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Small Business Money Traps to Avoid
First off, accept that you are going to make mistakes running your business. Calm down, we all do. And while it’s okay to lose a battle or two, just don’t lose the war. Remember, each time we make a mistake there is a valuable lesson to learn from it.
Financial mistakes are often the result of poor planning or a lack of financial discipline or know-how. Other times, they come down to unforeseen events that couldn’t have been avoided. And just because you succeeded once doesn’t guarantee you’ll get it right the next time. For example, Jellyfish.com sold itself to Microsoft for north of $50 million dollars. But co-founder Mark McGuire’s next venture, Alice.com, filed for bankruptcy after raising more than $4 million from investors.
As you can see, no one is immune from making business mistakes, misreading a market, or suffering from poor execution. Whether you’ve got dreams of making millions through an IPO or simply want to serve your target market in your neighborhood, do your best to avoid the money traps below and you’ll increase your odds of starting, growing, and running a successful business.
1. Going Into Unnecessary Debt and Not Managing Cash Flow
Unexpected expenses will inevitably occur as you start and grow your business. Whenever possible, avoid putting these expenses on the plastic. While using credit cards can rack up rewards points, unless you’re paying off your cards in full each month, be wary of the interest charges and costs of capital of using credit cards.
The charges can, and do, add up fast.
Your business should incorporate a margin of error for budgeting and be pragmatic with budgeting, not optimistic. Anticipate that your estimates will vary from the actual costs and have a cash reserve account to address any shortfalls.
It’s important to understand your business’s cash-flow and think strategically to understand annual and bi-annual expenses, and to continuously set aside reserves to cover the future investment in business assets.
Most businesses fail for one simple reason: They run out of money.
I was just reading last week about Saleen, a vehicle enhancement company, whose last filed SEC report stated they earned $5.349 million. However, they have only $7,261 in cash and over $7.1 million in debt and loan obligations. They are one of the many companies who have drowned themselves in debt and likely won’t be in business very long unless they turn things around.
Do you have sufficient cash reserves for your business? Understanding basic financial statements, including cash flow, is essential to making sure you’re keeping up with fixed and variable expenses.
2. Choosing the Wrong Business Partner
They say marriage depends on two things, “finding the right person and being the right person.”
Picking a business partner is the same.
When I look at past business endeavors I’ve learned the most from, so many of the difficult but valuable lessons I learned go hand in hand with picking the wrong business partners.
Here are a few of the lessons I learned from choosing the wrong business partners — all of which were very costly:
- Get everything in writing. E-V-E-R-Y-T-H-I-N-G.
- You cannot do a good deal with a dishonest person. Avoid doing business with anyone you don’t trust 100%.
- If you don’t know a potential business partner well, work on a small project or deal together first before partnering on the larger company, project, or partnership (akin to dating before getting married).
- Align business interests with the interests of all stakeholders. We can always rely on people to act in their own best interests.
This single mistake has cost me millions of dollars over the years and a few relationships as well. Needless to say, I’ve learned my lesson and will do my best not to make the same mistakes in the future.
3. Not Getting Everything in Writing
I cannot stress this enough.
One of the many challenges of starting and operating a small business is that businesses are not born with a set of systems, policies, and procedures to follow — so at times things are figured out on the fly. That can cause big problems.
As a small business owner you may be tempted to make oral contracts with people you know, but I’d strongly advise to get things in writing. It’s in everyone’s best interest. Here are some agreements to make sure you put on paper:
- Employment contracts
- Equity agreements
- Customer contracts — having payment timeframes is a must
- Supplier contracts
- Real estate contracts
- Any other contracts that make sense for your business
Make sure you understand the terms and conditions of the contracts. If you don’t, ask questions. It’s worth understanding every nuance of your contracts, especially contracts you will use more than once, such as those for employees, suppliers, and customers.
If contract terms are unclear or it’s too soon for a contract, consider using a memorandum of understanding (MOU) while you work out the additional details. A memorandum of understanding is not used instead of a contract, it is used prior to the terms being clear enough for a contract. If you have any questions on which to use, contact a lawyer.
Misunderstandings, confusions, and disagreements can cost your business time and money.
4. Wasting a Lot of Money on a Website
Don’t spend too much on your company’s website unless you clearly understand its purpose and functionality.
Not all websites are built the same. If you know why you need the website you think you do, then by all means, press play and go for it. But these words of caution are for the less tech-savvy business owners out there. Don’t get sold on a website and features you don’t need.
