Many professionals become small-business owners because they’re passionate about a particular idea or want to escape the corporate grind, not because they understand the financial aspects of running a company.
Mitchell Weiss, an adjunct professor of finance at the University of Hartford, teaches the basics of running a business in a class titled “Entrepreneurial and Small Business Finance.” He also leads a management consulting practice, through which he advises banks, private equity firms, and small to mid-size businesses.
Weiss’s upcoming book, Business Happens: A Practical Guide to Corporate Finance for Small Businesses and Professional Practices (due in September), draws from his expertise. The Intuit Small Business Blog recently chatted with Weiss to find out what common financial mistakes small-business owners make, how they can position their businesses to get a loan, and why they should be careful with crowdfunding.
ISBB: What are the biggest money mistakes that small-business owners make?
Weiss: It’s the legal structure, the taxation for that legal structure, and the costs associated with that legal structure. The most common legal structures used by small businesses are the [sole] proprietorship or partnership. It’s the least costly structure to set up, and the taxes are paid on the personal level. The downside to that is that you have unlimited legal liability. If something goes wrong with the business, you’re on the hook, because you own it. There’s no corporation protecting you.
By contrast, the corporation — a C corporation or an S corporation — is more expensive to set up and maintain. You have higher taxes potentially. But you’re protected against legal liability, because there’s this corporation between you and whatever risk that you might be taking on as a corporation.
Should small-business owners hire lawyers and accountants to help set up their business structure, or can they take the DIY approach?
Oftentimes, people do these things on a shoestring. They’re going to go online and try to do it themselves, and there are really terrific sites online that facilitate setting up a business. But you kind of get what you pay for, and I’m an advocate of seeking out advice and paying for that advice as it’s appropriate.
I tell people to go to their trusted networks. Then you interview your prospective accountants and attorneys and determine whether you feel comfortable. There has to be some chemistry between you and the other side.
Pay the money upfront, get the advice that you need, and structure your business appropriately. The legal structure does make a difference, especially if this business is going to grow and you are going to need to attract some investment capital.
Once they’ve set up their business and they’re ready to seek out a bank loan or investment capital, what can small-business owners do to make themselves attractive candidates?
They need to have a plan that they’re executing on. In demonstrating that they’re also in control and properly managing the business, they’re producing financial statements that are of decent quality.
As the borrower, you want to present an accurate and comprehensive picture of your business. What it is that you do? Why you do it? What [is] your value proposition in your market? And the performance metrics. This is what I’ve done over the last x-number of months and years.
Then it’s a matter of negotiating, and businesses should evaluate the cost associated with the loan that they undertake. Now, financial services providers, whether they are banks or non-banks that are offering financing, are fond of splitting the cost into two categories: interest rate and fees. It’s really up to the business owner to determine what that cost is in the aggregate.
How has crowdfunding changed the financial landscape for small businesses?
It’s another source of funding to be considered. The issue is that loans that come from crowdfunding sources are not regulated the same way as loans that are made by financial institutions. It’s incumbent for the small business to really read through the terms and conditions of the loan document that’s being presented by the crowdfunding company.
You really want to focus on the terms and conditions and, in particular, you want to zero in on the default provisions within the contract. What you want to know is: Do you have the ability to cure (correct) it? How long do you have to cure it? And what are the repercussions if you don’t?
In many loan agreements, once you have a default, the loan not only goes into immediate collection and everything becomes due and payable at that time, [it] also assesses interest at a higher rate. You want to see what your penalty rate would be once you’re in default and that you do have the ability to fix it, so that you’re not facing this economic catastrophe where your loan is called.
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