VIDEOS

People often think that starting or buying a business will offer them the opportunity to be their own boss, free from all authority and outside direction. True, small business owners don't have direct supervisors, but they are still subject to the needs and wants of their customers, the demands of the banks and landlords, the requirements of laws enforced by government bodies such as the Taxation Office, not to mention the ever-present competitive pressures from other businesses in the same market. And if you're part of a franchise system, the franchise will have a very significant influence over how your business operates. Hello, I'm Christine Kininmonth. On behalf of the ADF Financial Services Consumer Council, I'm going to take you through some of the facts, the fiction, the opportunities and the pitfalls of running your own business. In putting together this presentation, we're grateful for the assistance of the Australian Competition and Consumer Commission. The ACCC is an independent National Government Agency whose role is to enforce and promote compliance with the Trade Practices Act. The Act is designed to enhance the welfare of all Australians by promoting competition and protecting consumers, and also contains the mandatory Franchising Code of Conduct, which sets out a number of rights and obligations for franchisees and franchisors. We'll have more to say later about franchising. Our purpose is not to dissuade you from doing your own thing, but to help you to understand the realities of doing so. Owning your own business can be one of the most rewarding things you'll ever do, both personally and financially, but it can also destroy you, your family and your personal finances. Having chosen a career in the ADF and having committed to it for some years, you're probably a fairly motivated and self-disciplined person. If you're even considering being a small business person, you're probably quite driven to succeed. But if you're thinking about small business ownership as some kind of alternative, relaxed lifestyle choice, think again. It isn't. In fact, most small business owners work long and irregular hours. In many ways, they are the hardest bosses they'll ever have. Some people see a small business as a way to buy themselves a job, without having to work for someone else. But the financial and legal risks of being involved in your own business can be significant.  If you don't make healthy profits over and above your normal wage you could have bought yourself a very hard, very low-paid job from which you can't easily extract yourself due to legal obligations, such as leases, franchise agreements and personal guarantees. Losing your job as an employee is traumatic enough but if your small business fails, you'll often walk away with significant debts owing to an unsympathetic financier, which could result in your bankruptcy and the loss of your house. It's been estimated by CPA Australia that one in three new small businesses in Australia fails within their first year of operation. In the second year, it's two out of four, and by the fifth year, it's three out of four. The principal cause of small business failure is inadequate cash flow. You simply run out of money due to over-optimism, high levels of debt and poor or no business planning. In small business, cash flow is king. Without cash flow, you will fail. That's my personal guarantee to you. So what's going to make you the one in four who's successful in small business?

To help you answer that question, let's go through a list of issues, you’ll need to consider when thinking about going into business for yourself. Having a business plan sounds like a good start. The military excels at planning, so you'll be familiar with the concept. So many people go into a business, indeed they even part with their hard-earned cash or put their houses on the line to buy a business or franchise without any clear idea of their objectives. What they need to do, whether the business is likely to succeed, whether there's a market for what they propose to do, how much it's going to cost and how long and hard they need to work for the business to be the success that they desire. Remember, those who fail to plan, plan to fail. Imagine how stupid it would be to startle to buy a lawn mowing franchise in a desert. And what about starting a restaurant if you don't like working nights and you can't stand the public? Hard to believe? People do these and other similarly stupid things without a moment's thought. This kind of knee-jerk reaction can be very expensive and it's caused by a lack of planning and basic common sense. A business plan need not be hundreds of pages long, no need for paralysis by analysis, A couple of pages will do. And small business being what it is, you can be sure that the plan will change as you go. The key point is that you must discipline yourself to think through the issues before you start. Commit them to writing in a plan. If need be, retain the services of a qualified accountant to get you started. The bottom line here is that without a written business plan, there's a top chance that you'll be one of the many small business casualties that occur in Australia every year. An important part of your plan will be to consider your level of personal commitment to the business. Do you have the drive, the perseverance and the ability to take rejection again and again? To be a successful small business person you'll need a thick skin and the perseverance to come back for more punishment until you succeed. And even if you have those qualities, do you have the funding to start and to last the distance? Next, let's look at the cost of being in business.

