What It Takes To Be An Entrepreneur

The driving force behind the numerous small- and medium-size businesses that flourish in our economy, is the entrepreneur. For those interested in starting and operating a business, it is useful to understand who this unique individual is and whether they have similar personality traits.

Social scientists have conducted numerous studies to determine whether successful entrepreneurs evidence personality traits different from the general population.

They found that the typical entrepreneur is:

The following simple assessment questionnaire should give the prospective entrepreneur a general idea of whether he or she possesses personality traits consistent with this entrepreneurial profile. To score your responses, assign one point to each "Yes" answer and a zero to each "No" answer. Add the point values and use the following suggested guidelines for interpreting your score.

• A score of 17 or above indicates traits consist with those of the typical entrepreneur.
• A score between 13 and 16 suggests only moderately consistent traits.
• A score of less than 13 suggests a lack of consistency.

When interpreting your score, realize that the results are only suggestive and not conclusive. There are successful entrepreneurs with scores less than 13 while a score of 17 or greater isn't an automatic guarantee of success. Success also requires a good business concept, organization and managerial skills, the necessary financing, a lot of hard, demanding work, good timing, and a measure of luck.

A major factor contributing to the poor success rate of startup businesses is the entrepreneur's failure to carefully investigate and plan a new venture. For this reason, experts advise a two-fold approach to the pre-startup stage: do a feasibility study and, if the venture appears promising, prepare a comprehensive business plan. 

As the name suggests, a feasibility study is a careful investigation into the question: what is the likelihood of commercial and financial success for the proposed new venture? To proposed answer this crucial question, the entrepreneur must first determine whether there is a good fit between the knowledge, skills, and experience required to effectively operate the business and the capabilities of the management team the firm will eventually employ. Next, the entrepreneur must gather information on the factors that are key to the venture's success. These include:

If the feasibility study does not indicate a good match between the required skills and management abilities, or if solid evidence supporting the likelihood of success does not exist, the business is probably doomed from the start.

A well-prepared business plan is comprehensive blueprint for the firm. It details the business concept; how the firm will be organized, financed, marketed, and operated; the strategies used to guide operations; and the background and skills of its key people. By preparing a formal business plan, the entrepreneur is forced to:

• Convert pipe dreams to realities by crystallizing thoughts and submitting them to paper so they can be objectively evaluated;
• Gather the information necessary to clearly identify where the firm is headed, the market opportunities that make this possible, how management intends to take advantage of these opportunities, and the data to support the assumptions underlying plans and projections;
• Evaluate the firm's strengths and weaknesses relative to its industry, its market, its competition, and its customers and spell out how strengths will be exploited and weaknesses overcome;
• Identify the major factors that contribute to the firm’s success or lead to its downfall;
• Fully develop the firm's business concept and flesh out the strategies that will drive it;
• Think about realistic, attainable goals for the business and how progress toward them will be monitored and measured;
• Think carefully about each part of the business, understand how the parts must tie together to form a going concern, and identify the human, physical, and financial resources that are required to effectively run the business.

The sizable investment of time and energy required to do a feasibility study and write a solid business plan usually prompt new entrepreneurs to question whether the effort is really necessary. Business experts say, "absolutely and positively, YES." They agree that a strong research and planning effort are the most important weapon the entrepreneur has for dramatically increasing the odds of success. What's more, a realistic feasibility study and business plan serve as evidence that the firm is in the hands of knowledgeable management. This is evidence that any prospective financier or investor expects to see.

Before you buy an existing business, be cautious and investigate carefully before you invest. Buying a going concern involves as weighty a planning and decision process as that required to start a business from scratch. Both ventures require enough information to provide a convincing answer to the following question: is there sufficient evidence to indicate a strong likelihood that the business will, under my management, generate sufficient sales, cash flow, and profit to compensate for the risk assumed and the money, time, and effort invested? To answer this question, the entrepreneur must carefully investigate both the competitive environment surrounding the business and the internal factors critical to its success.

The firm's competitive environment refers to the external threats and opportunities that affect its success but are outside the direct control of management. The entrepreneur’s investigation of this area should focus on the following key factors:

Industry Outlook The longevity of any business is directly affected by the success of the industry in which it operates. If the industry is in, or moving toward, a state of decline, then member firms cannot be far behind. To understand the dynamics of the target firm’s industry, the entrepreneur must understand:

• The risks it faces;
• The factors that determine its success or contribute to its failure;
• The current stage of its life cycle;
• The outlook for long-term success.

Market Outlook Closely akin to the health of the firm's industry is that of the market(s) it serves. The entrepreneur should be satisfied that this market has a strong economic base, is either growing or has the potential for sustainable growth, and has a legal and political climate which is business friendly. Again, it is a rare business that can be successful in a weak or hostile market environment.

Customer Base Without a solid, loyal group of customers, it is impossible for the business to generate a satisfactory return on investment. To assess the quality of the firm’s customer base, the entrepreneur must have a clear understanding of:

• The characteristics that define the firm's target customer group;
• How the firm's products/services meet their needs;
• Why this group buys or should buy from the firm rather than from competitors;
• How they can be motivated to buy from the firm;
• Whether the size of the customer base is expanding or contracting;
• Whether the unit and dollar sales to the customer base are expanding or contracting.

Competitive Outlook Understanding the firm's competition and how it stacks up against that competition is as necessary for success as understanding its customers. The entrepreneur should identify:

• The firms against which it competes;
• Why customers buy from them;
• What its competitors do right and the mistakes they make;
• The strengths and weaknesses of its competitors;
• Their competitive advantages or disadvantages relative to my firm.

Location If location is crucial to the success of the business, the entrepreneur must be satisfied that the firm is attractively situated and, if so, that there are no major changes in the works which would adversely affect this site. If the current location is not suitable, the entrepreneur must determine whether a move can be made or whether one would be cost prohibitive. If the latter is the case, it usually rules against a decision to purchase the business.

Internal factors refer to those elements of the firm's operations that are under the direct control of management. These include the human, physical, financial, and intangible assets needed to run the business.

Personnel Chronic labor problems are usually the curse of small- and medium-sized firms, and the entrepreneur must be sure that he or she is not buying potentially irresolvable issues. The firm's personnel should be carefully evaluated to determine whether they are productive; adequately compensated; well-suited to the demands of the business and the management style that will be employed; and will remain with the firm when its ownership changes hands.

Physical Assets The firm’s physical assets such as buildings, equipment, and inventory must be carefully evaluated to ensure that fair value is received for the price paid. The asset base must be large enough to accommodate the expected level of sales and sufficiently productive to meet expected operating needs.

Financial Performance Earning a satisfactory return on investment is the primary reason for business ownership and the entrepreneur must be satisfied that the firm's financial outlook is promising. Financial records should be analyzed to determine whether:

Intangible Assets Intangible assets refer to any non-material properties that are crucial to the success of the business such as leaseholds, patents, copyrights, valuable intellectual property, or exclusive territorial rights. If the firm's earning power is dependent on such assets, they should be carefully evaluated for transferability and to ensure that the competitive advantage they offer can be maintained.

Valuing An Existing Business

The most difficult and usually most crucial step involved in acquiring an existing business is negotiating a fair purchase price. To the buyer, a fair price is one which reflects the value today of the future cash flows and profits the firm is expected to generate under his or her ownership. If the purchase price exceeds this important measure of value, then a burden is placed on the firm's future cash flows that will limit its financial success. 

In practice, a variety of valuation techniques ranging from unsupported rules-of-thumb to theoretically correct procedures are used to establish the purchase price of an existing business. Only one, the capitalization of future cash flows or earnings, provides a reasonable estimate of value. Yet, if the entrepreneur is to effectively negotiate an acceptable purchase price for the business under consideration, he or she must recognize the flaws in the more commonly used valuation methods.

Rule-Of-Thumb Methods All too often, business valuations are made using vague rule-of-thumb methods such as setting the price equal to some arbitrary multiple of the current level of sales or inventory value, or pricing the business on the basis of some arbitrary dollar amount per square foot of selling area. While the simplicity of these approaches makes them deceptively appealing, they lack rational foundation. For example, there is no reason why a multiplier of two or three times current sales is any better yardstick of value than four or five times that amount. Equally important, it is not sales, or inventory, or square footage that provides a satisfactory return on the entrepreneur’s investment. Value is created by the cash flow and profits that these factors generate.

Asset-Based Methods Asset based methods refer to techniques that use an estimate of the value of the firm's assets to set purchase price. Either current book value, replacement value, liquidation value, or some combination of the three is usually used to establish asset value. Book value is the accounting value of the firm's assets as shown on the firm’s balance sheet. Replacement value is an estimate of the dollar amount required to replace the firm's existing asset base, and liquidation value is an estimate of the resale value of the assets if the business were to cease operations.

While asset-based methods offer the advantage of computational ease, each suffers from the same fundamental flaw. The value of the business is mistakenly equated with an estimate of the value of its individual assets. It is not the value of individual assets that determines a firm’s success. Rather, the value of a business asset is determined by its contribution to the firm’s overall cash flow and profits when combined with the human, physical, and financial assets that make the firm a going concern.

