Why Do Most Small Businesses Fail?

If you’ve ever been interested in working for yourself, or starting a small business, you’ve heard the statistic that most small businesses fail within the first 5 years. Why is that?

The most common reasons given are:

  1. Lack of experience
  2. Being under-capitalized (running out of money before you achieve profitability)
  3. Poor location
  4. Poor inventory management (Not having enough of an item, or having too much which may suck up all your capital)
  5. Poor money management (poorly structed business loans, co-mingling of finances)

But I think the most basic one is lack of any business sense whatsoever!

I went to get a smog check for my car registration and I called up several smog check test centers within a 10 mile radius. I got quotes that ranged from $37 to $70.  The fact that the highest quote was 89% higher than the lowest quote was quite interesting.

I decided that instead of driving 9.5 miles to pay $37, I could drive only 2 miles and pay $39.95. That’s a good compromise between time spent and money saved (especially in Los Angeles where it takes forever to get anywhere).  However, I decided to stop at the first one I saw and ask if they’d do a price match, especially since the store was completely devoid of any customers. I asked them how much it would cost and was quoted a price of $65. I told them the store down the street quoted me $40 and the manager said that he knew the owner of that place and they indeed offer a $40 price, but he could afford to offer that price because they did a higher volume and made money on repairs too.  The best he could offer was $55.

I tried arguing with him that they probably did higher volume precisely because the price was lower, and that his costs were fixed and the marginal cost of performing an additional smog check were significantly lower than $55 or $40 or even $20. When you consider that you have idle staff and idle machinery, the cost of running a machine for 20 minutes is just the cost of electricity which couldn’t have been more than a dollar. By price matching price-conscious customers, you’re engaging in a perfectly legal form of price-discrimination which allows you to attain your optimal profit levels. After wasting 3 minutes, I realized he wasn’t going to budge and he was perfectly happy to see me go 1/2 mile down the street to his competitor, which incidentally seemed to be running at 75% capacity.

So if you’ve ever wondered why some small businesses fail its because they’re run by incompetent morons who lack knowledge of finance, marketing, consumer behavior or sometimes just plain common sense.

What You Need To Know About Being Sued

Personal Finance blogger Lazy Man & Money is being sued by a multi-level marketing company called MonaVie that sells a very expensive juice. The crux of the matter is that Lazy Man is highly skeptical of the claims the company makes about the product and the company is trying to shut down his freedom of speech on the basis of a very flimsy trademark infringement case.

While I am no lawyer and the extent of my legal knowledge is limited, I have been sued, involved in lawsuits and have been sent threatening letters that required legal opinion. Did I say I was sued – that’s only partially correct. The company I had a minority ownership stake in was sued.  My friends and I started an internet telephony company together to sell prepaid calling cards and pinless dialing services. When we started it several years ago, we were tired of paying outrageous per minute fees for international calls and we just wanted to make free telephone calls. We also wanted to make some money off of it and after raising about $30,000 and co-signing $75,000 worth of loans for telecommunications equipment we realized we didn’t have any money left for marketing. So we deliberately decided to infringe on an existing trademark of a foreign company that does not do any telephony or telecommunication business in the USA. We knew we were going to get sued in a year but since we didn’t have any money left we didn’t really care.

We were able to use the goodwill of the foreign company to bootstrap our small outfit to the point where we hired about a dozen people in India to do all the back-end work.  A year later the company sent us a cease-and-desist letter and we complied and changed the name. However, I didn’t know that the main partner re-inserted the company in to the website after a month or so. About 6 months later, the company came back and sued us for trademark infringement, all our domain names, $50,000 and 30% royalties on all income.  When you fight a legal battle against people with deep pockets, you usually lose! Especially when you are wrong. Long story short we lost our domain name and we settled for $1,000. Was it worth it? In terms of return-on-investment, yes. There’s no way we could have gained that sort of traction with a $1,000 marketing budget. But would I do it again – definitely not. However there is a lesson here, the same lesson I learned from working for Michael Robertson a few years ago – you should never back down from a good fight.