Remember, banks generally don't lend to small businesses on a good idea, on blue sky projections or even on cash flow. Mostly, they want bricks and mortar security, your bricks and mortar and lots of it. If you're putting up your own cash to start or to buy a business or a franchise, remember you're taking a big risk with your life savings. Look at it this way, you're investing your own money in your own business rather than investing it in reasonably safe real estate or blue-chip shares or a superannuation fund. Do you want to do that or would you prefer to borrow someone else's money via a bank? One thing to remember in answering this question is that you would need to earn a much bigger return from investing your own money in your own business than you could get by investing in conventional and safer investments. Why? Because you're taking a much bigger risk and bigger risks should lead to bigger returns. That's the old risk reward calculation. Remember, when you go to the bank for a loan, they'll generally want your personal guarantee on top of your real estate. This means that should the worst happen, the bank can go for all your assets, not just your house. Sounds tough? It is. And that's why you need to plan for success and not leave everything to chance like so many people do. A useful rule of thumb in thinking about your need for financial resources is to ask yourself how long it will take for your business to succeed and then double it. Whichever way you finance the business; there's a big risk involved. If that were not so, everyone in Australia would be in their own successful small business. If you have the personal qualities and the funding, then there's a good chance that be one of the one in four that are successful in the first five years of operation. Having decided that you're a candidate for small business ownership, let's say you've identified a small business or a franchise opportunity that you'd like to buy. Well, the next step is to do what we call a due diligence. Due diligence is the legal terminology for homework, checking that the legal documents behind the purchase are in order and are drafted as much as possible in your interests and that the financial information provided by the seller is correct. Remember that if you're buying a franchise, the terms of the legal documents may not be negotiable, so you must be prepared to walk away from the opportunity if its terms don't suit. The due diligence step is where you should consider using a lawyer and a qualified accountant to help you. Provided you understand how much you'll pay and the services you'll get, and this should be provided in writing before you engage any professionals, this will be money well spent. The role of your accountant should be to help you analyse the contents and the truth of the seller's financial information on which the price is based and to help you reach a conclusion about whether the price is reasonable. Factors to assess here are how long the business has been operating, the stability and growth path of its revenues and profitability, its seasonality and the personal following of the seller. Of particular importance here is the ability of the seller to start up business again in competition with you. If you don't cover off this point, you could easily find that the seller sets up a new business nearby, which could easily result in losing all your newly purchased customers. You are paying for goodwill and an income stream, so it's vital that you take the steps to protect that. Your accountant and your lawyer should advise you on these factors, all of which will have an impact on the value the goodwill and the legal documentation of the business you're proposing to buy. Note that financial statements provided by a seller are generally unaudited, meaning sometimes they're not worth the paper on which they're written. I suggest you try before you buy. Work in the business for as long as it takes you to satisfy yourself that its financial position is as it is claimed to be. If the seller won't let you do that, walk away. Remember that you need not pay the purchase price upfront in one lump sum. Consider paying by instalments, just in case the figures of the business turn out not to warrant the price you agreed to pay at the outset. In business negotiations, he who has the gold makes the rules. You'll be in a much better position to negotiate a reduction in the price if the money is in your bank account rather than theirs. The matter of business values is very much an arm wrestle. In some industries, there's a standard method of valuation. That's also true of some franchise systems. However, in the final analysis, it’s up to you and the seller to be guided by your accountant here. But remember that most people think that their business is worth more than it really is. By the way, if the seller tells you that the purchase is a once-in-a-lifetime opportunity and you need to buy right now or you'll miss out, walk away. High-pressure selling is particularly common in the sale of franchises. The ACCC's Franchising Code of Conduct provides a cooling off period to deal with the worst of this. But you should still protect yourself by not being pushed into signing or paying until you are ready. There's always another day and another opportunity. Next, let's talk about business structure. How to establish a business Having decided to establish a business or to buy an existing one, the question then arises as to which business structure you should use. Should you be a simple sole trader or should you use a company or a trust? You should be guided by your accountant here. But remember the KISS principle. Keep it simple, stupid. The more complex your business arrangements are, the more expensive they'll be to establish operate and unwind. Don't assume that you must have a proprietary limited company. The tax benefits aren't necessarily as great as you might assume, and your protection from upset creditors is certainly nothing like as strong as it used to be. Similarly, with the use of trusts, this can be expensive and of no value if you have no low-income earning relatives to whom you can distribute income through a trust. So, ask your accountant to demonstrate to you the costs and the benefits of various structures. Of course, some of you will want to go into business with another person, typically a friend or a relative. Be warned, most of these arrangements, be they in partnerships or jointly owned companies, do not work and end in tears and disputes. Yes, it's one thing to be someone's friend or spouse. It's another thing altogether to be in business with that person 24 hours a day. So, if you must do it, understand that when the pressure is on, you must be tolerant. Accept that running a business with two bosses can be frustrating. You can't always get your way, and that you aren't always right. The adage, and quote; It's my way or the highway, end quote; does not apply. Can you accept that? Most small business owners cannot. Some people will buy into an existing business on the basis that the original owner will stay indefinitely or on a gradual sell-down arrangement Obviously, there are many possible permutations here, but the important thing is to seek professional advice from an accountant and or a lawyer before you commit yourself Sometimes, for example, you can buy or even be given what's called a minority interest in a company, that is less than< 50%, only to find that it's effectively worthless, because the only buyer under the company's constitution is the other owner, and he or she doesn't want to buy when you want to sell. So you're stuck with worthless shares. This can be overcome with complex option arrangements between the parties, but this needs to be sorted out upfront, not when there's a dispute taking place Another trap for inexperienced players is to buy the shares in the proprietary limited company that owns the business, rather than buying the business from that company the problem is that by purchasing the company that owns the business, you're also buying the company's debts not just its business. So, for example, if the company happens to owe a large amount of tax, and the due diligence process doesn't pick that up, you will effectively be stuck with the tax bill. Sure, you can sue the seller for misrepresentation but once the money has changed hands, undoing the deal and seeking compensation can be an expensive and unproductive exercise. It's better to make sure the problem doesn't arise in the first place. This brings me to the issue of being a director of a proprietary limited company especially in circumstances where you don't own the whole company, or at least you don't have control of it by owning at least 51% of the shares. Once upon a time, being a director of a company was seen as a prestigious, lucrative and relatively risk-free position. Nowadays, all that has changed. The position of a director of any company, ranging from your own business to acting as a remunerated director of a large public company to acting as a volunteer honorary director of a club or charity, can be quite precarious financially and personally. The worst position of all is to be a director of a proprietary limited company in which you own nothing or in which you have a small minority interest. In that situation, you have little say, no control, but maximum liability. So, before you take on the role of a director, think very carefully about what the role involves and why you're doing it. It's important to remember that once you've become a business owner, it's fundamental to keep proper accounting records. To help, there's software you can purchase or you can devise your own. An accountant can advise you about these options. For many, the keeping of accurate financial records sounds as exciting as watching paint dry. But if you don't do this properly from day one, your business will soon be out of control. You will lose track of your financial position and your taxation and other statutory obligations will become an administrative nightmare. If you don't like the idea of keeping these records personally, think about employing a part-time bookkeeper. But don't assume that other people will look after your money as though it's their own. Financial record keeping and management is an area in which you simply can't afford to take your eye off the ball. And now to franchising.