Market Value Approach This approach is comparable to that used by realtors to value residential and commercial property. The purchase price of the business under consideration is based on prices at which comparable businesses have sold in the past. The problem with this method lies in finding representative historical data. It is virtually impossible to find past sales of businesses of exactly the same type and size, operating in the same industry and market environment, and reflecting a selling price based on estimated future cash flows and earnings.

The best estimate of the true value of a business is determined by setting a value today for the future cash flows or profits it will generate for its owner. Finance people refer to this valuation method as capitalizing cash flows.

A successful business is one capable of generating cash flows sufficient to meet the costs of operation the business, replacing assets as they wear out, and providing a rate of return that adequately compensates the owner for the risk assumed and the money, time, and effort invested. Arriving at this measure of value requires estimates of the firm's ability to generate future cash flows and earn a satisfactory rate of return. This latter figure serves as the capitalization rate used to reduce estimated future cash flows to a current value. (The current value of $110 to be received in a year at a 10 percent capitalization rate is $100.)

Establishing a purchase price based on true value is not easy. Doing so requires knowledge of sound valuation principles, the ability to make realistic estimates of future cash flows and earnings, and a healthy dose of informed judgment. Unless the entrepreneur has the necessary financial background, he or she should seek professional assistance with this important task. Paying a reasonable fee to a financial consultant with valuation expertise is a small price considering the consequences of mistakenly paying too much for the business.

While owning a franchise has provided financial independence for many entrepreneurs, the mere purchase of one does not automatically guarantee success. Franchise opportunities differ in many important respects and the entrepreneur should carefully investigate them before a commitment is made. Here are some tips for doing so.

Find the Hot Opportunity The franchise search should be focused on franchise companies experiencing, or have the potential for, above average growth. In general, these will be franchises that offer the consumer something unique such as a new product, new process, or new concept, rather than just "more of the same." There are several good publications that identify top performing franchises. Entrepreneur Magazine publishes two annual issues, the "January Franchise 500" and the "Franchise Yearbook," which provide opinions on attractive franchise opportunities. Other good publications include the Continental Franchise Review, Franchising World, and Opportunity.

Choose the Right Fit Operating a franchise unit, as true of any small business, is a time consuming, demanding task and unless the franchise and franchisee are a good match, it is doomed to failure from the outset. Before investigating franchise opportunities, the entrepreneur should take the time needed to identify his or her personal goals, business interests, strengths and weaknesses, and the financial resources available to invest in and sustain the new operation. These characteristics should then be matched with the franchise opportunities under consideration and those that do not provide a good fit scratched from the list.

Choose the Right Franchisor The fortunes of an individual franchise unit within the system are closely tied to the fortunes of the franchisor’s company. The more experienced and successful the franchisor, the greater the likelihood of success for individual units in the system. Successful franchisors are able to offer a proven operating formula and their experience puts them in a good position to assess the sales and profit potential of a new unit, identify a suitable site on which to locate it, and provide guidance during both the start-up and early operational periods.

On the other hand, if the franchisor is not profitable, the company will not be in position to provide franchisees with the services and assistance promised in the franchise agreement. Even worse, an unprofitable franchisor won’t stay in business and this usually means failure for the individual units in the system as well.

Identify the Failure Ratio How well or how poorly individual franchisees in the system have fared is a good indicator of the probability of success for a new franchise. The higher the franchise failure ratio (the number of franchise failures divided by the total number of units in the system), the more likely the failure of a new franchise.

Identify the Happiness Quotient Included with the information provided by a franchisor is a list of both current franchisees and those who have left the system in the past year. Interviewing a representative sample of these people provides insight into such important issues as whether the franchisor has been truthful about what is contained in the UFOC, the type of franchisor/franchisee relationship that can be expected, and how effectively the franchisor addresses and settles franchisor/franchisee disputes.

Justify Franchising Costs Investment in the typical franchise involves sizable up-front investment as well as ongoing costs in the form of royalties and fees. The entrepreneur should be completely satisfied that prospects for sales and profits of the franchise are sufficiently high to justify the cost incurred and to provide an adequate return on the entrepreneur's investment of time and money. The entrepreneur should gather enough information to provide a clear-cut answer to the following crucial question: what will the franchisor do for me that I couldn’t do for myself by starting the same individually owned business?

Heed the Restrictions It is important to keep in mind that the terms of the franchise agreement are legally binding for the life of the contract. The franchisee must abide by such stipulations as how the business is to be operated, royalties and fees that must be paid, methods of promotion and advertising used, the use of trademarks and logos, and sale of the franchise. In some respects, running a franchise is more like being a manager of someone else's business, rather than the owner of your own business. This reality is something the strong-willed, creative entrepreneur must seriously consider.

Choosing the legal form of ownership under which the new business will operate is one of the most important decisions the entrepreneur must make. Since numerous legal, financial, tax, and strategic issues grow from this choice, it should be carefully planned. To do so, the entrepreneur should understand the basics of the major organization forms and, where necessary, obtain expert assistance.

A sole proprietorship is owned and operated by the entrepreneur and has no tax or legal status separate from that of its owner. Federal income taxes are not levied on the business, and the firm's profits or losses flow directly to the entrepreneur's personal tax return. A sole proprietorship is easy to start and dissolve. For these reasons it is the most popular organization form for startup businesses. On the downside, the sole proprietorship suffers from the disadvantages of unlimited legal liability and limited life. Because the sole proprietorship is not a separate legal entity, both the assets of the business and the personal assets of the owner are subject to legal judgments against the firm. What's more, the operating life of the business is technically limited to that of its owner.

A partnership can be divided into two broad categories of ownership: the general partnership and the limited partnership. Under the former, two or more general partners pool skills and resources to act as co-owners of the business. General partners, absent any restrictions in the partnership agreement, have equal decision-making authority and are legally bound by the business-related debts and actions of each other. As true of the sole proprietorship, the general partnership is not a separate legal or taxable entity and, unless a pre-established buy-out agreement exits, it is dissolved upon the death or departure of a partner.

The most common variation of the general partnership is the limited partnership. A limited partnership has two classes of partners: general partners and limited partners. The general partner manages and controls the business and has unlimited liability for the business-related debts and actions of other general partners. On the other hand, the limited partner does not have a voice in management but personal liability is restricted to his or her investment in the business.

As true of the general partnership, both general and limited partners' share of profits or losses flows to their personal tax returns. Unlike the general partnership, however, the death or departure of a limited partner does not dissolve the partnership.

Two major roadblocks to the success of many startup businesses are insufficient capital and limited management expertise. The reasons are simple: initial financing for a startup is usually restricted to the entrepreneur's personal wealth and it is difficult, if not impossible, for a new entrepreneur to have the broad range of administrative skills necessary to single-handedly manage all aspects of a business. A possible solution to both problems is the addition of one or more partners who can bring both capital and management expertise to the table. This article discusses the characteristics to look for when seeking a partner and the next in the series looks at the components of a good partnership agreement.

A well-conceived partnership can offer the entrepreneur several advantages including shared business risk, increased capital, shared administrative and decision-making responsibilities, and the synergy that results when partners are well matched. Despite these advantages, the partnership form of business organization is not for everyone. Business statistics indicate that over fifty percent of the partnerships started each year are dissolved within three years. Like marital spouses, partners can become disenchanted with each other or even hostile for a variety of reasons including personality conflicts; changing goals and interests; disagreement over money, authority, or major decisions; and dishonesty.

A successful partner relationship is built on personal compatibility, complementary abilities, mutual goals, and a meaningful contribution of resources and effort. When considering a prospective partner, the entrepreneur should make sure that he or she has characteristics such as the following.

Resources The primary reason for taking a partner should be the contribution he or she is able to make to the success of the business. This contribution should take three forms: financing, management abilty, and business know how. A prospective partner should be able to make a monetary commitment of up to fifty percent of either the required owner's investment at startup or up to fifty percent of the existing equity if the business is a going concern. Equally important, a partner should understand the business and bring management skills that fill an existing void.

Compatibility In many respects a business partnership is like a marriage and it is important that the principals get along, work well together, share the same vision for the business, and have an established procedure for resolving problems and disagreements. The combination of money, egos, and the rigors of operating a business make for a potentially explosive environment. So, no matter how capable a partner may be, if his or her personality clashes with that of the entrepreneur, the business will suffer and the partnership is probably doomed to fail.

Personal Attributes Having a partner with desirable personality traits is nearly as important to the success and longevity of a partnership as money and management ability. Some of the more important traits the entrepreneur should look for are:

• Integrity As true of any successful relationship, a partnership is built on honesty, trust, and mutual respect. If a partner cannot be trusted to live up to his or her commitment to the business or is dishonest and may cheat customers, suppliers, or other partners, a successful business relationship is virtually impossible. What’s more, if the partners do not respect each other, serious disagreements are almost certain to occur.
• High Energy Level Startup firms and smaller businesses require a great deal of the entrepreneur's time, effort, and energy. For a partnership to be successful, all partners must carry their share of the business load and live up to their end of the bargain.
• Decisive and Accountable An active partner will be an integral part of the firm's management team. He or she must be able to make sound decisions and be willing to assume responsibility for actions taken.
• Flexible One of the major advantages of a small business is its ability to adapt to rapidly changing conditions. Likewise, successful partnerships require partners who are able to give-and-take and are sufficiently flexible to adapt to new strategies or methods of operation as the situation requires.

