It is more than the American dream. Many would say that it is our birthright: starting a business. And ironically, sometimes success can lead to failure.
“Regardless of what kind of business,” observes Bakersfield, Calif.-based CPA Michael Stevenson, “the risk of failure should always be kept in mind along with a large question mark: ‘What, if anything, could I be doing wrong? What have I missed?’ Answers to these questions spell success or failure.”
Agreeing with his colleague, Dr. Di Wu, department chair and associate professor of Accounting at California State University in Bakersfield, strongly maintains, “It is critical to know what takes a fledgling business down the road to failure.”
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And that is what we’re looking at in today’s story: how some business owners cause their own downfall because of the following issues.
Wu: They believe all the supportive statements from family and friends about their product or business idea.
You will almost always hear more compliments from those people close to you about how your product or service idea is a sure thing. But feedback from the general population could easily be much different and pertinent.
Stevenson: They rush into market with their great idea or product without seeing if anyone else is already doing it or has a patent on it.
There are very few things in the world that someone else isn’t already doing. For example, a client had a great software idea and rushed into marketing it only to discover that another person held a patent on the same exact type of software, so thousands of dollars were lost because of failing to do something as simple as a Google search to see if a similar product was already on the market.
Additionally, merely having a patent does not guarantee that you are the only one who can produce or market a product. Your patent is only as good as your ability to defend it. So, if you do not have the financial resources or the ability to bring legal action, you really can’t defend that patent.
Wu: Business owners need to know their limitations. “Don’t be a cheapskate!”
When you get out of your area of expertise, hire people who have the competence and ability to give you what you need. For example, if you are going to bring in a partner, retain a lawyer to draft a partnership agreement tailored to the needs of your business — don’t just grab something you find on Google or do it yourself! You may wind up spending more later for a fix.
Stevenson: Success can be a “curse” that leads to “lifestyle creep,” which can destroy your business and all you hold dear.
Accountants far too often are witness to what happens when a business or a professional — a lawyer, doctor and even a CPA — becomes tremendously successful, generates lots of cash flow and embarks on a spending spree!
They go from eating Top Ramen in a studio apartment to buying a megahome and expensive toys and spending weekends in Las Vegas or similar venues, and they begin to associate with people who are more well off than they are and think, “Well, this guy has a 32-foot fishing boat. I want a boat!” And they buy one, which later gives them a sinking feeling as their spending reaches a point where the enterprise can’t generate enough money to sustain this lifestyle creep.
So the owners start to borrow against the business to sustain the lifestyle; their business is neglected, which, if left unchecked, can result in failure of the business, bringing down families with it.
Wu: They fail or refuse to live well under their means.
Economies are never stable. Just look at the Great Recession of 2008 and what we are facing at present. Families and small-business owners who spent every last cent they earned faced certain trouble then and will now.
Those who lived well below the level of their income — maintaining six months or more of income in a savings account — are able to weather these storms and not worry about putting food on the table.
Stevenson: They get into tax trouble by treating their employees as independent contractors.
A sure way of getting in serious trouble with the IRS and state taxing authorities is to treat your employees as independent contractors, thereby not paying the employer’s share of employment taxes, workers’ compensation insurance and other fees.
This could result in significant payroll tax savings — until the employee walks into H&R Block to get their taxes done and hands them a 1099-NEC (non-employee compensation form) from the employer. Then the H&R Block employee says, “We are filing your taxes as an employee, so you get back another $5,000.”
The result is that the employer is red-flagged by the IRS and can wind up being audited and assessed back payroll taxes and penalties exceeding 100% of the back taxes, resulting in the possible loss of their business — and the assessment will still be owed by the business owners even after bankruptcy.
Stevenson: They invite family to participate, which can be asking for trouble.
Family complicates things, and generally family members believe they should participate in the success of a business equally if they are employed, while unrelated people generally do not have that expectation.
If you are going to include family in the business, it is important to set expectations and boundaries upfront to mitigate the potential for issues down the road. Do not forgo controls over cash or product simply because your employees are related to you. Too often, we see fraud in business regardless of familial relationships.
Where to Get Sound Advice Before You Launch Your Own Business
So, how can you avoid these pitfalls? “Spend time — at least six months — learning how a business functions,” both Stevenson and Wu recommend adding, “Small Business Development Centers located around the country are a great resource.”
“Also, a basic course in accounting is so beneficial,” Stevenson points out.
Taking a course in business law, which is offered at just about every college in America, in my opinion, is absolutely essential.
Dennis Beaver practices law in Bakersfield, Calif., and welcomes comments and questions from readers, which may be faxed to (661) 323-7993, or e-mailed to Lagombeaver1@gmail.com. And be sure to visit dennisbeaver.com.
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