Throughout this presentation, we've made references to franchises. Many ADF members find this an attractive way of getting into business for themselves. The Franchising Code of Conduct, as I mentioned earlier, is a mandatory code that sets out the rights and obligations of the parties to a franchise agreement. The code is enforced by the ACCC and their website contains some excellent information about the code and franchises including a number of publications and real-life cases. We recommend that you should review the ACCC website and the many ACCC publications that explain the code when considering the purchase of a business operated through a franchising system. It's important to understand that while a franchise is your business to operate, there will be strings attached. These include that you may be bound by certain strict rules, some of which you may not like, or be required to follow certain complex procedures should you wish to sell your franchise, and that the franchisee or may be able to terminate your franchise in certain circumstances, leaving you without any ongoing business to operate or sell. Of course, there are obvious benefits as well, such as a proven system and hopefully a profitable business earlier than you might expect if you were starting from scratch. The ACCC stresses the importance of seeking feedback from the list of past and existing franchisees the franchisors must provide to prospective franchisees. This is the litmus test for a franchise. If the existing franchisees are satisfied with the business, then it's more likely that you will be true. Past franchisees will also have stories to tell. You'll need to balance what they say with the details from the existing franchisees.  You're the one investing, so you'll have to weigh up the information and make some sense of it. Finally, I can't overstate the importance of seeking professional advice from a lawyer and an accountant experienced in franchising before you sign on the dotted line, and certainly well before you hand over any money.