A corporation is an artificial person granted existence by the state of incorporation. As such, it is a legal and taxable entity which can own property, conduct business, sue and be sued in its own name, and have a life separate and distinct from its owners. Technically, its board of directors governs a corporation. This group makes major policy decisions and appoints the firm's management. The owners of the corporation are its common stockholders. They elect the board of directors and are entitled to all profits remaining after other claims on the firm's income have been satisfied.

If the corporation is properly organized and its business appropriately conducted, the liability of its shareholders is limited to their investment in the business. Also, since the corporation is a separate taxable entity at both the federal and state level, profits or losses do not flow through to the stockholders' personal returns. This feature allows earnings to be retained in the business without being taxed as income to stockholders.

Because the corporate form can separate the business and its management from its owners, stockholders can sell or transfer their ownership interest more easily. It is also easier for stockholders to raise capital, expand the business, extend ownership interest to valuable employees, and do estate planning.

The disadvantages generally associated with the corporate form include the difficulty and added cost of incorporating the business; the double taxation that results from the tax levied on corporate earnings and on dividends or salaries paid to stockholders; and the obligation to pay other taxes such as franchise taxes and out-of-state business fees.

The S Corporation

Subchapter S of the Internal Revenue Code allows those small corporations meeting established requirements the option of being taxed as a partnership while, at the same time, maintaining their legal status of a corporation. Since S corporation income is not taxed, the firm's profits or losses flow directly to the tax returns of shareholders. This feature provides stockholders the advantage of avoiding double taxation on corporate earnings and dividends and, at the same time, retaining the luxury of limited stockholder liability.

Most states in the U.S. have enacted or introduced legislation that approves the formation of a limited liability company (LLC). This unique entity has the tax status of a partnership and the limited liability protection of a corporation. These features allow profits or losses to flow to the personal returns of the owners (called members) while protecting members from personal liability for judgments against the business.

The LLC offers other advantages over the limited partnership and S corporation. For example, under certain conditions a limited partner may be unable to take full advantage of a partnership loss on his or her tax return unless an active role in the firm's management is taken. Doing so, however, causes the loss of the limited liability privilege. On the other hand, LLC members enjoy both limited liability and the full tax flow-though benefits of the partnership form of ownership. Relative to the S Corp, the LLC can offer different classes of ownership, is not burdened by eligibility requirements, and may, under certain conditions, have some tax advantages.

The failure rate among startup businesses is high. About fifty percent of new businesses fail in the first year of operation and over eighty percent fold by the fifth year. These unfavorable odds can often be reversed if the entrepreneur understands why startups fail and then takes the steps necessary to avoid the pitfalls. The key reasons for the low survival rate and the remedies for combating them fall into three categories: pre-startup preparation, management competence, and financial safeguards.

The old adage about, "an ounce of prevention is worth a pound of cure" should be the Golden Rule for the new entrepreneur but this sage advice is rarely followed. All too often the research, analysis, and planning done in the pre-startup stage only scratch the surface of what is needed. Experts suggest that new entrepreneurs give inadequate attention to or omit one or more of the following steps.

Industry Analysis A study of the firm's industry is essential to estimating the potential for its product or service and the type of competition it will face from both other firms in the industry and substitute products and services. Research findings suggest that products or services that are too new or too old are far more likely to result in failure for a startup firm than those in a strong growth phase.

Market Research Careful research of the firm's prospective market is necessary to determine its most likely target customer group, to identify the nature and strength of its competition, and to make a reasonable estimate of the firm’s sales potential. A thorough analysis of the firm's industry and market is essentially a feasibility study which allows the entrepreneur to make a realistic estimate of the startup's chances for success and to prepare a convincing business plan if the decision is a go.

Business Plan A well-prepared business plan details the new firm's business concept as well as the operating, marketing, financial, and human resource strategies that will direct day-to-day activities. Preparing a business plan forces the entrepreneur to zero-in on each aspect of the business, to identify the factors which determine its success and failure, to establish guidelines for managing operations, and to gather the information essential in the quest for outside financing.

Expert Assistance The task of preparing a convincing business plan can be daunting for most entrepreneurs, so expert help should be sought. Paid and free professional assistance is available from variety of sources including consulting firms, financial planners, bankers, other entrepreneurs, vendors, trade associations, the U.S. Small Business Administration, Small Business Development Centers, and university business faculty.

While many new entrepreneurs have a strong technical background in the area of the startup business, many more lack the basic management skills important to success. Management deficiencies that severely limit a startup's chances include the lack of:

• Management experience;
• Planning and organizing skills;
• Leadership skills;
• Marketing skills;
• Financial skills;
• A total commitment of time, effort, and emotional energy to the business.

There are a number of options available to the entrepreneur for improving management skills including enrollment in management workshops and seminars, executive development programs, hiring employing personnel with the requisite expertise, acquiring co-owners possessing the requisite expertise, and using outside consultants to help with major decisions.

Startup firms are often inadequately financed and the entrepreneur rarely has the level of financial management skills necessary to ensure a continuous supply of positive cash flow. Important among the list of financial failings is:

Insufficient Start-Up Capital To avoid the risks of under capitalization, experts suggest that the entrepreneur first make an estimate of the most likely amount of financing needed to sustain the business and meet his or her personal needs for one year if the firm were to operate at a loss for that period. Second, the amount of this estimate should then be increased by a comfortable percentage to allow for the estimating error that usually occurs.

Inadequate Financial Records A record-keeping system that produces both traditional financial accounting information and a detailed statement of cash inflows and outflows is a must for any business. Without this crucial information and the entrepreneur's clear understanding what these data mean, it is impossible for him or her to track the financial health and financial performance of the business.

The Absence of Financial Controls Closely coupled with the need for financial information is the need to monitor and measure results. Sound business practice suggests that goals for such key performance areas as sales, operating costs, cash flows, and profits are established, and actual performance is routinely measured against desired results. A good financial control system gives the entrepreneur immediate feedback on whether the business is headed in the right direction, the rate at which it is progressing, and if and where corrective action may be needed.

Most business experts agree that a sound business plan is important to the organization and development of a new venture, for convincing a prospective financier that the venture is worthy of financing consideration, and crucial to the effective operation of a going concern. A business plan is a written description of the business, its goals, the action plans that will achieve these goals, and the background and skills of its key personnel. The business plan should be prepared by the entrepreneur with, where necessary, professional assistance.

The focus of the business plan should be providing the information needed to answer to two crucial questions: why the firm should succeed and how success will be achieved. The content needed to do so is outlined below.

The executive summary is a brief sketch of the firm's business and how and why it is expected to be successful. It is included in the business plan for the convenience of an outside reader, for example a prospective financier, and should briefly describe the following points:

The financing proposal is a summary of the key issues surrounding a request for financing. These include:

• The "exact" amount of financing needed;
• The time period over which this financing will be needed;
• Whether debt or equity (ownership) financing is needed;
• The specific uses for the financing;
• The proposed repayment schedule and available collateral if debt financing is sought;
• The expected returns and, if appropriate, the buy-back agreement if equity capital is sought;
• Cash flow projections over the time period of the needed financing;
• Pro forma financial statements for the time period of the needed financing.

The business description is a concise summary of the key points discussed in each of the various sections of the business plan. It provides the reader with answers to such questions as:

• How does the firm do business?
• What important events have brought the business concept or the firm to its current stage of development?
• Where is the market for the firm's product/service?
• To what target customer group will the firm’s product/service appeal and why should they buy it from the firm rather than competitors?
• What strategy will be used to market the firm's product/service and reach its target customer group?
• What competition does the firm's product/service face?
• When is the new venture expected to be successful and what are the keys to this success?
• What level of success has the existing business achieved and what are the keys to this success?
• What is the background and skills of the manager(s) who will lead the business?

Research and analysis of the firm's industry and market is needed to address two critical issues: "where" will the firm do business and "why" will commercial success be achieved. The entrepreneur can use the following guidelines to gather this information:

Operating plans are the basic strategies that establish the firm's long-term goals and the means for achieving them. The following operating plans are typically included in a business plan.

• The Marketing Plan identifies the marketing goals to be achieved and the strategic mix of product/service, pricing, and promotion expected to achieve them.
• The Operating Plan explains how the firm will do business. That is the day-to-day activities required to convert the firm's resources into saleable products/services.
• The Organization Plan identifies the legal form of ownership under which the firm will do business; the authority/responsibility relationships that form the firm’s organization structure; and the skills of the people who, do or will fill positions in this structure.
• The Financial Plan identifies the financial resources needed to carry out operating strategies.

A convincing business plan is based on realistic forecasts, projections, and strategies that depend, in turn, on a solid foundation of assumptions about the future. In order for it to have creditability with an outsider reader such as a prospective financier and be useful to the operation of the business, its underlying assumptions must be documented with supporting facts, figures, and sound reasoning. A business plan without this documentation is useless and will be viewed by any knowledgeable reader as nothing more than wishful thinking.

