It’s more than the American dream. Many would say it’s our birthright : start a business. And ironically, success can sometimes lead to failure.
“Regardless of the type of business,” observes Michael Stevenson, CPA based in Bakersfield, Calif. (opens in a new tab) “the risk of failure should always be kept in mind with a big question mark: “What, if anything, could I be doing wrong?” What did I miss? The answers to these questions spell Hit or failure .”
Agrees with his colleague, Dr Di Wu (opens in a new tab) department director and associate professor of accounting at California State University at Bakersfield, firmly asserts, “Knowing what sets a fledgling business on the path to failure is critical.
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And that’s what we’re looking at in today’s story: how some business owners cause their own downfall because of the following issues.
Wu: They believe all statements of support from family and friends regarding their product or business idea.
You will almost always hear Following compliments from your loved ones on the sure value of your product or service idea. But the comments from the general population could easily be very different and relevant.
Stevenson: They rush to market with their great idea or product without seeing if someone else is already doing it or has a patent on it.
There’s very little in the world that someone else isn’t already doing. For example, a client had a great idea for software and rushed to market it only to find that another person held a patent on the exact same type of software. to see if a similar product was already on the market.
Moreover, the mere fact of having a patent does not guarantee that you are the only one who can produce or market a product. Your patent is only as good as your ability to defend it. So if you don’t have the financial resources or the ability to take legal action, you really can’t defend that patent.
Wu: Business owners need to know their limits. “Don’t be a cheapskate!”
When you step out of your area of expertise, hire people who have the skill and ability to give you what you need. For example, if you’re considering bringing in a partner, hire a lawyer to draft a partnership agreement that’s tailored to your business needs. Don’t just grab something you find on Google or do it yourself! You might end up spending more later on a fix.
Stevenson: Success can be a “curse” that leads to “lifestyle drift,” that can destroy your business and everything you hold dear.
Accountants all too often witness what happens when a business or professional – a lawyer, a doctor, even a CPA – achieves runaway success, generates lots of cash, and goes on a spending spree!
They go from eating Top Ramen in a studio to buying a huge house and expensive toys and spending weekends in Las Vegas or similar places, and they start associating with people who are more affluent than them and think, “Well, this guy has a 32-foot fishing boat. I want a boat! And they buy one, which later gives them a sinking feeling when their expenses reach a point where the business cannot generate enough cash to support that lifestyle creep .
So the owners start borrowing from the business to maintain the lifestyle; their business is neglected which, if left unchecked, can lead to business failure, taking families with it.
Wu: They fail or refuse to live well under their means.
Economies are never stable. Just look at the Great Recession of 2008 and what we are facing right now. Families and small business owners who spent every penny they earned faced some challenges then and will continue to do so.
Those who were living well below their income level—now six months or more of income in a savings account – are able to weather these storms and not worry about putting food on the table.
Stevenson: They’re getting into tax trouble by treating their employees as independent contractors.
A sure way to get in serious trouble with the IRS and state tax authorities is to treat your employees like independent contractors , thus not paying the employer’s share of employment taxes, workers’ compensation insurance and other costs.
This could result in significant payroll tax savings – until the employee goes into H&R Block to do their taxes and hands them a 1099-NEC (Non-Employee Compensation Form) from the employer. Then the H&R Block employee says, “We file your taxes as an employee, so you get an extra $5,000 back.”
The result is that the employer is reported by the IRS and may end up being audited and assessed for payroll taxes and penalties exceeding 100% of back taxes, resulting in the eventual loss of their business – and the assessment will still be due from the owners business even after bankruptcy.
Stevenson: They invite the family to participate, which can cause problems.
Family complicates matters, and generally family members believe they should share in the success of a business equally if they are employed, whereas unrelated people generally do not have this expectation.
If you’re considering including family in the business, it’s important to set expectations and boundaries early on to mitigate the risk of problems later. Don’t give up cash or product controls just because your employees are related to you. Too often we see business fraud independent of family relationships.
Where to get sound advice before starting your own business
So how do you avoid these pitfalls? “Spend time – at least six months – learning how a business works,” recommend Stevenson and Wu adding, “Small business development centers (opens in a new tab) located across the country are an excellent resource.
“Also, a basic course in accounting is very beneficial,” Stevenson points out.
Taking a course in business law, which is offered at just about every American college, in my opinion, is absolutely essential.
Dennis Beaver practices law in Bakersfield, California, and welcomes comments and questions from readers, which may be faxed to (661) 323-7993, or emailed to [email protected] . And don’t forget to visit dennisbeaver.com (opens in a new tab) .
This article was written by and presents the views of our contributing advisor, not Kiplinger’s editorial staff. You can check advisor records with the SECOND (opens in a new tab) or with FINRA (opens in a new tab) .
