THE FIVE BIGGEST MISTAKES SMALL BUSINESSES MAKE WHEN FACED WITH A DOWNTURN IN BUSINESS.

By: Mark Martella, Esq.

If you have owned a small business in the past ten years, at some point you have probably gone through some difficult times.  While many businesses have been forced to shut their doors, others have not only survived, but have succeeded.  Over the past ten years, I have seen a common thread among the businesses that have not succeeded.  The purposes of this article is to identify some of those common mistakes I have seen to help you avoid the same pitfalls of these businesses.  If you have not made any of these negative decisions discussed below, then you are hopefully continuing your path to success.  However, if you have made some of these decisions, or fear having to make these decisions in the near future, please read this article carefully, and feel free to contact me to discuss your options to avoid these potential issues in your business.

MISTAKE NO. 1 -WAITING TOO LONG TO REDUCE LABOR COSTS.

As a former small business owner myself, I know the difficulties a business owner faces in having to make the decision of letting a person go, especially if that person is a good employee.  There is always the hope that “next month will be better”, and that if you cut somewhere else or if you do not take a salary for a month, you will be able to keep that person on long enough for the business to turnaround.  While it may be an extremely difficult decision to make, you must keep in mind that if you keep employees on your payroll that are not supported by your business income, you jeopardize the jobs of all of your employees as well as yourself.  Therefore, the ultimate damage incurred from not making cuts will be greater than the financial impact to one or two employees, versus your entire staff.

Business is constantly changing,  especially here in Southwest Florida which was so dependent upon the real estate and construction industries.  Many businesses related to those industries such as contractors, real estate offices and secondary industries like furniture stores and restaurants, closed up during the economic downturn.  However, if you look around, others have survived.  While many companies hired more and more employees during the boom years, they failed to act quickly enough to reduce staff, or change their business plan to address the new economy.  Therefore, if you are facing difficulties making payroll and do not have the work flow or income stream to support all of your employees, you need to sit down and make the difficult decisions that are necessary for the ultimate survival and turnaround of your business.

MISTAKE NO. 2 - NOT REALISTICALLY BUDGETING FOR FUTURE FIXED EXPENSES.

Proper budget planning goes hand in hand with the staffing issues discussed above.  So often I will meet with a business owner who just looks at the income stream and has not realistically budgeted their actual expenses.  It is crucial that at the beginning of each year, whether it is January 1 or the beginning of your fiscal year, that you make a realistic budget listing all of your expenses, to determine how much revenue you will need to bring in order to not only cover those expenses, but also to have a reasonable profit.  I have literally sat down with some clients who have not taken a paycheck in two or three years trying to keep their business afloat.

Unfortunately, for many start-up businesses, they are undercapitalized to get through the first six to twenty-four months, when cash flow may not be built up enough to meet monthly expenses.  Therefore, they fail before they even have the opportunity to get off the ground.  For these reasons, it is imperative that you have a realistic budget of your known fixed expenses, such as, rent, utilities, advertising, technology, taxes, office supplies and any other specific items required for your business.  There are many free business planning tools online that you can use to determine a realistic budget for your business.  If you are an existing business, you can look at your tax returns for the last few years to make a determination as far as where your income is going, where you can cut if possible, and then determine how to make adjustments so that your business is profitable.  Failure to do this analysis on a regular basis will result in poor financial results.

MISTAKE NO. 3 - BORROWING FROM PERSONAL ASSETS TO HELP YOUR BUSINESS SURVIVE.

Mistakes numbers 1 and 2 above usually lead to this third mistake, namely, borrowing from your personal assets to keep your business alive.  There are four main sources that I see people borrow from, in no particular order, in an effort to keep their doors open: 1.) friends and family; 2.) their personal credit cards; 3.) equity in their home; and 4.) their IRA or 401-K accounts.  While practically every business uses some form of credit or credit line as a means to assist them during cash flow slowdowns, there is a difference between a business use of a credit line versus pouring money from personal assets (of not only yourself but friends and family) into a business that may be too far gone due to not reacting quickly and appropriately when facing a decline in business.

It is very important to remember that under Florida law, your homestead is protected from creditors.  Therefore, if you have equity in your home that you subsequently took out a second mortgage on in order to inject money into your business, you have now taken a personal asset that was protected from creditors of your business and created a secured lien for the bank that you borrowed the money from to pay off debts.  As a result, you turned an unsecured debt of the business into a debt secured by your own personal assets.  Not a wise move especially if ultimately your business does not survive. 

Another personal asset protected from creditors is your 401-K account.  So often I will see people draw down on their retirement funds.  Again, these funds are protected from your creditors under Florida law.  Nevertheless, because people become desperate and willing to do whatever they believe it will take to keep a business open, they will drain their 401-K to pay off creditors of their business. Not only do they make the mistake of using funds a business creditor could never touch, they also incur severe penalties and tax consequences with the IRS as a result of the early withdrawal of these funds.  Depending upon the circumstances, I generally would advise a client not to touch their 401-K unless it was to feed their family or buy medicine.  As stated above, if your business has been having a negative cash flow for twelve to twenty-four months, and the only assets left to pull from are your 401-K’s, there are probably bigger issues that need to be addressed before even contemplating such a drastic action and ultimately, possibly jeopardizing your retirement.

Another self-financing vehicle is the use of credit cards.  Assuming you are incorporated to protect your personal assets, by using your personal credit cards to pay debts off your business, you have thereby defeated the reason for incorporating to protect your personal assets from your creditors.  Since the credit card is in your personal name, should the credit card company sue you and obtains a judgment, it can now levy on your bank account or wages. Again, giving your creditors the benefit of pursuing your personal assets where they would not have had access to same, but for your use of the credit cards, is simply a bad business decision. 