Success as an entrepreneur is no guarantee of success as the manager of a growing business. The individualistic, freewheeling, personality traits that mark the entrepreneur are often at odds with the management skills needed to be a first-rate CEO. If the firm is to grow beyond that of a self-managed, one-man operation, the entrepreneur must learn a new role. He or she must realize that management skills do not automatically accompany business ownership. They must be acquired and refined.

While a firm is struggling to gain a profitable foothold in the market, the entrepreneur can get away with a management style that is largely self-management because the do-it-yourself approach is the swiftest and surest way to get things done. It is when a fortunate firm enters the growth stage that the differences between entrepreneurship and management are in stark contrast and, most often, when these differences create major organizational problems. As the firm grows, the business becomes more complex, the number of employees and size of its asset base grow, and staff specialists and managers are added to fill administrative voids. It is at this point that the do-it-yourself personality traits of the successful entrepreneur are at odds with the management skills needed to effectively accomplish goals through the efforts of others. At this critical juncture, the entrepreneur must have his or her management skills refined and be ready and willing to make the difficult jump to being a good manager.

Experts generally agree that management is a process consisting of clearly defined activities. These activities distinguish a true manager from other employees of the firm. Unlike the entrepreneur, a manager is not the primary "doer." Good managers are strong leaders, and good motivators. They inspire others and get things done through the efforts of other people. It is a manager's job to plan activities, organize resources, direct the people who will carry out plans, and control operations so things remain on course. These key activities are referred to as the functions of management and a good manager relies heavily on the conceptual, interpersonal, and decision-making skills needed to do them well.

Simply put, what successful managers do is effectively execute the functions of management: they plan, organize, direct, and control what happens in the firm.

Planning is the most basic of management functions and, along with control, is the activity to which a successful manger devotes the majority of his or her time. Planning means deciding in advance what needs to be done, how and when it should get done, and who will be given the responsibility for getting it done. It can be thought of as the continuous process of taking a peek backward to determine where the firm has been, a close look at where the firm is, and a long hard look forward to establish where the firm is expected to go. Formal planning is primarily a mental activity. It requires the small-firm manager to think through actions in advance using a combination of good information and informed judgment. The good news on planning is that it works. Managers who engage in formal planning on a regular basis have businesses that are more profitable and less prone to failure than those who don’t plan. The bad news is that the management group least likely to do formal planning is small-firm managers.

Organizing involves blending the human, physical, and financial resources needed to carry out planned activity. It means creating a highly coordinated combination of people, jobs, information flows, activities, and organizational relationships that are all on the same page and all headed toward the same ends. To accomplish this, the manager must create a working environment that gives employees the opportunity to maximize their contribution to the firm's goals.

Directing refers to the use of interpersonal skills to influence the behavior of others and motivate them to put forth their best effort. These skills include leadership, the ability to motivate, awareness of the individual strength and weaknesses of subordinates, sensitivity to their interests and personal concerns, and the ability to communicate effectively. Good managers understand that there is a clear-cut distinction between authority and leadership. The former refers to the right to command or control and stems from ownership or position in the organization. Positive motivation and influence do not automatically accompany ownership. They are products of good leadership. A successful manager understands the importance of downplaying authority and earning the respect and loyalty of employees through effective leadership.

Controlling means comparing actual results with planned performance. It involves designing the standards and identifying the feedback information needed to determine whether actual outcomes are in line with expectations or corrective action is required. Performance standards are established in the planning process and serve as both formal expressions of what management expects to achieve and as yardsticks for measuring the progress. They can be established for both the firm and individual employees. At the firm level, they take the form of progress indicators such as market share targets, an expected level of profitability, or cost control guidelines. Employee performance standards are the predetermined personal goals by which employees are evaluated and accomplishments rewarded or failing efforts redirected.

Central to each management function is the quasi-science, quasi-art of effective decision making. Unfortunately, too many small-firm managers confuse good decision making with seat-of-the-pants guessing. Good decision-making involves a series of well-defined steps that are consistently applied. A good decision maker:

• Identifies problems and opportunities early on;
• Gathers relevant information;
• Identifies alternative solutions or courses of action;
• Carefully evaluates the cost-benefit tradeoff associated with each alternative;
• Chooses the alternative that best meets the firm's goals;
• Learns from decisions by comparing actual with expected results.

Essential Management Skills

Because managers of different businesses perform varied tasks, it is virtually impossible to make general statements about the specific duties managers perform. Yet, management specialists are quick to agree that truly effective managers share a common skill set that includes:

• Interpersonal Skill is the ability to deal effectively with subordinates and it is as much a part of successful management as any other single attribute. Effective managers are those able to accomplish the firm's goals through the efforts of other people. A manager with good interpersonal skills is a leader: one who communicates with and relates well to subordinates and has the ability to influence and motivate them to work together to accomplish common goals.
• Conceptual Skill refers to the ability to visualize an entire process, the various parts that make-up that process, how the parts fit together, and how the sum of the parts relates to other processes in and outside the firm. This skill determines a manager's ability to effectively plan and coordinate resources, people, and activities so that operations run smoothly; to create effective solutions to problems; and to use sound judgment when making decisions. It is also vital to a manager’s ability to visualize how the firm relates and should relate to its customers, its market, and its competition.
• Technical Skill is the specialized knowledge a person brings to the job. While managerial skills are more important than technical skills for upper-level executives in larger organizations, technical knowledge is critical for managers of small- and medium-size firms. In these firms managers represent the ultimate level of responsibility and the person to whom employees turn when technical issues arise.
• Decision-Making Skill refers to the part art and part science of effectively choosing from alternative courses of action the one which best furthers the firm's goals. This trait is closely related to conceptual skill and, because of its importance to the management process, is often labeled as the ultimate mark of a good manager. Despite common misconceptions, the ability to make good decision goes beyond intuition and luck. Good decision-makers blend conceptual abilities, informed judgment, and a logical set of clearly defined steps to make rational choices. They gather information, identify alternative courses of action, evaluate the data, make the choice that best meets established goals, and then monitor outcomes to determine what works and what must go back to the drawing board.

Financing The Firm

Of the many problems confronting the new small-firm entrepreneur none is more troublesome than locating and attracting reliable sources of financing. To improve the odds of raising capital for the firm, the entrepreneur’s search should start with:

• Preparation of a solid business plan including a financing proposal that spells out the type and maturity of financing needed, how the funds will be used, and when cash flow needed to repay the financing will be generated;
• A clear understanding of the type of financing available given the current stage of the firm's life cycle and its credit capability;
• A clear understanding of the financing sources that may be available to the firm and the criteria each uses to measure eligibility.

Financing sources can be divided into two broad categories: Private sources including individuals and non-government institutional lenders and investors; and government agencies including those sponsored by or working in conjunction with those agencies. 

Personal Resources The most frequently used financing for startup firms is the personal resources of the entrepreneur and those of interested family and friends. These resources include hard assets such as personal savings, certificates of deposit, and stocks and bonds, and what can be borrowed against a home equity or credit card line-of-credit or a signature loan from a credit union, bank, or personal finance company.

Trade Credit  Business firms that sell goods and services to other businesses usually offer qualified customers credit terms on purchases. This form of financing is known as trade credit and, while it does not involve the direct loan of funds, it is a major source of financing for business inventory. What's more, since trade suppliers are interested in the profit margin on repeat business, the credit standards applied to determine customer eligibility are usually more liberal than those used by traditional lenders.

Equipment Manufacturers Manufacturers of business equipment often provide financing for the purchases of their qualified customers. This financing usually takes the form of installment loans or industrial leases and is arranged and made through the manufacturers financing division or subsidiary. Like trade suppliers, equipment manufacturers are interested in earning the profit margin on the sale and typically apply more lenient standards to determine credit eligibility than traditional lenders.

Angels Angels are wealthy individuals interested in making equity or ownership investments in startup businesses and going concerns that hold the prospect for generating above average rates of return. Since angels are equity investors, the firm does not have to meet the collateral and credit capability standards required by traditional lenders. The downside to this type financing is first finding an interested investor and then parting with the sizable equity interest and degree of management control that will be demanded.

Commercial Banks Commercial banks are the largest single group of suppliers of short and extended term debt financing to small and medium size businesses. However, because of the many regulatory restrictions on management and the use of depositors' funds banks must face, they are not normally aggressive risk takers. The major concern of the typical banker considering a business loan is safety of principal and interest. This means the typical small-firm borrower will have to meet stringent credit standards, demonstrate the ability to repay the loan, and pledge hard assets sufficient to collateralize it.

Commercial Finance Companies Like banks, commercial finance companies make short and extended term loans to businesses. While the credit standards used by commercial finance companies are less rigorous than those of the typical commercial bank, these lenders make only asset-backed (collateralized loans) and the interest rates charged are higher than those of a bank.

