The Business Gamble – are you Winning?
Business Owners Back Ourselves By Starting Out,
But very few of us ever check if we are winning….
Anyone who leaves their job to go into business is taking a gamble – betting on being better off – better off because of more money, happiness, power, profit etc.
Every new SME owner is taking a risk that their SME returns will be greater than a salary would have been.
In actual fact the bet isn’t quite as simple as an equivalent ‘lost salary’. At the very beginning the new business owner will also add to the wager by contributing time, and also often savings, into setting-up the business – so with each day spent and dollar invested the wager grows. New owners do this happily trusting this short-term speculation will pay-off in the long-term.
So in principle, to win this business gamble every entrepreneur needs to recover three components:
- Earnings higher than the old job
- Pay-back of the investments of time and money
- Interest as a return on taking this risk. If the savings are being used to invest in the new business the return should at least be equal to any interest earned if the savings were kept in the bank.
Most business owners don’t ever stop to consider this reality, they are caught up in “living their dream” – BUT if they did stop and work out exactly was at stake I feel sure many of them would make different, and more profitable, decisions. I would even go so far as it helping reduce the very high rates of new SME failure currently being experienced.
To work out if you are winning your own gamble – start by considering the two sorts of bottom lines that exist because there are two sorts of profits:
Trading Profit : from the day-to day activities of the business as it goes about selling goods and services (after expenses of course). This is the “bottom line” referred to for annual business planning.
Capital Gains : from finally selling the business. This is the ultimate “bottom line” we get when we finally step away forever.
These are effectively your short and long term profits and it may be appropriate to sacrifice one for the other, so long as the whole profit overall improves. This trading-off short term gains for longer term capital gains may be a very good reason to “underpay yourself” when considering your annual budget e.g. “I’ll take less this year so I have enough cash to buy that new machine; do that shop re-fit; purchase that extra stock…” each of these decisions puts less money in your pocket now, with the view to improving sales and therefore the overall business value. Critically, this is additional gambling and so these trade-offs also need to be measured and monitored to ensure they remain worthwhile year-in and year-out.
When you have clarity around how much you have actually gambled for owning your business, you understand the true opportunity costs, and can start to tip the odds in your own favour.
Does Your Business Gamble Look Like This?
This is a very common example I see all too regularly….
Frank leaves his job to go into business for himself as a hipster’s barber; he is wagering he will be better off on his own. Frank contributes time and money into setting-up the business; he finds a small shop to rent under the stairs at a railway station and does the fit-out, painting etc himself – using every cent of his savings to get the look and feel just right. With each part of the setup he continues to increase his wager.
In the “initial stages” of his new business Frank works long hours and wears many hats. His view is that one day he will sell this business for lots of money. He sets his prices based on what is competitors are doing, undercutting them a small amount (excuse the pun) so his profit is small… Frank spends most of his takings on marketing and advertising and some is reinvested in a more comfy client chair, he draws a very small salary that covers his personal expenses, but works without a budget. Soon he finds he is operating mostly hand to mouth, with no savings and a very small salary.
Unfortunately, this is where many new business owners get stuck. The “initial stages” drag on and on… As the rate of growth of his business reaches a plateau (or worse starts
to slip) so Frank continues to under-pay himself indefinitely for his contributions.
Poor Frank is a terrible business manager as far as I am concerned!
Now his salary is much lower than it was when he had a job, and although he has invested all his savings he isn’t getting any interest like he did when the money was in the bank. At this stage he would be financially better-off by return to a salaried job; but he sticks it out because although he doesn’t know how to win this bet, he also doesn’t want to lose face.
Now, here is how you can win your own bet….
If you count up all that you intend to gambling right from the beginning, and set a timeline of how long you are prepared to place your bet for, then you will start out with a very clear picture of the exact bet you are taking – which of course also allows you to look more objectively at your alternatives…. It might suddenly seem worthwhile after all to stay in your job, with a renewed sense of security and gratitude for not working weekends, late hours and taking holidays.
But, if you do decide to go ahead in the very least do a “back of an envelope” budget (but preferably a fully fledged one) that includes all of these setup costs – time, investment and interest – then divide this total by the length of time (number of weeks) you are willing to wait for repayment. This will give you a weekly amount that you need to get back from your business IN ADDITION TO whatever is a fair salary for the daily time you contribute working in your business (fairy salary is the amount that needs to be paid to someone else to get the job done if you weren’t there). These two amounts when added together are what you will need to be equally as well-off as you are before you leave your job.
This initial clarity can be very confronting, and many people simply refuse to do it, but once you get over any shock the benefit is you can start making properly informed decisions. Having a complete understanding will undoubtedly drive you to be very clear about your pricing, and focused on exactly how many sales per week are needed to make sure your business gamble pays off.
Going back to our hairdresser example – for Frank these decisions may be something along the lines of:
- Initially setting his prices to cover costs, plus a 15% mark-up, without including any of his time (instead of pricing to undercut his competitor)and paying attention to extra special customer service
- Forgoing most of his “fair salary” for the next year as sales grow to $60,000 and spending the amount sacrificed on advertising (even though this further increases his bet)
- For the following TWO years he is willing to only take home no profit so he can invest in more advertising and better equipment until Sales grow by another 50% to $90,000
- At the point of plateau the business operations will be well known, so prices can be raised a bit to improve profit levels sufficiently for him to pay himself a good salary, comparable to if he was hiring someone to do the work for him, AND also pay some profit as return for his risk.
Up to this point he is still gambling by trading off his short term take home salary, against his perception he will get a greater income (profit) and capital gains(profit) in the long-run.
At some time in the first few years, Frank’s rate of business growth will most likely plateau.
After a few year’s of strategic decisions Frank’s business is able to operate just like any company on the stock exchange, with a good separation of ownership receiving returns for investment (profits), and employees receiving returns for work (wages)
In real life, what you do may vary according to other decisions you need to make; which may also include shuffling things about for good tax planning. You may CHOOSE not to pay yourself a salary covering any portion of your direct and/or management time, you may also choose to take that amount out of the business as a fancy car instead, or set up a trust to redistribute earnings to your family, or reinvest it to grow some more, etc etc. There are countless decisions that you can make to swap and shuffle your rewards and returns about to suit your world (as long as the taxman is happy). The key point here is understanding what is sufficient to ensure you are fairly paid for all of your contributions, and that at the end of the day you win the gamble so you are better off than staying in your job.
Regardless of how you shuffle things, because you know exactly what you need to earn, and have made decisions accordingly, your business becomes independent from you donating FREE time and effort for day-to-day business operations in a viscous cycle of trying to get ahead.
The fact remains everyone who takes a gamble by going into business without fully understanding ALL the costs, will never know if they are winning their bet.