Business ownership can be more or less risky depending on the road you choose
They say there’s more than one way to skin a cat, and that holds true for business owners. Once you’ve decided that business ownership is for you, the next step is choosing the right path. There are essentially three ways to become a business owner. You can (1) start a business on your own, (2) buy an existing business, or (3) buy a franchise. Each has its pros and cons. Fully understanding these options will give you a better idea of which path to take.
1. START A BUSINESS ON YOUR OWN
Starting your own business has the most risk and possibly the most reward. Many aspiring entrepreneurs already have a vision for their ideal business, but for others, the first challenge is figuring out what kind of business to start. Questions to ask yourself are: “What am I good at/enjoy doing?” “Is there a market for this, and if so, is there a market where I want to have my business?” Or, if you look at it from the reverse angle, “what is there a market or need for my area?” “Do I have what it takes to fill that need or meet that market demand?” You get the point; you have to have an idea of what kind of business to start. Of course, to open your business, you will need start-up and working capital.
Pros of starting your own business
- Total control: The sky is the limit for your business plan. You own it. You can decide how you want to operate it. As long as your business is legal, moral, and ethical, you can do what you want.
- Autonomy: There is no one you must consult with to make a decision.
- Income: Traditionally, a start-up with a sole owner has the potential to make the most money because there is no one to split it with (other than the IRS). As the sole owner, the profits are yours to keep.
Cons of starting your own business
- You’ll have a lot to do: You will need to create your own operating systems, marketing and advertising, policies and procedures, etc. You will need to document the systems so employees can use them. (This also makes your business more scalable).
- Limited resources for help: SCORE and SBDC (business mentors) are available, but outside resources are few.
- Limited financing options: Most start-ups are self-financed, or you must seek investors on your own. Since
there is no income when starting a business, bank financing will be very limited to non-existent.
- Years before you make any money: Identifying and penetrating your customer base takes a lot of time and resources — making money is often a slow boil.
- High failure rate: There is generally a lot of time and money spent figuring out what works and what doesn’t work.
2. BUY AN EXISTING BUSINESS
Since it’s a known entity, buying an existing business poses less risk than starting from scratch. Some of the challenges include finding a good match.
Pros of buying an existing business
- Cash flow and goodwill: The business has money coming in and has developed a marketplace presence.
- Actual historical results: It has profit and loss statements as well as balance sheets that you can review. The tax returns are where you’ll typically find the most accurate information.
- Attractive to lenders: If the business is profitable (if it’s not, look elsewhere!) lenders may be interested in helping finance the purchase.
- Established location and customer base: Most businesses have a location where they operate. The business also has customers who are purchasing its products or services providing the cash flow mentioned above.
- Systems may be in place: Instead of having to create systems and experiment, there are already functioning systems in place. The more robust they are, the easier it is for the new owner to step in and keep the business operating efficiently.
- Owner financing: The owner generally carries a note on a portion of the purchase. Most banks will require this as part of their financing package. This way the owner/seller has a financial interest in a successful transition to the new owner.
Cons of buying an existing business
- What is the real cash flow? Some businesses have more than one set of books. Some industries are notorious for doing a lot of cash business that is often under or unreported. Making a buying decision is tough when you are not sure of the numbers.
- What is the goodwill? If it is all tied up with the owner and their personal relationships with customers and vendors, then that goodwill leaves when the owner leaves.
- Hidden seller motive: Knowing if there is a hidden motive is difficult, if not impossible, to discover. Is there a major account that is leaving or going out of business? What about new pending regulations for the industry or the local business area?
- Poor training/support by the former owner: Even with seller financing, the seller may not be all that motivated to provide the kind of training and support you really need.
- Limited availability: There are good, profitable businesses for sale, but they are limited in number.
3. BUY A FRANCHISE
Investing in a franchise offers a fast path to business ownership with a proven system. But just with the other two ways to become a business owner, there are pros and cons to consider.
Pros of buying a franchise
- Lots of choices: There are around 5,000 franchises in 80 or so industries, so you can usually find a franchise that will be a good fit.
- Projections are based on other franchisee’s results: You can talk to franchise owners who are already running the franchise. You can get a good idea of how you might do in the same business.
- Proven systems: This is what franchising is all about. A franchise’s proven systems and processes will help you be successful and mitigate risks.
- Not a first-time effort: Generally there are several — if not hundreds — of other franchisees that are in the business, so it is continually being refined.
- Home-based options: Service franchises that can be operated from home or a small office are much less of an investment than brick-and-mortar franchises.
Cons of buying a franchise
- Lots of choices: Because there are so many options, finding a good match can be difficult. A franchise consultant can help you narrow down the options through their assessment process.
- Not all franchises get good results: This goes without saying. You should be able to learn this through the validation process of talking to franchisees. Remember, anything negative you’ve heard about franchising is probably true in some cases, but it is NOT true of all brands.
- There will be some ramp-up time: There will be a time of no positive cash flow. You’ll need working capital and sources of money to pay your personal bills until the franchise starts making money. Through validation and talking to the franchisor, you can get a very good estimate of what this might look like.
- Royalties: Generally you will pay the franchise a percentage of your top-line revenues. The percentage or amount is disclosed to you in the Franchise Disclosure Document. By talking to franchisees (a.k.a. validation), you can understand what you get in return for the royalty, such as ongoing support, updates to the systems, new training, etc.
Going into business is a personal decision. For some people, starting from scratch may be the best way. For others, however, the reduced risk of a franchise is more attractive. Finding a good match and then going through the validation process can really help determine where the business can take you. In addition, with a franchise, you have a built-in support system that you do not have with either of the other options. Whichever path you choose, good luck with your leap into the world of business ownership!
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