Finally, by borrowing money from your friends and family without giving them some security interest, such as a mortgage on your home or a lien on a vehicle, can lead to family strife and the loss of a friend.  For example, if you decided to pay $5,000.00 back to your mother, but then had to file for bankruptcy within a year of the payment, that payment to your mother without a security interest recorded contemporaneously with the providing of the loan, would be deemed a “preferential payment”, and, in a bankruptcy, could expose your mother to having to pay that $5,000.00 back to the trustee to distribute to your creditors.  That can lead to an uncomfortable Thanksgiving dinner!  For these reasons, it is imperative to sit down with professional advisors, such as accountants, financial advisors and attorneys, prior to making these difficult financial decisions to identifying possible problems down the road and come up with a strategy that is in yours and your family’s best interests.

MISTAKE NO. 4 - FAILURE TO COMMUNICATE WITH BUSINESS PARTNERS TO AVOID MAKING DIFFICULT BUSINESS DECISIONS.

Having a business partnership with other individuals is no different than a family dynamic or even a sports team dynamic.  It is very easy to get along when everybody is making money and everyone is happy.  However, when you face a challenge in your business, whether financial or otherwise, it becomes a true test of business partners to get through these difficult times.  Just as when there may be a squabble between family members when individuals do not talk for days, weeks, months, and sometimes years, or the dissention that you see among a football team that was a cohesive unit while winning and then hits a losing streak with anonymous players complaining to the press, the same occurs in a business environment.  However, just as lack of communication can devastate a family or sports team, I have seen it just as dramatically devastate a business. 

When you are a small business owner, you wear many hats.  While you may wish to be running your restaurant, preparing tax returns or selling office supplies, you must also wear the hats of manager, human resources and marketing.  As discussed above, when facing business challenges, there will be difficult decisions that have to be made concerning personnel, suppliers,  rent and the location of your business, as well as marketing and cost cutting matters.  Too often I see that there has been a breakdown in communication between key personnel, quite often who may also be family members.  This lack of communication can be like a cancer, and like cancer, it will grow terminal if not immediately and radically addressed. 

Therefore, if you are the head of your business, you must take charge and make the difficult decisions required for the best interests of all of the members of your company, your employees and the company’s ultimate survival and future success.  Putting your head in the sand and ignoring conflicts will lead to the demise of your business.  If you feel that you do not have the ability or the skills to make these decisions/confrontations, or if it is just not in your nature to do so, then you need to get a third party involved to help you.  Whether it is a business coach, your accountant or your lawyer, you and your partners must sit down and do an analysis of what are the strengths and weaknesses of your business, and what you need to do to go forward.  Being an “ostrich” and hiding your head in the sand while ignoring the facts because you fear hurting someone’s feelings is the worst mistake you can make.  If you want your business to survive, you must take the action necessary for the best interests of the survival of the business, despite the pain and angst it may cause.

MISTAKE NO. 5 - RELYING ON “HOPE” AS A MARKETING STRATEGY.

You may be asking yourself why an attorney is talking about marketing when discussing the biggest mistakes a business can make in this new economy.  The truth of the matter is, whether you are a lawyer, an accountant, a flower shop or bakery, if no one knows you exist or knows about your product and has a compelling reason to buy your product, nothing else matters.  Too often, the first place that businesses look to make budget cuts is in their advertising.  They believe that their advertising is not working and it is an area that can be easily reduced.  As the former President of the Charlotte County Chamber of Commerce, I quite often reviewed reports where businesses stated that they ended their membership due to the down economy.  The reality is that in a down economy, the last thing they should be doing is cancelling their Chamber membership but, rather, they should be looking at ways to make the most of their membership and take advantage of the networking opportunities and free advertising as provided by your Chamber.  “Hoping” that people will find you in a time where they are literally getting hit with thousands of marketing messages every day, is a recipe for failure. 

Cutting your marking budget in down times again, in my opinion, is the worst place to cut.  The real issue you must address is whether your marketing is working.  You must make a determination as to what is your return on investment (ROI) for your advertising.  If you cannot measure your ROI for each piece of advertising, then you are wasting your money in that area.  Every place you advertise should be measurable.  The best example I can suggest that you look at as far as your web page is concerned would be Google Analytics.  This can provide you with a detailed analysis of items such as how long people are staying at your website, what pages they are visiting and, what page they are exiting from.  Obviously, if you are selling a product online, you want to see people leaving from your checkout page.  You should do the same type of analysis for each format of advertising you are using to determine whether or not they are effective.  Rather than cutting your advertising budget, you need to spend it more wisely in targeted areas with measurable results.

CONCLUSION

The foregoing was a brief summary of some of the common mistakes that I see small business owners make.  The common thread you will see among all of these mistakes the failure to plan, analyze and communicate.  Additionally, not turning to professionals early in the process to guide them along the way ultimately leads to more expensive professional fees down the road.  Remember, while you may have great experience in your particular business niche, turning to professionals such as lawyers, accountants, realtors and financial planners, provides you with their experiences and collective resources of thousands of business experiences through their clients.  They can share those experiences with you before you make the same mistakes that they have seen happen to others.  One of my favorite sayings is that: “You can learn from the mistakes of other people or you can be those ‘other people’.” 

This is the purpose of this article is to inform our business community so that its members can avoid the pitfalls discussed above.   A successful business community leads to job creation and contributes to the continued growth of a vibrant community. If you would like to discuss any of the issues raised in this article or if you have your own unique concerns, please don’t hesitate to give me a call. 

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If you have any questions or would like guidance or advice on small business issues or other general business law matters, please contact Mark Martella in the firm’s Business Law Practice Group.