The Most Common Mistakes a Business Owner Makes

Daniel YergerFinancial Planning Leave a Comment

At MY Wealth Planners, we advise business owners and managers at all stages of a business, from startup to the sale of the enterprise. Understandably, then, we’ve also seen mistakes. A lot of common mistakes. We’ve even made some ourselves! This week, we’re talking about the three most common stages we see by business owners in the startup phase, the scaling phase, and the exiting phase of their business. If you’re a business owner, this is sure to be valuable for you, and even if you’re not a business owner, it might be good to know a problem when you see one, whether it’s at the business you work for or even if you’re just considering monetizing a hobby. Keep in mind that we’re writing this from the lens of wealth maximization, so if your priorities for a business lie elsewhere, you can take the wisdom herein with a grain of salt.

Common Mistakes for the Startup

The first mistake we see business owners make is right at the top: getting their entity right. Whether you’ve gone out and gotten an attorney to draft agreements, start your business with a handshake, or otherwise just start selling doodads you make in your garage, you have a business. By default, if you don’t take any action in defining your business, it’s going to be a sole proprietorship or a partnership. In the case of a sole proprietorship, the net profits of the business will simply flow through to your personal tax return as if you’d earned them working a normal job, though you’ll have a higher tax bill due to self-employment (15.3% instead of 7.65%). However, there are some specific gotchas in this area to be aware of:

First, just because you’re married doesn’t mean you need a partnership. While you and your spouse might be equal participants in a business, you should be aware that filing as a partnership versus as a sole proprietorship will require an extra tax return and the potential expenses thereof. Given that your business ultimately flows through to you as a couple, it may not be advantageous to formally establish the business as a partnership, though it can be a complicated tax question and your mileage may vary. This is a really good area to talk to a qualified tax preparer (CPA or EA) about the pros and cons with regard to your self-employment taxes if all the profits flow through under one of you versus being split between both of you, and the potential extra costs of having a partnership return prepared, which can easily go into the thousands of dollars per year.

Second, you can read a lot about S Corporations as a tax treatment and how they can save you a lot of money on self-employment taxes. However, there is no free lunch. S Corporations, like partnerships, complicate the tax treatment of your business and can add on additional compliance costs. Additionally, the primary advantage of S Corps is that you can distribute profits without paying self-employment tax. However, you are required to pay yourself reasonable compensation for your work within the business as a W2, which many business owners fail to do. A classic example of this is real estate agents, who have extremely volatile income. Some will make hundreds of thousands of dollars consistently over time, but many go through boom and bust cycles, which can make sustaining an ongoing paycheck to themselves from the S Corporation challenging. And if you underpay yourself? Beware some severe audit risk and tax penalties.

Third, having a partner or partners in your business is akin to getting married. Consequently, the quality of your business relationship is only as good as the paper it’s established on. While many businesses start with a clink of pints in a bar or a handshake in the garage, establishing early on the proportions of ownership, who will be doing what and what everyone’s ongoing obligations are, and how the sale or transition of ownership will occur in the future is incredibly important. If you can do without having partners, it’s materially advantageous for countless reasons, but many businesses simply cannot exist or thrive without the talents and capital of multiple people involved. Consequently, pick your partners as carefully as you’d pick your spouse, and ensure you have your business operating agreements in good order for both the good and the bad times that may come in the endeavor.

Common Mistakes for the Scaling Business

So now you’ve gotten past your survival curve and you have a thriving business. Huzzah! But as the Notorious B.I.G. said: “Mo money, mo problems.” Most common mistakes at this point come down to a difficulty in transitioning mindset from the startup phase to the scaling phase of the business. For some business owners, this is a non-issue because they’ve already accomplished their original plan, which was to make “enough” money on their business either to sustain it as a hobby or make it into a lifestyle business with minimal growth beyond that point. So now the problems they’re faced with come in the form of how they scale their business. The most common mistakes we see at this phase are as follows.

First, making a leap from the scarcity mindset to the abundance mindset can cause a serious slowdown in the growth of a business. For example, it’s not uncommon for burgeoning business owners to be poor on paper. In other words, spending as much revenue from the business as possible to buy assets or otherwise create expenses that reduce the profitability of the business and as a result, make it “poor on paper” for tax purposes. The problem is that while continuing this behavior on paper indefinitely is an okay-ish tax mitigation strategy, it fails to let the business grow in value, as well as can produce many money-wasting behaviors such as one time expenses like spending money on buying new equipment that isn’t really needed rather than building up capital to grow the team or production capabilities of a team or an organization.

