The often repeated statistic is that 30% of businesses fail in the first year and 50% in the first 2 years. Starting a new business is difficult and only a small percentage will become successful. However the rewards for the survivors can make it very worthwhile.
Our Business Advisory Team has devised our list of top ten tips for people starting a new business.
1. Don’t give up your day job
Most small business owners start out in salaried employment and then pursue an idea or opportunity that arises. As a result, there can be a fast transition from a steady income which regularly pays the bills to a cash dependent business with no returns to the owner.
If you have employment, explore the options of starting your business in your spare time, or reducing your employment hours to part time. The regular income will make the transition to self employed a lot easier. For professional people contracting or lecturing can be a good way to supplement income while building your business.
Before you make the move, work out what needs to be spent and where the money will come from. Consider your spouse’s income, your personal assets and access to borrowed funds. In the first few years it will be difficult to borrow from a bank and often home equity or relatives become the sources of finance.
2. Get professional advice
A business can be operated in your own name, or via a company or trust. Each one of these has its own advantages and disadvantages. Although it is easy to set up your own trust or company, it can be very difficult to move to another type of structure after you have commenced trading.
Also consider the need to have a comprehensive budget and business plan. This will help to determine if the business is on track. Advice from an accountant can be helpful here. When employing people, you should also be aware of all of your obligations for payroll, on-costs and business registrations.
For businesses that have intellectual property, professional advice should also be sought on how to protect this via registered designs, patents and trademarks.
We recommend developing a business relationship with a lawyer, banker and accountant from the initial startup of your business. These advisors can provide regular assistance as your business grows and help you to avoid pitfalls along the way.
3. Keep records and understand what they mean
Record keeping is not done just to keep the ATO happy. If done properly it will give you the information necessary to run your business successfully. Accounting programs such as MYOB or Xero are ideal for small businesses, but if records are not your thing you should consider engaging a bookkeeper for a few hours each month. Keeping records on a timely basis will assist in collecting money from customers and understanding your expenses.
We recommend that you also talk to your accountant about devising some key performance indicators and preparing a cash flow budget. These will give you the tools necessary to monitor performance and plan ahead. Your accountant will also be able to help interpret the results from the records and show you what to look out for.
4. Separate business and personal assets
If you have a company, partnership or trust structure it is vital to understand what is a business asset and what is not. We find that the clients who get their affairs into a mess inevitably mix business and private expenditure in the business records.
Firstly, ensure that you have a business bank account into which you deposit income and from which you will pay expenses. If you pay all of your expenses from this account your record keeping will be a lot easier. If you need a credit card for business expenses, get one that is just used for business and have a separate personal account. It is tempting to park excess business cash in your personal high interest or mortgage offset account, but it is better to open a high interest account in the name of the business.
By keeping good separation of business matters, your records will be tidier and the amount of work required to be done at year end will be reduced.
If your entity is not paying you a fixed salary, you will need to take drawings from your business bank account. This should be done in a controlled manner with a predetermined limit. If you are drawing funds from a company, remember that the company is loaning you money and you will need to repay it. The ATO does not like overdrawn loan accounts and has specific legislation to penalise shareholders if they have drawn excessively from a company.
The other benefit of keeping a clear distinction between your assets and the business assets is the concept of limited liability. When a company incurs a debt, the debt belongs to the company, not to the shareholder. In the unfortunate circumstance where the company becomes insolvent, there is generally no recourse to the shareholder’s assets to pay for the company’s debts.
5. Think twice about signing a 3 year lease
We have seen a number of startup businesses that have signed up for a shop lease on commencement of the business, only to find that sales did not eventuate as planned. If the business closes, the obligations to pay for rent will continue until another tenant can be found. This can add several months rent to the loss already incurred on closure of the business.
Similarly think twice about long term commitments for advertising, office equipment and other services. These are likely to turn into personal obligations if the business cannot pay them, and are best avoided until the business has a track record.
Be very wary of franchise businesses with glossy brochures but without a proven performance history. We have seen a number of businesses fail after signing on with franchisors only to find that the sales did not come and that promised support did not eventuate. A few successful franchises can be sold to another buyer for a profit, but more often we find that the owner ends up with nothing more than a capital loss.