Yes, you need a website. But no, you don’t need a $15,000 website.
Before you make a big investment in a website, think about these questions:
- How does your company’s website fit into your overall business strategy?
- What is the purpose of your website?
- Who is going to make changes and updates to your website, and what will they charge?
- Do you have the specific functionality or security necessary for your website?
This pains me to say, for fear of being misunderstood, but investing large sums of money in building a website for your small business is a total waste of money unless you specifically need security or hard-to-find functionality.
If you’re new to the world of technology and weren’t born a digital native, you might think investing in an expensive website is a good idea. And in fact it can be, if your business needs the functionality of a complex website.
And it bears repeating: Yes, you absolutely do need a website for your business. It’s just unlikely that you need an expensive one.
You should be able to find someone to build you a fairly simple company website for a couple of thousand dollars at most. Check out our post on saving money in your startup and scroll down to website services to learn more about free (and next to free) resources to build websites.
5. Wasting Money on SEO
What is your return on investment (ROI) from each visitor to your website? Do you know?
A few weeks ago I spoke to someone who wanted an online store built for her business (which made sense), but she wasn’t willing or able to set aside a monthly budget to attract visitors to her site (marketing, Google, and Facebook ads). In other words, she was willing to invest in a great website that no one would find.
Likewise, if you aren’t selling a product or service and generating revenue from your website, what is the actual value in investing money to attract visitors to your website?
Do you have a conversion and content strategy for your website? Meaning, do you have a plan to turn visitors to your website into customers? Are you using data and reports to track your site’s analytics? If not, wake up: It’s 2014, and you need to be.
That said, if you are not, don’t invest money in building an expensive website or SEO unless you have a comprehensive strategy to generate revenue from it.
If you are reading this right now, you should at the very least be capturing email addresses from your website’s visitors. We have a great post about email marketing, which explains how to build an email list and turn your website visitors into paying customers.
6. Hiring the Wrong Staff
As a small business, your early hires are one of the biggest investments and risks you will have. They must be able to handle a wide variety of tasks, be good under pressure, have the ability to think on their feet, and have cross-disciplinary knowledge.
Getting clear expectations in writing is a good start.
You should also consider assigning potential employees to a small project to evaluate their dedication, competency, and fit for your business before hiring them full-time. Most businesses fail to do this and then suffer when they make a bad hire.
Hire slow, fire fast.
Hire the best, but whenever possible, try to compensate them in ways other than salary. Vesting equity, extra time off, and additional benefits and perks are great ways to attract top talent among your early employees without paying high salaries.
7. Commingling of Funds
This is a huge money trap. While it make seem ‘okay’ to use your business debit and credit card for personal expenses, especially if you’re a solopreneur, avoid commingling funds.
Keep separate bank accounts and stay disciplined to keep business assets accessible only for business and separate from your personal assets. Not only will this help you keep more accurate records, it’s also important for internal financial record keeping and IRS and tax reporting.
8. Pricing Errors
Small businesses often over-value or under-value their products or services. How do you price your product or service? That all depends on your industry, the competition, and the value you deliver to your customers.
Make sure you understand the difference between cost-based pricing and value-based pricing before you determine your pricing strategy.
Cost-based pricing considers the cost to produce or manufacture your product, and then builds in a margin to cover overhead and profit. Cost-based pricing can fluctuate based on changing input costs — a baker may have to raise the price of bread if, say, if the price of flour goes up. This method is especially effective when entering a new market, to keep prices low to attract new customers, and in markets with mass productions, which are in turn very competitive.
Value-based pricing considers the value to the customer rather than the cost to produce. What is the increase in savings, profit, or efficiency customers can expect by using your product? Charge slightly less than the value they’ll derive from using your product or service, and you are delivering value to your customers. Value-based pricing usually results in higher prices.
I consulted for a company that sold photo booths, and they operated on a value-based pricing model. They looked at the ROI based on the number of events that buyers would have to run to recoup their investment. Using this approach, which was ingrained into the sales process and explained to customers, they were able to use value-based pricing to maximize their profits.
Also note: Cutting friends and family a “special deal,” while nice, also isn’t going to help your business unless they are helping to spread the word. But most friends and family will already be allies for your business, so it’s smart to limit friends and family freebies and discounts, at least until the business is on solid footing.
We all make mistakes. The only people who don’t are six feet under. That said, some small business mistakes are more deadly than others.
What other crucial, small business money pitfalls would you add to this list? We’d love to hear your feedback and experiences below in the comment section.
Work hard and good luck.