estimated tax worksheet and four payment coupons that you send in with your quarterly tax payments. Mark the due dates for your quarterly taxes on your calendar so you don’t forget!

  If you have employees, you also need to withhold taxes from each paycheck they receive. You must then use the money that you deduct from their paychecks to make timely payments to the IRS and the appropriate state authorities. In addition to federal and state income tax, you need to withhold and send in Social Security and any other state or locally mandated payroll taxes. Pay these taxes immediately after withholding them from your employees’ paychecks, and never use the money to fund your business needs.

  I recommend using a payroll service to ensure that your payments are made correctly and on time to all the different places that these tax filings need to go.

• Keep your business accounts separate from your personal accounts. The IRS knows that small-business owners have more opportunity to hide business income and inflate business expenses. Thus, the IRS looks skeptically at business owners who use and commingle funds in personal checking and credit card accounts for business transactions.

  Although you may find opening and maintaining separate business accounts bothersome, do so. And remember to pay for only legitimate business expenses through your business account. You’ll be thankful come tax preparation time to have separate records. Having separate records can also make the IRS easier to deal with if you’re audited.

• Keep good records of your business income and expenses. You can use file folders, software, or a shoebox to collect your business income and expenses. Whatever your method, just do it! When you’re ready to file your annual return, you need the documentation that allows you to figure your business income and expenses.

  Charging expenses on a credit card or writing a check can make the documentation for most businesses easier. These methods of payment leave a paper trail that simplifies the task of tallying up your expenses come tax time, and they also make the IRS auditor less grumpy in the event that he audits you. (Just make sure you don’t overspend, as many people do with credit cards!)

In addition to keeping good records, you also need to decide on what basis, cash or accrual, you want your company to keep its books. Here’s the lowdown on the options:

• Cash: Most small-business owners use the cash method, which simply means that for tax purposes, you recognize or report income in the year it’s received and expenses in the year they’re paid.
• Accrual: The accrual method, by contrast, records income when the sale is made, even if the customer hasn’t yet paid; expenses are recognized when incurred even if your business hasn’t paid the bill yet.

Sole proprietorships, partnerships, and S and personal service corporations generally can use the cash method. C corporations and partnerships that have C corporations as partners may not use the cash accounting method.

The advantage of operating on a cash basis is that you can have some control over the amount of your business income and expenses that your business reports for tax purposes year to year. Doing so can lower your tax bill. Suppose that, looking ahead to the next tax year, you have good reason to believe that your business will make more money, pushing you into a higher tax bracket. You can likely reduce your tax bill if you pay more of your expenses in the next year. For example, instead of buying a new computer late this year, you can wait until early next year. (Note: The IRS recognizes credit card expenses by the date when you make the charges, not when you pay the bill.) Likewise, you can somewhat control when your customers pay you. If you expect to make less money next year, simply don’t invoice customers in December of this year. Wait until January so you receive the income from those sales next year.

Paying lower taxes(legally)

Every small business must spend money, and spending money in your business holds the allure of lowering your tax bill. But don’t spend money on your business just for the sake of generating tax deductions. Spend your money to make the most of the tax breaks that you can legally take. The following are some examples of legal tax breaks:

• Take it all off now or spread it around for later. As a small-business owner, if you have net income, you can deduct up to $500,000 (for tax year 2013) per year for equipment purchases (for example, espresso machines, computers, desks, and chairs) for use in your business. (Unless Congress amends the tax laws, this expense limitation is set to revert to its previous and much lower $25,000 limit in 2014.) By deducting via a Section 179 deduction, you can immediately deduct the entire amount that you spend on equipment for your business. Normally, equipment for your business is depreciated over a number of years. With depreciation, you claim a tax deduction yearly for a portion of the total purchase price of the equipment. For example, if you drop two grand on a new computer, you can take a $400 deduction annually for this computer’s depreciation (if you elect straight-line depreciation). If you elect the special 179 deduction, you can claim the entire $2,000 outlay at once (as long as you haven’t exceeded the annual cap).

  Taking all the deduction in one year by using the Section 179 deduction method is enticing, but you may pay more taxes in the long run that way. Consider that in the early years of most businesses, profits are low. When your business is in a low tax bracket, the value of your deductions is low. If your business grows, you may come out ahead if you depreciate your early-year big-ticket expenses, thereby postponing to higher-tax-bracket years some of the deductions that you can take off.

• Make the most of your auto deductions. If you use your car for business, you can claim a deduction, but don’t waste a lot of money on a new car, thinking that the IRS pays for it — because it doesn’t. The IRS limits how large an annual auto expense you can claim for depreciation. Another advantage of purchasing a more reasonably priced car: You won’t be burdened with documenting your actual auto expenses and calculating depreciation. You can use the auto expense method of just claiming a flat 56 cents per mile (for tax year 2014).
• Deduct travel, meal, and entertainment expenses. For the IRS to consider your expense deductible, your travel must be for a bona fide business purpose. For example, if you live in Chicago, fly to Honolulu for a week, and spend one day at a seminar for business purposes and then the other six days snorkeling and sunning, you can deduct only the expenses for the one day of your trip that you devoted to business. (An exception to this rule enables you to write off more of your trip: If you extend a business trip to stay over a Saturday night to qualify for a lower airfare and you save money in total travel costs, you can claim the extra costs that you incurred to stay over through Sunday!)

  Don’t waste your money on meal and entertainment expenses. You can deduct only 50 percent of your business expenses; by all means, take that 50 percent deduction when you can legally do so, but don’t spend frivolously on business trips and think that you can deduct everything. The IRS doesn’t allow business deductions for club dues (such as for health, business, airport, or social clubs) or entertainment (such as executive boxes at sports stadiums).

Keeping a Life and Perspective

David Packard, co-founder of Hewlett-Packard, said, “You are likely to die not of starvation for opportunities, but of indigestion of opportunities.”

Most small businesses succeed in keeping their owners more than busy — in some cases, too busy. If you provide needed products or services at a fair price, customers will beat a path to your door. Your business will grow and be busier than you can personally handle. You may need to start hiring people. I know small-business owners who work themselves into a frenzy by putting in 70 or more hours a week.

If you enjoy your work so much that it’s not really work and you end up putting in long hours because you enjoy it, terrific! But success in your company can cause you to put less energy into other important aspects of your life that perhaps don’t come as easily.

Although careers and business successes are important, don’t place these successes higher than fourth on your overall priority list. You can’t replace your health, family, and friends, but you can replace a job or a business.