July 24, 2012

4 Preventable Losses for Startups

Nobody starts a business in order to lose money, but here are four ways new start-ups do that lead to preventable losses.

Failure to control expenses

Watch what you’re spending by setting and adhering to a budget. It may sound like common sense, but if you’re not careful your rationalizations about it being a startup cost will bury you in debt and put your company in the red. Your new business does not need top of the line in everything at the very beginning. Start small and build up, just like a newlywed couple. You may have to lease a copier instead of buying one or work out of your basement before leasing office space in the finest corporate building. As your business grows, your expenses can grow, but don’t put the cart before the horse. You have a vision for what you would like your business to be, but don’t expect to get there on day one.

Growing too fast

It is possible to get overeager after some glimmers of success and grow your company too fast. Doing so depletes resources and can, worst case scenario, lead you into bankruptcy. To illustrate, consider two companies that began as local sensations: one made doughnuts and the other ice cream. Both began with one person or family and a recipe. Both were beloved by all who tasted their offerings. Both expanded and developed more efficient production methods as demand for the product increased. That’s where the stories go separate directions.

The doughnut company expanded to a region, then a nation (where it quickly became a public company on the NYSE) and then internationally. The brand and the products saturated most markets: convenience stores, grocery stores, fund raising and stand-alone locations. In so doing, the profits plummeted and the novelty of the doughnuts wore off. They were no longer a special treat because they could be purchased anywhere at any time. The quality didn’t change, but the demand no longer outweighed the supply. At peak performance (when the expansion increased exponentially), shares of the stock were trading just above $46 at a volume of 0.87 million. Currently, shares are trading at just over $6 at a volume of 0.44 million.

The ice cream company, on the other hand, chose to grow at a snail’s pace, preferring to leave customers begging for more rather than go into debt. Started 30 years earlier than the doughnut company, the ice cream is currently sold in only 20 states in the US. It was in business for more than 50 years before expanding outside of the town where it began, but it has never failed to make a profit, even during the Depression.

Starting a business is like starting a marathon. Pace yourself or you won’t make it to the end.

Paying yourself too much

This is closely related to the failure to control expenditures. When children hear that one of their friends’ parents owns a business, the immediate assumption is that the family is rich. Entrepreneurs know better, but some start a business with that goal in mind. Be careful not to mix your personal financial situation with your business finances or lines will blur and books won’t balance. The IRS frowns on such things. You may be tempted to give yourself a raise when personal finances get tight. Don’t do it, at least not until the business has profited enough to allow that additional expense. A guiding thought to help you is to ask yourself if the company can afford to give all the employees the same percentage of a raise at the same time. If not, wait.

Not having a debt collection process

In the quest to gain and please new clients, some start-ups fail to follow up on past due invoices. Studies have shown that the longer an invoice is past due, the less likely it is that invoice will be paid. Unpaid invoices are a loss. Make follow up phone calls. Send second notices. Document everything, and when necessary, call in a debt collection agency to help. Even after paying their contingent fee, collecting some of a debt is better than collecting none of it.

Tiffany Marshall is a freelance writer, writing on behalf of debt recovery companies like Direct Recovery. Her brother is a vice president of corporate banking and provided most of the tips for this article.

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