Small Business 101

Essentials of Entrepreneurship and Small Business Management

If you are thinking about starting your own business, you probably have tons of questions about where to start. Get advice from Small Business 101 to learn more about the basics of entrepreneurship.

Norman M. Scarborough is the William Henry Scott III Associate Professor of Information Science at Presbyterian College, in Clinton, South Carolina. There he teaches courses in business law, statistics, management information systems, and small business management.

He's also the co-author of "Essentials of Entrepreneurship and Small Business Management" (Prentice Hall), which focuses on ways to build a business plan that is successful. Norman was online to take your questions and discuss his book.

The transcript follows.

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Pittsburgh, Penn.: Could you briefly explain the pros/cons of various corporate structures for a small business.

Thanks.

Norman Scarborough: There are three basic forms of ownership - plus a few special variations - from which entrepreneurs can choose. The three basic forms of ownership are the sole proprietorship, the partnership, and the corporation.

The simplest form of ownership is the sole proprietorship, which is a business operated by a single individual. The primary benefit of this form is its simplicity; one can start a sole proprietorship in a single day. You obtain any licenses that your local or state government may require and open the doors. The biggest disadvantage of this form is the unlimited personal liability of the sole proprietor. In other words, the business's debts are also the personal responsibility of the owner. If the company cannot pay its debts, creditors can (and will) look to the owner's personal assets to satisfy those debts. Entrepreneurs in "high risk" businesses where customers may file lawsuits for personal injury or professional errors should avoid this form of ownership.

A partnership is an association of 2 or more people who engage in business for the purpose of earning a profit. Like a sole proprietorship, partnerships are easy to create. However, I strongly recommend that anyone forming a partnership work with his or her partners and an attorney to create a partnership agreement that spells out the details of how the partners will run the partnership. For instance, how will you resolve tie votes on key issues? What contributions will each partner make to the business.

Two key disadvantages exist for partnerships: unlimited personal liability and disputes among partners. Just as in a sole proprietorship, at least one partner (the general partner) in a partnership must accept unlimited personal liability for the company;s debts. (Limited partners, who basically serve only as investors in the business, have limited liability; they can lose only the amount they have invested in the business.) Business history is littered with failed and broken partnerships in which the partners got into squabbles that they could not resolve. The best way to avoid these squabbles: create a partnership agreement and focus on communicating with your partners.

Neither sole proprietorships nor a partnerships themselves pay taxes; the net income of the business is passed through to the proprietor or the partners, who pay taxes at their individual tax rates.

A corporation is a separate legal entity from its owners, which means that those owners have limited liability for the company's debts - a big plus for many entrepreneurs. However, forming a corporation requires more work and more expense than the other forms of ownership. Creating one can cost anywhere from $500 to $1500.

Corporations have the greatest ability to accumulate capital for growth, but they suffer from double taxation. Because they are separate legal entities, corporations themselves pay taxes at a special corporate rate. Then, if the owner decides to distribute some or all of those profits as dividends to shareholders, those same profits are taxed again (this time at the shareholders' individual tax rates).

Two other forms of ownership, the S corporation and the limited liability company (LLC), provide entrepreneurs with the advantages of the corporate form of ownership (such as limited liability) while avoiding the disadvantage of double taxation. Like the sole proprietorship and the partnership, these 2 forms of ownership serve as conduits for the business's net income, passing it onto the individual owners, where it is taxed at their individual rates.

The LLC is growing in popularity these days because it offers most of the same advantages as the S corporation but it is not subject to most of the restrictions that an S corporation is. An attorney can help you prepare the necessary documents for an LLC -the articles of organization and the operating agreement.

Bottom line for choosing a form of ownership: There is no one "best" form. You should understand the advantages and disadvantage of each form and how they affect your individual situation. Then pick the form that is best for you.

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Vienna, Va.:

Mr. Scarborough,

Thank you for taking time to answer questions. I was wondering what is the best and easy way to write a business plan? How often do we have to look at it?

Norman Scarborough: You are already off to a great start simply by recognizing that you need to create a business plan before launching your company. There are several reasons to create a plan, including raising money for start-up. However, I think the most important reason for creating a plan is to help you create a strategy for success for your business. Creating a plan forces you to ask - and then answer - some tough business questions before you plunge into the market.