Venture Capitalists Privately owned, non-regulated venture capital firms are highly specialized financiers. They make equity investments in small and medium size businesses that represent more risk than what is acceptable to the traditional institutional lender but, at the same time, hold the promise of producing abnormally large rates of return. For entrepreneurs with the good fortune to attract the interest of a venture capitalist, the financing provided will usually have the following characteristics:

• While financing may be made available at any stage of the firm's life cycle, it is usually designed to fill the firm's growth needs until the time its stock is expected to be sold to the public or repurchased from the venture capitalist. Usually, this is from five to seven years.
• The total amount of venture capital committed will be large but the funds will be parceled out as the firm reaches various stages of its development.
• While the financing provided will entitle the venture capitalist to a large equity interest in the business and a management advisory role in the decision making process, these financiers are not interested in owning the business. The venture capitalist will expect to liquidate his or her equity interest at some future date through a buyout agreement or when the firm is taken public.

Under the right conditions, debt can be an attractive method of financing the firm. As long as the rate of return earned on invested borrowed funds is greater than the cost of the debt, the excess return accrues directly to the business along with a tax deduction on the interest payments. But debt financing has its downside in the form of the financial risk it creates. Debt payments are legal obligations that have to be met even if the business loses money on the invested funds.

The creditor has the legal right to foreclose if payment is not made and having too much debt can literally sink the ship if times get tough.

There are a number of factors influencing the firm’s capacity for debt financing such as its life-cycle stage, rate of growth, stability, and expected cash flows. While one size does not fit all firms, there are a few critical constants that apply to every situation.

How Much is Needed? If you’re in the market for debt financing, the first question to be answered both for yourself and the prospective lender is exactly how much money is needed and for what purpose. This figure is used to judge the merits of the financing request and the effect the loan will have on the firm’s existing debt capacity.

Rule-of-Thumb Estimators. Two important considerations to the question of appropriate debt capacity are:

• Is owner’s capital absorbing an adequate share of the financing risk?
• Is there sufficient cash flow and earnings to meet financial obligations?

To answer these questions, lenders will first decide whether there is a sufficient proportion of owner’s invested capital to support both the loan request and the total amount of debt for the business. Then, they will compare earnings and cash flow to amount of debt payments the firm.

• Percent Debt This simple balance sheet ratio is calculated as Total Debt divided by Total Capital (Debt plus Equity) and measures the percentage of total financing supplied by creditors as opposed to owners. Since creditors consider equity financing a buffer against loss, the lower this ratio value (the higher the percentage of owner’s capital), the more protection perceived by the lender.
• Times Interest Earned This ratio is used as a rough indicator of ability to meet debt service charges. It is calculated as Net Operating Income divided by Interest Expense, and the higher this ratio value the greater lender’s comfort level. The more earnings generated by operations relative to the interest expense that must be paid, the better the firm is able to meet its obligation.
• Burden Coverage Like the TIE ratio, burden coverage is an indicator of ability to pay. But it is considered a superior measurement because it compares cash flow from operations to all mandatory financial obligations in the calculation rather than just interest expense and the nebulous accounting concept of "income." Again, the larger the ratio value the more secure the financial health of the firm and the creditor’s position.

Calculated ratio values are measured against an acceptable standard such as an average for a group of firms in the industry or the lender’s subjective criteria. To get an idea of how a lender will judge your firm’s ratio values, compare them to averages for your firm’s industry. Industry averages can be obtained from references such as Robert Morris and Associates Annual Statement Studies that are available at Small Business Development Centers and some libraries.

The Litmus Test The most telltale measure of a firm’s ability to use debt financing is the extent to which its cash flow from operations (CFFO) is sufficient to meet mandatory financial obligations. Any serious consideration of debt capacity, then, must focus on realistic estimates of a reasonable range over which CFFO will fluctuate as business conditions change. The important question to be answered is how low can available CFFO fall during a business slump. It is this expected lowest level of cash flow that determines the maximum amount of debt-service charges the firm can meet and hence the maximum level of debt it can safely afford.

The tool used to make these troubling estimates is the most basic and, as many business experts suggest, most important approach to small-firm planning, the cash budget. A cash budget is a projection, usually monthly, of itemized cash inflows and outflows over a specific time horizon. Projections are made and available cash flow measured using a combination of assumptions about the planned level of operations and the "most favorable," "most likely," and "least favorable" scenarios for the firm.

For most small firms finding capital is at best a difficult task. It takes careful preparation and an understanding of who provides small-firm financing and how they evaluate a financing proposal. Of the two major categories of small-firm financiers, private and governmental, government and related agencies offer the most promising opportunities.

There are a number of state, municipal, and federal government sponsored financing programs available to eligible small businesses. Some programs are limited to firms in a given industry or conducting a specified type business, some are aimed at businesses which provide jobs and contribute to the economic growth in a community, and some are intended firms meeting general eligibility requirements. 

State governments and many of their municipalities have their own economic development agencies or sponsor quasi-governmental agencies whose purpose is to promote business and economic growth in their jurisdictions. To accomplish this goal, they offer a variety of services and incentives to qualified businesses. One of the more important services usually offered is either direct- or participating-loan financing at interest rates slightly better than the going market rate. The primary purpose of these loans is to induce businesses to locate in the area and to encourage existing firms to make job-creating investments in new plant and equipment. Information of these agencies and their programs can be obtained from a number of sources including the State Information Office, state and local Chambers of Commerce, and local Small Business Development Center offices.

The SBA, operating through its many regional offices, is the major provider of governmental assistance to small businesses. While this agency makes only a limited number of direct loans, it does sponsor a variety of federally supported financial assistance programs to eligible startup and existing small firms. Of this group, the following are the most important.

Loan Guarantees Through its loan guarantee program, the SBA underwrites up to 90% of a loan made by a private lender to an eligible small business. The purpose of the guarantee is to remove the default risk for the lender. By doing so, a loan, that would otherwise be considered too risky, becomes more attractive to the lender. There is a $750,000 ceiling on the guarantee portion of the loan as well as a maturity limit of 25 years. To qualify for the loan guarantee program, the firm must meet the SBA's size and industry-affiliation criteria and demonstrate that:

• A private lender has turned down a non-guaranteed loan request;
• The business has the potential to repay the loan as well as its existing debt;
• There is an adequate amount of owner's capital invested in the business;
• Management has the expertise to effectively run the business;
• The firm has either a profitable track record, or reasonable and supportable projections of a profitable future.

SBA Certified Development Companies The SBA also participates through its 502, 503, 504, and 7a programs with community organizations known as Certified Development Companies. The purpose of these programs is to make packaged loans in which the CDC, banks, and SBA participate to eligible startup and existing small businesses. This financing is made available for the purchase of land, buildings, machinery and equipment, and for legitimate business expansion.

Micro-Loan Program Through this program the SBA finances non-profit organizations who, it turn, make small loans of $25,000 or less to start-up or existing businesses. These are firms that would normally have difficulty borrowing from conventional sources. Each micro lender sets its own criteria for a loan and charges an interest rate that is slightly above market rates. The small-firm borrower does not, however, pay loan origination or loan preparation fees to the lender. To be eligible for micro-loan borrowing, the business must generate less than $5 million in sales and the loan proceeds must be used to finance any legitimate business purpose.

Small Business Investment Companies SBICs are privately owned, profit seeking, venture capital firms that are licensed, financed, and regulated by the SBA. SBICs make venture capital investments in small firms which meet the their particular investment criteria. They finance small firms in three general ways: straight loans, hybrid loans, or equity investments.

Straight loans made by SBICs generally have a long maturity and are similar to those of other conventional lenders. Hybrid loans, on the other hand, are debt contracts with an added provision that gives the SBIC an exercisable option to buy an ownership interest in the business at a pre-established price. Through equity financing, the SBIC buys an immediate ownership position in the firm.

Other SBA Programs The SBA also supports small businesses through other finance-related programs such as:

• The Seasonal Line-of-Credit Guarantee Program through which temporary working capital financing is provided to qualified firms;
• The Specialized Loan Program through which direct loans are made to eligible businesses in select industries such as construction and international trade or to specialized groups such as women, the handicapped, and minorities.

The SBA also provides assistance to small firms seeking contracts from governmental agencies through programs such as the Small Business Innovative Research Program.

The FmHA provides financial assistance through a loan guarantee program to businesses located in areas with a population of 50,000 or less. Like the SBA, the FmHA will guarantee up to ninety percent percent of a loan to an eligible business. The terms and interest rates on the loan are, however, set by the lender and reflect current market conditions.

In order to get the most out of the dollars flowing through a business you must get a handle on the costs of operating it. Effective cost control means more of your scarce cash is retained in the business, profits are increased for any volume of sales, and less outside capital has to be raised.

Like cash management, cost control is more a management task than a financial one. It involves nothing more than a basic understanding of cost concepts, how costs behave in your firm, and careful planning and control. Also like good cash management, the planning and control of costs starts with budgeting. 

A budget is simply a plan expressed as numbers; for example, dollars, units, or percentages. It reflects the entrepreneur’s estimates of what costs should be for planned levels of operation. While the firm’s accountant or financial advisor can and should help compile and estimate cost numbers, the meat of the budget process is a management activity. It is basic to the planning and control responsibilities of every entrepreneur.