Much of this presentation has been aimed at ADF people starting out in a small business. Of course, at that point, people are generally optimistic, with no serious thoughts about selling out in 5, 10 or 20 years’ time.

While it's not possible to incorporate every possible exit strategy and legal documents on day one, you should think about this before you commence. For example, some people will set up a business that is so personal it will be worthless on the day of their retirement. Others will build the business with eventual exit in mind by way of a buyout from staff, a trade sale, the establishment of a franchise system or even a public float. Think about your exit strategy and talk through the possibilities with your trusted colleagues and professional advisors before you set up or purchase the new business. 

Consider how, as a business owner, you should organise your business and personal affairs to ensure an orderly transfer of your assets in the event of your untimely death or disability. You'll need to consult an accountant and a lawyer experienced in tax and estate planning. You may also need to consider the purchase of life insurance on key people, which is an oft-ignored aspect of small business structures. Without proper attention to these details, there is a significant risk that your estate and your beneficiaries will suffer unnecessary taxation, including capital gains tax. There may be shortfalls in cash flow arising from business disruption. And there may even be lengthy and expensive disputes between members of your family over the ownership of your business assets.

While your own business can be a lonely place, remember that there are people out there who can help you. Beyond your accounting and legal advisors with whom you must have a close working relationship, don't forget that a lot of information and assistance is available from Federal Government agencies, such as the ACCC, the Taxation Office, the Australian Securities and Investments Commission, state governments and regionally based business enterprise centres. Industry associations such as the Franchise Council, Chambers of Commerce and your local Rotary and Lions Clubs can also help, even if by just providing an opportunity to talk to people who've been there before you. Remember, the keys to success in your own business are disciplined planning, adequate cash flow, enthusiasm and long-term commitment. Without these, you may well be one of the three out of four casualties that we mentioned earlier in this presentation Before I leave you, let's recap. Before starting or buying a business, there are 10 steps to take. One, have a business plan. Remember those that fail to plan, plan to fail.

Two, what's the real cost of being in business for yourself? Do you have the funding to start and to last the distance? Three, do a due diligence and consider using a lawyer and a qualified accountant to help you. Four, when deciding which business structure is best for you, a simple sole trader a company or a trust, remember the KISS principle. Keep it simple, stupid. Ask your accountant to demonstrate to you the costs and benefits of various structures. Five, take care who you go into business with. It's one thing to be someone's friend or spouse. It's another thing altogether to be in business with that person 24 hours a day. And whatever your role, be sure that you know your responsibilities. Six, keep proper accounting records. If you don't like the idea of keeping these records personally, think about employing a part-time bookkeeper. Seven, if you're buying into a franchise, understand what you're in for. Speak to those already in the business. Are they happy? Why? Why not? And seek professional advice before you sign. Eight, think about your exit strategy and talk through the possibilities with your trusted colleagues and professional advisors before you set up or purchase the new business. Nine, what will happen to the business if something happens to you? Be sure to plan for all eventualities. And ten, being in business for yourself can be a lonely place. Remember that there are people out there who can help you. the most rewarding and exciting phase of your career.