6. Pay your PAYG and super obligations
Our tax system requires an employer to deduct tax from employees’ wages and at the end of the quarter give the money to the ATO. The tax deducted is then credited off the employees’ tax bill. This system leaves the tax deducted from wages in the employer’s bank account for up to four months. Similarly, the 9% minimum superannuation employer contributions are required to be paid quarterly but will be retained by the employer for up to four months.
It is very tempting to dip into this cash to pay the business accounts, but be warned: if the company does not pay the PAYG and superannuation on time the directors become personally liable for the unpaid amount. If you are unable to budget for these forward payments we recommend transferring the funds to a separate bank account after the payroll payments are made. This bank account should only used for ATO payments.
7. Put aside funds for tax
If a new company starts now it does not have to pay any tax until the end of this financial year and depending on the when the tax return is lodged, it may not have to pay tax for another 11 months after the end of the financial year.
This seems like a tax holiday for almost 2 years, but inevitably the tax will need to be paid. If the company is profitable in its first year in 2012, in May 2013 the company will need to pay 100% of its tax for 2012. Two months later, the June activity statement will require another 25% of the 2012 tax amount to be paid as the initial instalment for 2013.
We advise clients to put aside around 30% of their profit for tax. This is especially important in the first year of operations as expanding businesses are often cash poor and if the ATO aren’t asking for quarterly instalments it is easy to divert tax funds to somewhere else.
8. Think twice about buying that BMW
Many small business owners seek to buy a prestige vehicle as a reward for their hard work and to show that they have been successful.
Buying a motor vehicle in your business name can be effective but only if you can demonstrate a high level of business usage for that vehicle. All of the private usage of the vehicle will need to be reimbursed by the user of the vehicle, or taxed at the highest rate of personal tax via the fringe benefits tax system. Reimbursements made to a business for private use are often over $15,000 per annum as all of the costs (including depreciation, registration and interest) need to be reimbursed, not just the running costs. You should also note that “business use” excludes the journey from your home to the normal place of work and back again, making it very difficult to produce a log book with 100% business use.
In addition, depreciation deductions for cars are limited to a maximum cost of $57,466. This means that no tax deduction will be allowed for part of the depreciation or lease expense for high value vehicles, even if business use can be demonstrated. An alternative may be to keep the vehicle in your name and claim motor vehicle costs using the cents per kilometre method in your personal return.
Note that work vehicles, vans and 1 tonne utilities, have exemptions from the fringe benefits and substantiation rules. These will be more tax effective than passenger vehicles.
9. Be prepared to chuck it in
Being realistic about the prospects of success is essential. It is better to walk away from a business with your marriage intact and some home equity left. Before starting, we recommend that you work out your breakeven point and how much capital you are prepared to lose in developing the business.
If the business is losing money, be aware of your obligations as a director and as an employer. ASIC and the ATO take a dim view of business owners who cannot pay their debts to employees and the public generally. If the business looks like it is in difficulty, seek professional advice at the earliest opportunity. This may allow you to protect your personal assets and terminate the business while leaving open options for the future.
Closure of a business may not be the end. You may be able to sell your idea and let someone else develop it, or put your idea on hold and wait for the right time. The important thing is to bite the bullet and act early. Not only are you incurring costs by keeping the business open, you are potentially losing salary income that you could otherwise be earning.
10. Get mentored
Whatever challenges your business faces, you can be sure that someone has gone through something similar before you. There are a number of government and community programmes that will put you in touch with other business people who can assist with the journey.
Enter some of these names into your search engine to get started:
The Executive Connection (TEC)
Small Business Mentoring Service
Regional Development Victoria
Your local council business group
Many of the government programmes have services which are free or have a nominal cost. Some will provide cash grants to assist you in developing markets and technologies.
Saward Dawson has a number of experienced small business advisors who can be your first point of contact in starting a new business and can travel the journey with you. Where appropriate, we can also direct you to other specialist services for your business.
For more information and assistance with starting a business, please contact your Saward Dawson advisor.