While a well-prepared budget details the entrepreneur’s expectations, it is not rigidly etched in stone. Since the budget is developed under assumptions about the future, it should be adjusted when actual conditions are significantly different from what was anticipated. Budget numbers then are guidelines that provide the entrepreneur with a greater ability to anticipate what should be and how well actual results compare with those expectations.

The best answer to this simple question is found in the old business adage, "no one plans to fail, they just fail to plan." Entrepreneurs often take the shortsighted view that budgeting is a waste of time because there is no immediate payoff. But the truth is that budgeting saves time and money in the long run. With a solid budget the entrepreneur:

• Has better control over costs;
• Has the hard numbers needed to effectively evaluate planned results;
• Sees potential problem areas more quickly;
• Is less apt to be caught in unpleasant financial surprises;
• Can better evaluate the cost/benefit ratio of expenditures associated with decisions;
• Can better evaluate the impact of external events on costs and profits.

Equally important, the act of preparing a good budget produces as many benefits as the budget itself. Working through each expense line of the budget forces the entrepreneur to look at what costs "should be" and adds to his or her understanding of how the firm’s costs behave and affect profits when activity levels change.

If these are not reason enough for budgeting, this one fact should be. While budgeting is certainly not a panacea for all small-business problems, a large percentage of small firms that fail have entrepreneurs who do not budget.

The first step in developing budget projections is to take a hard look at past financial records so that costs can be divided into variable, semi-variable, and fixed categories. Studying these data provides insights into:

• The firm’s cost structure;
• What costs should be;
• How cost items, individually and in the aggregate, fluctuate by season and with changes in the level of operations;
• How much capital is needed to support each activity essential to the firm’s survival;
• How profits are derailed.

Armed with these insights, the entrepreneur is in position to translate planned operations and assumptions about business conditions into budget projections. When these projections are combined with a cash budget, the entrepreneur not only has guidelines for cost control but a working knowledge of when expenses must be paid, which can be delayed, and for how long particular payments can be delayed without adversely affecting the business as well.

Budgeting and forecasting is not necessarily complex, and budget savvy can be developed with practice and by using available help. Today, typical small-business accounting and dedicated budgeting software packages contain the tools needed by the entrepreneur to effectively crunch numbers. What’s more, how-to budgeting literature and assistance with budget development are available from regional U.S. Small Business Administration Offices and local Small Business Development Centers.

A number of key variables must come together for a business to be successful but none are more important in the mix than its customer base. The revenue that customers produce is the lifeblood of the business and planning the advertising strategy that will reach them is an essential part of the firm’s overall marketing plan.

New entrepreneurs learn quickly that customers won’t be lined up eagerly awaiting the arrival of the business. Rather, the support of good customers must be earned and it is up to the entrepreneur to identify the group the firm can effectively reach and how it can attract and hold their business. Here are some tips on how to go about this important task.

You can't win them all. Inexperienced entrepreneurs often overlook the fact that consumers are not all alike. Their needs, motivations, and purchasing capabilities differ, and one firm cannot be all things to all people. Instead of using a shotgun approach to attracting prospects, the entrepreneur should concentrate on a clear-cut target market. A target market is a specific consumer segment with common traits or characteristics. To attract this customer group, the firm’s offering must be consistent with their distinguishing characteristics; it must be able to reach them with the right message given the resources available, and it must be able to profitably serve them once they are on board.

Understand the differences In order to identify a suitable target, the entrepreneur must first identify the traits that distinguish the intended consumer group from others. Distinguishing characteristics cluster around such factors as:

• Demographic, social, cultural, economic, ethnic, and life-style characteristics;
• The disposable income or budget level available for purchasing the firm’s product/service mix;
• Spending habits including the frequency with which the firm’s product/service is purchased.
• How the product/service is used after purchase;
• From whom the firm’s product/service is purchased, what brand names are purchased, and why those sources and brands are used;
• The needs and wants the firm’s product/service satisfies or the problems it solves;
• Who in the household makes the decision to buy or who influences the decision-maker;
• The influences to which the decision-maker or influencer respond;
• How competitors advertise and the message they send.

Find The Target The easiest and most cost-effective way to identify the target market is to identify a small sample of customers who regularly use the firm’s product/service or a close substitute. Once identified, the sample can then be queried directly or by survey to determine their identifying traits or characteristics. These characteristics are then used to develop the target market profile. The representative sample can be identified through such means as talking with the customers of a competitor, through door-to-door inquiries or telephone surveys, or from an existing customer list if the firm is a going concern.

Send The Right Message To The Right Customer All too often, the small firm’s advertising is nothing more than a bland, unimaginative, stereotype, clone of other advertising. To effectively attract customers, advertising must convey the right message and the message must reach the right audience. Again, the key to developing the right message is to understand the target market and then tailor the message to fit the circumstances.

Results Are In The Detail Once the target customer group has been reached, the firm's offerings must be fine-tuned to meet their specific needs. This usually means doing the little things that separate the firm from its competitors. For example:

• Maintain convenient store hours and an inventory mix that reflects customers' stated preferences;
• Get to know customers personally and treat each one as if he or she is absolutely vital to the firm’s existence;
• Make friends of customers, not enemies;
• Maintain reliable, quality service;
• Identify customer problems don’t ignore them;
• Solve customers’ problems, don’t run from them;
• Get feedback from the firm’s customers on why they buy from the firm;
• Get feedback from competitors' customers on why they don't buy from the firm;
• Read industry and trade periodicals regularly to get new business ideas and to stay abreast of changes in consumer tastes and preferences.

Location Isn’t The Only Answer While location is critical to some businesses, it is not a universal prescription for success. More often than not, if the firm's specific mix of product/service, promotion, and customer relations are right for its target market, they will find the business.

Price Isn’t The Only Answer While new entrepreneurs tend to be overly concerned about what price to charge for their product/service, research indicates that consumers are usually more concerned about considerations other than the absolute rock bottom price. Factors such as convenience, good product/service mix, quality, good customer relations, and reliable service are often more important than minor price differentials.

Getting The Most From Advertising Expenditures

Among the many challenges facing the startup firm is the difficult task of creating the right advertising message. One that effectively:

• Establishes the identity of the new firm;
• Informs potential customers of the product or service offered;
• Attracts business;
• Increases sales.

Unfortunately, the message delivered by many new firms misses the mark and advertising expenditures end up in a non-productive black hole. To avoid costly mistakes and, at the same time, increase the likelihood that the advertising investment will reap positive returns, the entrepreneur needs a well informed, carefully thought out strategy. 

Advertising strategy should be an offshoot of the firm’s overall marketing plan, and it should be developed with the following basic rules in mind.

Set Precise Goals Certainly, the ultimate goal of all advertising is to attract customers and increase sales. But inexperienced advertisers often fail to appreciate or even choose to ignore a basic advertising reality: There is no universal formula for reaching all audiences at once and scatter-gun approaches either waste money or are unsuccessful. To be effective, advertising should be aimed at specific, narrowly defined goals and the first step in preparing an advertising campaign is to clearly identify exactly what each expenditure is expected to accomplish. Examples of commonly used advertising goals include:

• Promoting special events such as a new product or grand opening;
• Generating customer inquiries or sales leads;
• Generating new customers;
• Attracting competitors' customers;
• Improving the firm's public image;
• Improving brand name recognition;
• Increasing product usage or order size.

Both the advertising message and the medium used to deliver it would normally differ with each goal. For example, what is said, how the message is delivered, and who is targeted to receive it would be quite different if the purpose of the advertisement is, in one case, to announce a grand opening and, in the other, to generate customer inquiries.

Send the Right Message One important goal of advertising is to communicate a message that is clear, convincing, meets its intended goal, and is seen as important by the targeted audience. The characteristics that should be contained in the message are found in the simple acronym AIDA which stands for:

• Attract ATTENTION;
• Hold INTEREST;
• Spark DESIRE;
• Motivate ACTION.

Hit the Target Getting the message to the right audience is as important to the success of advertising as the message itself. The right audience is the target market identified in the firm’s marketing plan. This is the group of potential customers whose identified demographic characteristics, behavioral traits, needs, and wants make them likely candidates to buy the firm's product or service.

Pick the Right Messenger The small-firm entrepreneur has a wide variety of cost-effective advertising mediums from which to choose. None is inherently good or bad. Rather, each has its own set of advantages and disadvantages and the right choice depends on the firm, the advertising objective, the message, the target audience, and cost. The guiding principle for choosing an advertising medium is simple: Use the medium that most efficiently reaches the target market. To make good choices, the entrepreneur should learn as much as possible about the characteristics, effectiveness, advantages, and disadvantages of each advertising vehicle that fits within budget limitations.

Frequency is important Advertising is most effective when it is done regularly as part of a well-planned campaign. While one-shot advertising may occasionally be justified: for example, when introducing a new product or announcing a special sale, such advertisements are quickly forgotten and even more quickly lose effectiveness unless they are done frequently and linked directly to an overall marketing strategy.

For the right business the World Wide Web offers an opportunity to broaden its advertising and promotion horizon or even tap into the vast potential of the e-commerce market. But making money on or from the Web is not a foregone conclusion, and doing business there is certainly not for everyone. 