Next comes a failure to start thinking ahead when it comes to the needs of the team within the organization. The first phase of a business is all about breaking even, and by the time the business breaks even, it might be doing hundreds of thousands or even millions of dollars in revenue, depending on the underlying expenses it takes to generate that revenue in the first place. Yet, at this stage, many business owners carry the scarcity mindset into their hiring and staffing, resulting in “as low of wages as the market will bear” and an exhaustingly slow trudge towards ever offering benefits such as health insurance or a retirement plan in the business. The consequences of this behavior include having difficulty recruiting and retaining talented team members, but can also rob the employer of a valuable incentive to build up their own retirement savings and to improve their own benefits packages.

Last is the failure to delegate. This is particularly important in a business that is regulated and requires a license or educational credential to perform a specific type of work. For example, in a medical office it makes no sense for the doctors to greet patients or handle insurance paperwork. Their practice, clinic, or hospital is fundamentally paid to deliver medical care, which they are uniquely licensed to provide. Consequently, as much of their time as possible should be spent doing just that, because the cost of paying someone to pick up the phone every hour is perhaps $20-$30 an hour, but not seeing two to six patients during that same time is likely costing that organization thousands of dollars in revenue. Even in a non-licensed business like a retail store, if the business owner’s time is better spent marketing, finding better products, or improving supply chains, the last thing they should be doing is running the register.

Common Mistakes for the Exiting Owner

We finally arrive at the end of the business’ lifecycle, or rather, the end of the business owner’s life cycle within the business. At this stage, the primary problem is this: You’ve built something of value in your business. You have customers, clients, team members, vendor relationships, and trusted partnerships. Yet, 90% of small businesses fail to outlive their founders involvement. Why? Because the founder has failed to prepare for their own departure. Here are the three biggest stumbles we see before the finish line.

Number one: The business owner has failed to prepare in advance. This seems fairly straightforward, “proper preparation prevents poor performance” as the saying goes, and yet many business owners wake up in their fifties or sixties and say “I’d like to retire now,” and attempt to do just that. Yet, preparing a business for sale or to transition to the next generation of management, can be a multi-month or even several year process that requires attention to the profitability of the business, talent management of the team, and ensuring that the established processes and procedures of the business can carry on in the owner’s absence. Anyone even beginning to contemplate leaving their business should spend at least a year, if not several, in preparation for the event.

Number two: The business cannot survive without the business owner. This can occur in both licensed and unlicensed businesses, but in both cases, is characterized by a simple observation: Can someone perform the core responsibilities of the service of the business and the management of the business other than the business owner. In the case of the surgeon, this means finding another surgeon to take their place. In the case of the corporate manager, this means hiring a replacement CEO to take charge after their departure. Once again, these are major investments on the part of the business, and can take months if not years to get right and in place.

Number three: the culmination of all the common mistakes we’ve described, summed up by this phrase: All the eggs are in one basket. A desire to grow and build a business over time can cause business owners to overconcentrate their wealth in the business. This means being poor on paper, reinvesting profits into the business, and constantly scaling and growing the business without taking the time to take something out of it for themselves. Consequently, this can put them at a real disadvantage at the point in time where they are most vulnerable to the risk this entails: If no one will buy the business, despite the immense value of the business, they can’t retire because they have no wealth outside of the business to provide for them. And if the potential buyers of the business know that the owner’s retirement plan hinges on this sale, they have a lot of leverage to demand discounts to the value of the enterprise, such that the business owner may not be able to walk away with the full value of the wealth they’ve built over the years.

The Great Game of Business

There are a million more common mistakes and mishaps that can happen in the world of entrepreneurship. It’s not for everyone, and sadly, more people fail than succeed. Yet, whether it’s monetizing a hobby or trying to build an empire, entrepreneurship can be one of the most challenging and exciting endeavors of a lifetime. Ensure that if you go down this path that you learn from the experiences and common mistakes of others and build something worthy of your name by avoiding the simple trips and errors that have happened many times before and will likely happen many times in the future.

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