By Joshua Dietz, JD, LL.M.
Small businesses have an essential role in the U.S. economic landscape. They are credited for approximately 47% of private sector employment, 40% of private sector payroll, and 32% of U.S. export trade value.1 However, despite the substantial statistics, small businesses still appear fragile.
The likelihood of having a successful start-up may be roughly equivalent to flipping a coin. About 70% of small businesses survive 2 years, 49% survive 5 years, and only about 33% make it 10 years.2
This raises two important questions: (1) What differentiates the successful businesses from the unsuccessful? (2) Can small business owners increase the potential for their business's longevity and success?
There is good news. Small business owners can increase their odds by planning, which has been credited as a primary factor resulting in significant improvements to overall business success rates. The following provides a general overview of four specific areas where business planning can be critical to longevity and success.
Entrance planning is an important first step for developing a stable foundation. The National Federation for Independent Business, which has been researching business start-up success rates since the 1970s, says the entrepreneur's approach toward pre-planning and evaluation for a new business has resulted in a 30% improvement in those success rates over the past half century.3 While business owners may be knowledgeable in their specific industry, more are recognizing that running a business requires experience and knowledge in multiple industries (e.g., tax, insurance, accounting, legal, banking, etc.).
Practicality dictates that a single business owner, or a small team of co-owners, cannot master every aspect necessary to operate a successful business. New entrepreneurs are increasingly utilizing a network of advisors and mentors.
While evaluating advisors and mentors, it is wise to recognize that experience matters. A study by MIT's Sloan School of Management compared U.S. Census data with Internal Revenue Service tax data and found that the most successful business start-ups were founded by owners in their forties.4 Researchers identified that entrepreneurs are also 125% more successful if they were previously employed in their respective industries prior to starting their own business.5 However, entrepreneurs, especially younger entrepreneurs, should not be dissuaded. Instead, this information lends credibility to the positive impact a team of knowledgeable and experienced advisors and mentors may provide.
Financial miscalculations are the most cited reasons for small business closings, and one of the top reasons businesses fail is because they simply run out of money.
All industries have a basic cost threshold and some businesses have higher operational expenses than others. Many businesses close because they either fail to obtain sufficient funding or that funding is not spent wisely. A common business mistake is to obtain loan financing for operational expenses that do not produce or increase revenue. Budgeting practices of successful businesses include having access to liquidity and targeting such funds for optimal use.
Another common oversight is not managing accounts receivable (AR) — the money owed to a business for services and goods that have already been provided. Essentially, companies with AR are financing their customers' purchases. Small businesses need to understand delays in payment receipts standard for their respective area or industry and have a plan to mitigate this area of financial risk.
Taxes are another critical area that catches many business owners by surprise. Most owners are familiar with federal individual income tax rates and they may even be aware of the federal self-employment tax. The reality is there are several applicable tax regimes that apply to every business (federal income tax, state income tax, state and local tax, payroll taxes, excise taxes, etc.), all of which vary depending on location, the particular industry, and other circumstances of the business.
Mistakes may result in missed tax savings opportunities and trigger severe penalties, not only for the business but also for the owners personally. Knowledgeable attorneys and tax professionals can help verify businesses are operating under the proper entity structure, using accurate accounting methods, meeting all tax reporting requirements, and paying the correct amounts to the correct tax agencies.
Exit planning, or succession planning, may cause owners to immediately think of retirement. But exit or succession planning also includes selling the business, passing the business to heirs, and exiting due to unforeseen circumstances such as disability or death. After investing significant resources into their businesses, it is important for owners to have a plan in place to collect the return on that investment and increase the success of ownership transition.
Numerous family businesses do not have an exit or succession plan and a significant portion of owners who plan to retire within five years have not identified a successor. A CNBC survey found that in the Baby Boomer generation, 78% plan to sell in order to fund their retirement yet only 30% have actually documented their plan.6 A successful business transition—especially one on which the business owner's retirement security might depend—takes time and a plan should be put in place well in advance.
In addition to planning for a successful exit at retirement, there is always a risk of an owner's death or illness. In such a scenario, having a manager or team of key employees in place who can independently operate the business is critical. With proper planning, such key players can be incentivized to remain with the business for extended periods.
Disability insurance or life insurance benefits can provide necessary liquidity to keep the business operating, avoid a fire-sale liquidation, or allow the business to be smoothly transitioned to a co-owner. Proper planning can ensure the financial security of the family of a disabled or deceased owner, without over dependence on the future success of the business.
Of course, business exit or business succession planning is neither quick nor easy, but its potential payoff may be the difference between a smooth transition with financial security, or business and family disputes and an increased likelihood of business failure.
Small businesses are an important aspect of the U.S. economic structure. Owning a small business can be a very rewarding endeavor, but it also requires consistent planning and investment.
The right team of advisors can help identify areas of concern in any existing business plan. They also can help design and implement financial, tax, and exit or succession strategies that address a business owner's individual goals while helping to increase the odds for the longevity and success of the business itself.
Joshua Dietz, JD, LL.M.,joined The Nautilus Group in 2020 as a member of the case development team. Prior to that, Josh focused his practice on estate, business, and taxation planning for individuals and small business owners. His legal experience also includes real estate, oil and gas, and insurance coverage litigation. Josh earned his B.S. in Interdisciplinary Studies from the University of Texas at Arlington, his JD from the Texas A&M University School of Law, and his LL.M. in Taxation from Boston University School of Law. He is a member of the State Bar Associations in both Texas and Florida.