Before jumping into cyberspace, it is important to learn the basic jargon. Here are some of the more important concepts and terms.

The Internet is a worldwide network of millions of computers linked by a maze of telephone lines, satellite signals, and even cable TV. The Net was established in 1969 as a government funded medium for exchanging information between the U.S. Defense Department and high-level university researchers working on sensitive government projects. Since that date, the purpose and character of the Internet have changed dramatically. The Net now accommodates a wide variety of personal, political, social, and business commerce and its users range from elementary school students and chat-group junkies to businesses advertising or selling virtually every conceivable product or service.

The World Wide Web (WWW), while often mistakenly referred to as the Net, is neither the Internet nor a computer network. It is an information access system or, more technically, a multi-media (text, images, pictures, sound, etc.) software system running on the Internet. This system consists of the following major components.

• Data Transmission Systems made up of telephone wires, cable, and satellite systems through which computers, computer networks, and web sites are linked and information transmitted.
• Web Sites are official cyberspace locations that can be accessed by computer. More technically, a web site is the Universal Resource Locator address (URL) of the computer residing at that site. A web site may consist of a single homepage, any number and variety of text and graphics files, links to other web sites, or the capability to process online ordering and payment transactions.
• Domain Name is the string of characters following the "www" in a web-site address. The Domain Name System (DNS) refers to the electronics used to translate the numeric addresses computers understand into recognizable alphabetic names. It is the DNS electronics that links together the thousands of networks comprising the Internet.
• HTML (HyperText Markup Language) is the most basic and most widely used Web-programming language because all web browsers can read it. However, more complex languages such as JAVA, Perl, Active X, or CGI provide the capability to do much more with the web site.
• Hypertext Link is a "hot button" located on a web page that allows the user to click to other pages on that web site or other web sites.
• Web Servers are host computers capable of finding URLs, linking and communicating with other servers or computers, and storing, sending, and receiving files. Web servers are housed at a variety of locations including, fee-based Internet Service Providers (ISPs) such as AOL or a local service provider, educational institutions, government agencies, or businesses hosting their own web sites.
• Web Browsers, such as Netscape or Internet Explorer, are multi-media software programs that allow a computer to connect with a web site through its modem and send and retrieve information.
• Search Engines are searchable databases or indexing systems that store vast amounts of WWW information by category and sub category. These crucial links with strange names such as Yahoo, Lycos, or HotBot allow the user to query stored information and access the hosting sites.
• Meta-Tags are coding in Web pages that direct a search engine to the intended Web-site. The tag can be a company name, a description, or a key word that is related to the intended site. Without meta-tags, some search engines can't determine the content of a web site and won't include it in a search request.
• Banners are graphic images used on Websites to advertise a product and to serve as a direct connection to the advertiser's Website. 

Electronic Commerce (e-commerce), which is also known as e-business or e-tailing, refers to business conducted online and involves everything from buying tickets to a football game to the complete management of the supply and distribution chain of large pharmaceutical companies. At least one of the two web sites involved in a web transaction has the software necessary to provide a secure environment, a shopping cart system, and electronic transaction processing. In business transactions such as the distribution of pharmaceuticals, the two firms can transmit a variety of data such as inquiries, orders, invoices, and payments directly through their computer systems.

Affiliate Networks or Integrated Solution Providers are large web-site hosting services (ISPs), such as GeoCities, zStores, XOOM and Tripod who provide free web sites in exchange for advertising links and/or e-commerce-site development services.

Before you leap into cyberspace, use the following do’s and don’ts to fine-tune your strategy.

Do it Right Creating an attractive web site that effectively promotes the business involves much more than technical proficiency with a web-programming language and graphics. An effective site is "message oriented." It describes the business, projects the intended image, and answers the questions a potential customer will have. So take the time to find a web developer who has the necessary combination of programming, graphical, and marketing skills to do the job right. Given today’s relatively low cost of web-site development, it definitely pays to get good help.

Hit the Target The World Wide Web consists of a broad demographic spectrum of users and, to be effective, it is crucial that the firm's target customer group is clearly identified before the web site is created. If you don’t know who is to be reached and what motivates their interests and buying habits, you can’t tailor the right message to reach them.

Hit the Target Quickly Web surfers are impatient and it is important that the first (home) page quickly captures their interest. Be sure the homepage has a definite purpose that is clearly conveyed, an attractive appearance, is well organized, immediately lets them know what the site has to offer, and provides useful information.

Keep it Lean and Mean To help send visitors where they want to go on the site as fast as possible, well-designed sites will:

• Adhere to the "three click rule." A visitor is moved from the point of entry to the ultimate destination in three or fewer clicks. Speed and efficiency must be built into the site’s architecture at the development stage.
• Avoid graphics-intense pages and unnecessary animation. Needless over-design slows loading and navigation of the site and clutters pages to the point of confusion.
• Avoid pages with wordy narratives that take too long or, even worse, never get to the point. Unnecessary verbiage and confusing business jargon are irritations. More often than not, bullet points get the message across much more effectively than lengthy descriptions.
• Keep page length short and limit the number of categories contained on each. Efficiency facilitates site navigation and allows visitors to either quickly locate their choice or to narrow down information by clicking deeper into the site.
• Be cautious about the use of "cutesy gimmicks" to attract attention. Bells and whistles are not a substitute for good information and, more often than not, will be viewed as non-professional clutter.
• Be cautious about including advertising hot-links on your site. While links to other sites may reduce the cost of site operation or even generate revenue, they also clutter pages, are a distraction to the main message and, when clicked on, exit the visitor from your site.

Track Results A common advertising mistake of many small-firm entrepreneurs, regardless of the media used, is placing an ad and then forgetting about it. They don’t monitor and evaluate results to determine what works and what doesn’t. To do this with a web site almost certainly dooms it to failure. Site development is an ongoing, ever-evolving process. At the minimum, hit rates should be closely tracked and feedback information actively sought from visitors. For example:

• Make certain either the site itself or your ISP has the technical capability to count hits. After about three months, your hit rate should be steadily increasing. If it is not, find out why.
• Include a visitor’s e-mail response or feedback page on the site and ask for constructive criticism.
• Log on and do your own spot checks to verify that links to your site are working.
• Log on to your site and evaluate it with a visitor’s perspective.
• Ask constituents such as employees, suppliers, customers, and friends to visit your site and provide constructive feedback.
• Stay abreast of major changes taking place in cyber-world and especially in web-site development.

Update Another important key to a successful brochure site is fresh, useful information. There are a number of effective ways to periodically update your site. For example, including an archive of useful articles or information pieces, an advice section, a Q & A page, news releases, promotions, and price specials are easy, low cost ways to keep the site current.

Facilitate Response The primary goal of a brochure site is customer communication, so make it easy for the customer to do so. Make certain the firm’s address is prominently located, include an e-mail response page, and list the firm’s telephone number on each page. If the budget allows, a toll-free number is recommended. It not only facilitates communication but also helps promote an image of a reliable business that is there to meet customer needs. 

The entrepreneur is the biggest fish in the pond, right? Sometimes, but there are two groups who are at least as, if not more, important. These are its customers and its employees. Why, because customers are the lifeblood of the business and its employees the backbone.

But finding good employees is often as difficult for small firms as establishing a loyal customer base. Since a business can only be as good as the people who make up the organization, it is important that the entrepreneur take the time and effort to find good employees. 

Know the Firm’s Needs. One key to having good employees is correctly matching the knowledge and skills of the individual to the needs of the job. To do so effectively, you must first:

• Analyze the requirements of the job;
• Define the abilities needed to be productive in that job;
• Identify the personal characteristics needed to successfully fit in;
• Commit these findings to writing in the form of a job description.

Taking the time to complete these four steps is important. The effort clarifies the information needed from applicants to determine who is the right person for the position. Equally important, a written job description eliminates confusion over what is expected of the employee, the training that must be provided, and the basis for evaluating employee job performance.

Beat the Bushes Making a good hiring decision is partially determined by the size of the pool of talent from which to choose. The larger the pool, the greater the chance that the right person will be hired. To improve the chances of finding enough qualified prospects from which to choose, consider the following sources.

For unskilled and semi-skilled jobs, outlets such as the following typically provide a fertile, low cost, method of attracting job applicants:

• Local advertising media such as newspapers, job banks, and bulletin boards;
• On-site "Help Wanted" postings;
• Employee, customer, and vendor referrals;
• Online (Web-based) employment services;
• Informing relatives, friends, and other social contacts of the job opening;
• Placement service of high schools, vocational schools, and job training programs;
• State or local government employment offices.

The search for high-skilled, staff, or management personnel is usually more productive if directed toward specialized recruiting sources such as:

• Online (Web-based) employment services;
• Local and regional employment agencies;
• Executive recruiting agencies (headhunters);
• Referrals from professional contacts such as the firm's banker, accountant, or lawyer;
• The placement service of area colleges and universities.

Using employment agencies can be costly, but the expense is somewhat offset by the time and effort saved. Since the agency advertises the position and screens applications, the entrepreneur is relieved of these responsibilities. Also, don’t ignore the online services. E-commerce has literally revolutionized the recruiting business. You can now be in contact with prospects from around the globe with no more effort than a mouse click.