There are consultants available who will write a plan for you. I don't recommend this route, however. You are the driving force behind your business idea, and you need to be the driving force behind your business plan. No one can communicate your enthusiasm for your idea better than you can.

That is not to say that you should not enlist the help of others in preparing your plan, however. As you write your plan, consider getting input from bankers, attorneys, accountants, other entrepreneurs whom you respect, and others. What suggestions can they offer you?

There is a network of Small Business Development Centers across the US that can help entrepreneurs write business plans. They don't charge anything, and you can find a list of them at the Small Business Administration's (SBA's) Web site: www.sba.gov

Finally, you can use one of the software packages to help you write a plan - such as Business Plan Pro. Packages such as this one guide you in a question-and-answer format. They also make the financial section (one that befuddles many potential entrepreneurs) much easier. You can see some sample plans created with Business Plan Pro at the Palo Alto Web site: www.bplans.com

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Potomac, Md.: We're a small publishing company structured as an LLC that wants to create a stock pool to reward talented employees. What's the best way for us to do that?

Thank you.

Norman Scarborough: This can be very difficult to do with an LLC. The reason is that an LLC actually does not issue stock as a corporation does. Creating a stock option plan or an employees stock ownership plan (ESOP) is a great way to reward and to retain loyal employees. With an LLC, probably the best way to reward your employees is through a profit-sharing plan. Your attorney can help you set one up.

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Manassas Park, Va.: Hello. What are the chances of getting a grant to start to my business?

Norman Scarborough: With all of the changes in the government budgeting process these days, getting grants for business start-ups has become much more challenging. Loan guarantee programs have replaced many grant programs at both the state and local level.

For instance, the Small Business Administration (SBA) offers a wide variety of loan programs for entrepreneurs who qualify. These programs typically do not involve direct loans, however. They simply encourage banks and other lenders to make loans to entrepreneurs and small businesses by guaranteeing repayment of a certain percentage of the loan if the entrepreneur defaults. The result is a lower risk level to the lender for making the loan.

You can learn more about these loan programs (there are many!) at www.sba.gov, the SBA's Web site.

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Washington, D.C.: What are the most popular small businesses that are being started these days?

Norman Scarborough: Small businesses exist in practically every industry in our economy. However, the fastest growing sector for start-ups is the service sector - everything from home cleaning services and on-site computer repair to pet-sitting and day-care. One advantage of starting a service business is that start-up costs usually are lower. In some cases, you may be able to operate your company from your home.

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Silver Spring, Maryland: I am an administrative assistant. What are my options for starting my own business?

Norman Scarborough: First, you should take a personal inventory. What are your skills, abilities, and talents? What do you enjoy doing most? The best route to entrepreneurship is taking an avocation - a hobby - and turning it into your vocation - your business!

Look around for business ideas. They are everywhere! Have you noticed a particular need in your community that is unfulfilled? Sometimes great business ideas strike you when you least expect them to.

You can start your own business from scratch, buy an existing business, or go with a franchise. Franchising has become very popular across the globe because it allows entrepreneurs to be in business for themselves but not by themselves.

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Philadelphia, Penn.: Many new small businesses offer no benefits to employees. Is this giving them a competitive advantage against older businesses or may it cause such businesses to experience slow growth as they may face difficulty in obtaining and keeping a skilled and dedicated workforce that might soon leave for employment with benefits?

Norman Scarborough: You've hit on an issue that many business owners face today. Small companies often find that they cannot afford (especially in the face of ever-climbing healthcare costs) to offer the benefit packages that their larger competitors do, which makes it more difficult to attract and retain quality workers.

However, owners of small companies can use their creativity to reward their employees in other ways. One way is to offer key potential employees a share of the company's profits, something that not only gives them an incentive to stay but also to work hard to make the business more profitable. As the company grows, so does their compensation.

