Often when people go into business or start a small business they really don’t think through the details of what they are doing day-to-day as it relates to the long term health of the business or their personal financial health.
A classic example is the Personal Guarantee. When you go into business you will need to make financial commitments to various parties like landlords, vendors, etc. Most of these commitments are promises to pay. The real question is “Who is promising to pay?” Is it your company that is promising to pay or is it you personally that is promising to pay…or is it BOTH.
When you go into business did you form a corporation? LLC? Hopefully you did because those things can give you some legal protections that, if something goes wrong, you’ll wish you had.
A personal guarantee from the small business owner is often requested/demanded by vendors and landlords when new start-up business gets started or even with established businesses. The idea is the the landlord or vendor doesn’t want to rely solely on your business (corporation or LLC) to pay a debt. If the business fails they want the business owner, YOU, to be personally on the hook for the obligation.
Before you sign a personal guarantee make sure you understand what that means and consult with an attorney, these things can be tricky. I would also recommend that as a business owner you avoid a personal guarantee whenever you can. Nearly all vendors/landlords say that the personal guarantee is required and standard but believe me…they are not always required.
If you have signed a personal guarantee you may have the opportunity to withdraw it after you have some experience with the vendor or when the time comes for a lease renewal. Keep track of any and all personal guarantees you sign. You don’t want an obligation you forgot about to bite you somewhere down the road.
Don’t just automatically sign a personal guarantee, push back and avoid it if possible.
Also, keep track of every personal guarantee you sign because someday you may need to cancel or withdraw it.
Finally, seek advice from an business attorney before signing any material contracts or personal guarantees.
Here’s an article you might find useful regarding business partners:
I see many, many small businesses that use the business owners’ personal credit cards to finance their business. Although this is often an easy source of cash it can be a terrible way to manage and grow your small business.
Often the biggest issue we see is that the business owner doesn’t understand the relationship between the interest expense on the credit card debt as it relates to the net profits the business generates. We regularly see businesses where they are guaranteed to lose money on the sale of an item which the business owner set the price. Meaning the business owner thought he had priced the product to make a profit but in fact the price guaranteed a loss.
Here are some problems you might want to try to avoid. Here’s an example of what we see.
John owns a small sign business let’s call it SignCo. John started the business in his garage a few years ago and now he’s opened a shop in a small retail center. When John started the business he was a sole proprietor but last year he formed an LLC when he moved into his retail space. To get the retail space looking good John needed to buy some shelving, signs, cash register, chairs, etc. SignCo is too new and a bank won’t give the business a loan but John has personal credit cards and he puts his purchases on those cards. John has total of $20,000 on his credit cards and his interest rate is 18%.
John put together a budget for SignCo and he wants a 10% profit after operating expenses.
SignCo’s average sale is $100. How much does SignCo need to sell each month just to pay the interest on John’s credit card debts?
The answer $3,000 per month or 30 signs per month just to pay the interest on John’s credit cards. That’s $36,000 per year or 360 signs to pay the interest. It will take the sale of another $200,000 to pay the principal!
The math: $20,000 x 18% = $3,600/yer interest divided by 12 months = $300 per month @$10 profit per sign that’s 30 signs per month just to pay the interest.
The point is you need to understand the relationship between your profits and your debt costs before you make a decision to borrow money from anyone, including yourself.
Here are associated articles “How to Start a Business like you’ve Done it Before” and Business Owners and the Personal Guarantee
Finally, too many small business owners also fail to realize that personal credit card interest may not be tax deductible without some tricky accounting and documentation. If a business owner is running up his personal credit cards and then paying them off from his income from the business he is likely losing a substantial tax deduction, assuming he’s actually making a profit.
A very helpful book on managing small business finances:
Another article you may find useful:
Understanding the Inventory to Cash Cycle in Your Small Business
Many people we encounter think that starting a business based on a hobby is a good idea…it rarely is.
Maybe they’ve read too many “Do what you love” seminar headlines. The reality is, it’s either a business or a hobby and never both.
This recent article in the Wall Street Journal gives you a look into one persons attempt to turn their hobby into a business.
Buying a business has many challenges not the least of which is the due diligence process prior to the closing of the purchase. Most small business owners run their business with no thought of selling it. Their record keeping and bookkeeping are done for their needs and there is little or no thought given to how a buyer would view their information.
When buying a business Due Diligence has 4 basic areas of focus. Three of the four require the assistance of the seller:
- Industry Due Diligence: The seller is often the worst source for this information. Many small business owners have no real idea of the industry outside the 4 walls of their business. Get what you can from the seller but be prepared to conduct your industry due diligence with outside resources. Most industries have Trade Associations that can be a good source of information. Here’s a link to a Directory of Trade Associations
- Business Operational Due Diligence: This is where the seller has the most information. They usually can give you, the business buyer, every detail of the business process. During due diligence focus on understanding why the seller does something their way. Also, you will likely find that the business seller has not documented their processes very well or more likely not at all. When discuss operations with the seller try to take all the notes you can so that you can get focused on the critical areas you need to understand. You’ll have plenty of time later to figure out if you want to change something. Keep in mind that you will be replacing the owner so spending time focusing on what the seller actually does day to day is important. You might want to start a specific list and identify evey seller’s duty – daily, weekley, monthly, annually.
- Financial Due Diligence: This is the wild card. Different seller’s are all over the place on this. I’ve seen million dollar businesses run from a shoe box and $50,000 businesses with perfect accounting. Don’t focus on how they keep their books, just focus on how you can determine from their books if the information is reasonably accurate and you can determine how much money the business is actually making. Most small business financial due diligence starts with bank accounts. Do the deposits made at the bank equal the sales reported for the business? If not, why? Once you pull on that thread it will lead you to other questions.
- Technology & Intellectual Property Due Diligence – This is an area of rapidly growing importance. When buying a business make sure that the asset is owned by the seller. there are some obscure laws about who actually owns intellectual property once it’s produced. Also, often I.T. systems are licenses and not assets that themselves can be sold. Do some homework in this area and it could save you some headaches down the road.
We have a saying when buying a business, “There are good businesses with bad books, good businesses with good books, bad businesses with bad books and bad businesses with good books”. Make sure your due diligence helps you determine which kind of business you are evaluating. Understand the bookkeeping situation but don’t let that automatically disqualify a business for possible purchase.
Keep in mind that your goal is to buy a good business, not just buy a good bookkeeping system.