Ask the Right Questions The odds of correctly matching job needs and employee skills are greatly improved if the entrepreneur gets good information. The information requested on the application form and the questions asked in the interview should be directly related to the needs of the job. Again, a good job description is crucial.

Equally important, avoid gathering irrelevant information. It’s a waste of time and a good source of frustration and annoyance. For example, if information traditionally found on application forms such as marital status, hobbies, or gender is not relevant to job performance, why ask the questions?

Stress the Positives Small businesses are often at a disadvantage relative to large firms when it comes to attracting high caliber employees. Larger businesses have the resources to offer such initial attractions as higher starting salaries, better fringes, and more formalized training programs. Employment in small firms can, however, provide the right individual with distinct advantages. Those advantages should be stressed in the job announcement and in the interview session. For example, the typical small firm can offer:

• The opportunity to learn all aspects of the business;
• More and varied responsibilities;
• A deeper sense of accomplishment;
• More personalized working relationships;
• A good working environment;
• The absence of a large-firm, bureaucratic structure that stifles entrepreneurial spirit.

Keep 'Em When You Get 'Em Woe to the entrepreneur who thinks the firm can prosper and grow through his or her efforts alone. It’s just not going to happen. Good employees must be appreciated and successful entrepreneurs find ways, non-financial as well as financial, to recognize and reward their contributions.

A nagging question haunting most entrepreneurs is how do I profitably increase sales and grow my business in ways that don’t cost a fortune? For many small firms this can be done in ways that aren’t too expensive, risky, or time consuming. 

Many entrepreneurs believe that increasing sales means finding new customers through such time-honored techniques as media advertising, cold calls, or direct mail. While these approaches may generate new customers and sales, they are costly and there is no guarantee that the expenditure will produce worthwhile results. The following techniques are low cost, take relatively less time and effort, have little or no risk, and work for virtually all types of small businesses.

Referrals Despite common belief, small businesses attract more new customers through referrals from existing customers than by any other means. If handled properly, satisfied customers can be the firm’s most powerful sales force. But it is up to the entrepreneur to stimulate referrals through a creative, carefully planned, and systematically applied approach.

Some effective ways of getting referrals include:

• Offering existing customers rewards for generating new business. For example, for each new customer brought in, the existing customer receives a cash reward or a significant discount on their next purchase.
• Having customers give family members and friends a gift of real value on behalf of the firm. For example, the auto dealer provides the car buyer with a valuable gift, such as designer sunglasses or free tire rotation and balancing, to give to a friend or family member that comes to the dealership for a test drive.
• Asking customers for referrals. For example, the firm’s salesmen show their business customers a list of other firm’s in the industry and ask if there are any prospects the customer would recommend.

Increase Average Sales The idea here is to increase either the amount of each customer’s purchase or the frequency of purchase. One effective way of accomplishing the former is to add products or services that compliment the firm’s product line. For example, the traditional bookstore may add a complimentary product line consisting of books-on-tape or CD and reading accessories. Another technique for increasing the average expenditure is to focus selling effort on upgrades of the basic product. For example, PC makers offer a base desktop model and then sales personnel tantalize the customer with component upgrades such as larger monitors, better speakers, or expanded memory.

In order to increase the frequency of purchase, the seller must provide the incentive for the customer to do so. One technique that is effective for many firms is the special invitation service. For example, the woman’s clothing store has an exclusive showing of its new fall line for good customers. Or, selected customers are invited to see an item that fits their tastes or interests before it is put on the shelf. Often, a discount on an immediate purchase is given the invited customer.

Add Value Another effective way to increase sales is to make the customer feel that he or she has maximized the value received for the dollars spent. This can be accomplished by including with the purchase an item that cost the firm little or nothing but adds value in the customers’ eyes. For example, a hardware store may include a complimentary instructional book or video with the purchase of a major or do-it-yourself, home-improvement item. Likewise, a service firm may include extra time for the standard fee in order to make good customers feel they are getting a little more than what they paid for.

Use Risk Reversal Another method of adding value is to offer products or services that are as risk free as possible for the customer. This can be accomplished in a number of ways such as money-back guarantees, increased warranty periods, or the purchase of an extended warranty. In the case of a service firm, risk reversal may take the form of no payment on the service rendered unless and until it provides measurable results for the customer.

Use Crossovers Crossovers are reciprocal selling or referral agreements between businesses. That is, each firm offers or recommends the other’s products or services to their respective customers. For example, a movie theater might include with ticket purchases a discount coupon on a pizza purchase at a local pizzeria while the pizzeria offers a discount on movie tickets with each pizza purchased. Likewise, a small business consultant may have a reciprocal recommendation agreement with banks, savings and loans, and attorneys.

Unless the firm is one of the fortunate few, new customers and increased sales are not going to make a magical appearance. Making it happen requires a careful planning, a creative strategy, and the expenditure of time and effort. It takes time to develop a well-thought out plan of attack and it takes time to put the plan into effect. Experts suggests that about one-third of a small-firm entrepreneur’s time should be spent developing new business.

What’s more, increasing sales takes some measure of creativity. The techniques suggested above are flexible and can be varied to fit different situations. If one is not perfectly suited to a particular business, the entrepreneur can explore different ways to adapt it to the firm’s purposes.

Increasing sales is usually thought to be the only key to improving the firm’s profits. Yet, reducing cost is often much quicker and a more effective way of boosting the bottom line. This is because a one-dollar increase in sales produces only pennies of operating income. How many pennies depends on the firm’s operating profit margin; what remains after expenses are deducted from a sales dollar. On the other hand, every dollar reduction in operating expenses results in a full dollar-for-dollar increase in operating income. But controlling costs is not automatic. It takes a diligent effort and here are some tips that may help get the job done.

Know Thine Enemy An effective cost control program requires the entrepreneur to first learn basic cost concepts and then how to measure and evaluate the cost behavior. These are basic management tools that should be an important part of every entrepreneur’s arsenal.

Monitor Costs Regularly Effective cost control also requires a continuing effort. Unless costs are reviewed on a regular basis, cost awareness becomes less vigilant or, even worse, non-existent. The result is cost excesses and shrinking profit margins.

Use Available Technology Entrepreneurs often fail to gather and analyze cost information because of the effort involved. However, the low cost and availability of user-friendly software reduces the burden of information gathering and analysis and advances in data-gathering tools such as bar codes help the entrepreneur know what costs are and how to handle them.

Take Charge There is only one sure way to identify who is spending the firm’s money, what they're buying, and whether the firm is getting its money's worth: the entrepreneur authorizes all expenditures and signs all checks. This is especially important when times get tough and unnecessary expenditures associated with better times are likely to still be hanging around.

Avoid Overkill When cutting costs, be cautious about where they are cut. Avoid excessive reductions in areas that could cripple the firm’s ability to do business such as advertising and key inventory items.

Lease where Possible Leasing property or equipment under a cancelable lease provides the firm cost flexibility and reduces its risk exposure. If these assets are owned, the firm is locked-in and unable to adjust rapidly to significant changes in sales.

The largest operating expense for most small firms is labor cost. Management and employee compensation, payroll taxes, and fringe benefits average almost 50% of each sales dollar for the typical small firm. Cost-cutting techniques that help keep labor costs in line include:

• Rearranging the duties of existing personnel or utilizing temporary help before hiring additional full-time employees;
• Spending the time needed to identify job qualifications for new positions and recruit candidates able to meet them and likely to stay with the firm for an extended time;
• Educating employees on the need for cost control and ways to minimize waste and improve productivity;
• Tracking employees’ hours and breakdowns of these hours according to the time spent on specific jobs and activities;
• Scheduling production and employees to minimize overtime;
• Setting employee work standards and productivity goals and routinely reviewing performance relative to them;
• Using incentives such as contests, prizes, and bonuses to encourage employee efforts to control and cut costs;
• Using incentives to encourage reductions in absenteeism;
• Using temps to fill peak-period labor needs;
• Gearing management bonuses to cost reductions;
• Using outsourcing, where cost-effective, for routine services such as credit and collections, payroll, and other record keeping activities.

The purchase of goods and services, including merchandise inventory, is a significant cost to most small firms and usually the largest single cost element for retailers and wholesalers. Cost containment in this area is important to maintaining competitive prices and adequate profit margins. Techniques that help control purchasing costs include:

• Taking the time to carefully search for and maintain competitive sources of supply for both first-time and repetitive purchases;
• Attempting to negotiate prices on all major purchase items. More often than not, suppliers expect and are responsive to price negotiation;
• Comparing supplier price quotations on the basis of total cost. This figure should include the key aspects of cost such as unit price, shipping, cash discount, and quality;
• Using mail-order purchasing where possible. Catalogue purchases are quick, easy, and usually provide the most competitive pricing;
• Using the Internet often reduces the time spent on comparison-shopping and also leads to less expensive alternatives. Today, virtually all major vendors have websites containing product, pricing, ordering information, and e-commerce capability;
• Using just-in-time inventory practices where possible to minimize the space and cost associated with carrying inventory.