Also, owners of small companies can do lots of little things for their employees that managers at large companies cannot. One entrepreneur rented a movie theater in the middle of the day and treated all of his workers to a movie - on company time. Others have provided refrigerators stocked with snacks and lunches for workers to enjoy. Promoting from within gives employees the chance to move up a small organization must faster than they could at a large business. Also, praise and recognition not only are powerful motivators but they also are quite inexpensive.

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Lorton, Va.: Thank you for taking our questions. Do you know if SBA give loans to cover living expenses as well as start-up costs? The consulting business I am hoping to start has very little in the way of actual capital requirements, but giving up my job to start it is a major financial commitment. Can I get a loan to cover a "salary" to myself to cover childcare and other living expenses?

Norman Scarborough: Yes. When you get an SBA loan, it is actually a loan from a bank; the SBA simply guarantees part of the payment back to the back in case the entrepreneur defaults on the loan.

A "red flag" pops up when a banker sees a business plan that does not include a provision for the entrepreneur to pay his or her personal expenses during start-up. A reasonable salary for the owner (not an exorbitant one, though) is a legitimate business expense.

Your question also points out another important aspect of launching a company: In the early days, a company is very likely to experience negative cash flow. Your plan should show that you will have enough capital to get your business (and yourself) through this initial period of negative cash flow.

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D.C. area: What are some things aspiring entrepreneurs should be doing to prepare themselves right before they leave a full-time working situation? Finances, planning, etc.?

Norman Scarborough: One of the biggest adjustments for entrepreneurs who leave the corporate world is the reality that the steady paychecks no longer come in. The entrepreneur is the last one to be paid! I've seen entrepreneurs skip salary draws because cash flow in their companies was so tight. Sometimes that means lots of peanut butter (can't afford the jelly) sandwiches. That's why building a business plan with a sound financial plan in it is so crucial to business success.

Another adjustment comes in the area of decision making. In a corporate environment, there are plenty of other execs to bounce problems and ideas off of. This is not always true in a small business. You call the shots - good or bad! (That's why an advisory board can be a valuable addition to any small company.)

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Washington, D.C.: Can you tell me a bit about LLC? Is it a good choice for small business?

Norman Scarborough: LLCs offer the advantages that the corporate form of ownership does. (The primary one for most entrepreneurs is limited liability for the company's debts.) However, LLCs avoid the double taxation disadvantage of the corporate form of ownership (see earlier question).

Since its beginning in 1977 in Wyoming, he LLC has become quite popular now as a form of ownership because of the advantages it offers entrepreneurs. Some experts now say it is THE form of ownership. It does not face the limitations that the S-corporation does (e.g., a limit of 100 stockholders).

However, it is not the best choice for entrepreneurs who want to raise large amounts of capital through an initial public offering or who want to reward employees through stock ownership plans.

It is an excellent form of ownership to consider. However, the best form of ownership is the one that is best...for you!

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Rockville, Md.: Do I need to work with a business attorney before starting a business? Any Web sites related to this topic?

Norman Scarborough: Having access to a qualified attorney you trust is an excellent idea for entrepreneurs in the start-up phase. You are very likely to encounter many situations in which an attorney's advice will help you avoid more serious (and more expensive) problems down the road - ranging from the choice of a form of ownership to basic contract negotiations.

There are many Web sites that can help, but two I've found quite useful are www.nolo.com and www.cch.com.

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Falls Church, Va.: Hi Norman,

I am one of the would-be entrepreneurs and would like to know some of the basic costs or hidden costs that every new entrepreneur may need to know before starting a business?

Also, who should I make contact first once I find a new development center?

Thanks.

Norman Scarborough: Your question points out the need for a sound financial plan before launching a business. In addition to estimating their ongoing operating expenses (such as rent, utilities, salaries, wages, etc.), entrepreneurs need a realistic estimate of their start-up expenses. This is where it's easy to overlook costs. For instance, an entrepreneur launching a clothing store must purchase a business sign, display racks, hangars, and many other items.

Despite the best plans of any entrepreneur, there always will be costs that he or she never expected - license fees, deposits for utilities, etc. That's why it's always a good idea to build a cushion into your cost estimates. There always will be cost overruns, and you don't want them to break your budget!

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Norman Scarborough: This has been a real pleasure. Thanks for all of the great questions!! Happy managing!

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