On to the next story. A few years ago, I had put down a deposit on a spec home in Florida. It was a small deposit and it was pure speculation. If the home prices increased, I would close on it else I would walk away from it and my deposit. Unfortunately for the builder, the market turned sour and it seems everyone was walking away from their deposits. So I got a letter in the mail saying that if I didn’t close on the home he would sue for damages on various technical aspects of the contract.  I showed it to my lawyer and he said its a shake-down. His advice was to ignore the letter since the cost of pursuing this line of reason was too expensive for the builder.  He was right. Unfortunately, I found out the hard way that this goes both ways. Someone I know embezzled money from me and some investors by arranging  a sale of assets to an out-of-state entity. He set up a dummy corporation with the same name and deposited the check from the buyer into that account. He was then nice enough to wire us some of the money but then he skipped town with the rest. After talking to lawyers and the DA’s office in that town we realized that it would probably cost us between $25,000 and $50,000 to get a judgment against him, and if he’s spent the money, we’re out of luck! The lesson here is that suing people can get to be very expensive.

The third story is about me and a group of investors suing a group of real estate developers for deliberately misleading investors on an investment. The gist is they lied and withheld materially important information. Obviously we formed a group and sued them all. 1 of them settled for a third of the amount owed (plus interest and legal fees), 1 of them went underground and the 3rd is claiming she has no assets. The legal cases involved the last two are still underway so I can’t really say much about it except that suing people really does get very expensive, especially when you’re paying an attorney $375/hour to fly to another city and take a deposition!

So what’s my 2 cents on Lazy Man’s case? I don’t think MonaVie has a strong case and they know it too. Otherwise they would be wasting time with multiple cease-and-desist letters, they’d just sue him. Secondly, I think its just going to create more bad publicity for the company as multiple bloggers write about this and link back to Lazy Man’s site (boosting his rankings in the search engine for the search term – MonaVie is a scam). However, they’re obviously well capitalized so they’ll probably take this a lot further than they should. If it was me, I’d just pay Lazy Man to advertise on his site. That would just make him lose credibility in the eyes of the “faithful” MonaVie followers.

Please go visit Lazy Man’s site and try to link to it with the word MonaVie in the anchor text! Or if you want some entertainment, go visit Help You Sue.

Weekly Round Up Of Interesting Articles

Here are some must-read articles I’ve read this week. None of them talk about gold breaking a $1000, dividend stocks or things you’ve probably read in the news.

How To Start Multiple Businesses

A couple of years ago, I went to a real estate seminar and met a successful businessman. He was in his sixties and I was amazed to learn that he had more than a dozen small businesses going and was also trying to start his own bank.

Since I wanted to find out how did he manage to run so many different ventures, I offered to buy him lunch. (Incidentally, that’s a great way to cheaply pick the brains of someone who normally wouldn’t give you the time of day!)

Most of the various businesses he ran were some how interconnected and did a lot of business amongst themselves. Since they were in somewhat related fields, the management was a lot easier. For example, one of his businesses was writing newsletters for Trade Unions and another one was printing & mailing services.

I also learned that he had small interests in a dozen more businesses. He had cultivated great relationships over the years and whenever one of his friends needed advice on starting a new project, he would get the right people involved and help get them up and running. In return get a minority ownership stake in them, but then he moved on to other ventures. He also got a seat on the board of directors, so he had involvement in the general direction of the business but his actual time commitment was pretty small after the initial push.

I’ve always thought that was a great model to follow, especially for someone like myself with a short attention span! Not only do you not have to work a whole lot, but if have enough of these going, they provide economic diversity and lower your financial risk.

Recently I’ve partnered with some friends to create WebStigma, a  San Diego web development and web design company that focuses on business strategy and online marketing.

[Webstigma: san diego seo]

Between us, we have experience with creating business and social networking websites, creating online business development plans and strategies, web-based applications and providing search engine optimization and marketing solutions.

If you’re interested in hiring us, mention that you’re a reader of “Living Off Dividends & Passive Income” and we’ll give you a 10% discount. Use the contact page on the Webstigma site to get a quote. No project is too small or too large for us!

And the best part is that my partners know I’m going to be studying for my MBA full-time and are OK with me working only part-time.

Due Diligence For Businesses

Today’s guest post is from James at DINKS finance:

This posting will be on the topic of doing due diligence when evaluating investment opportunities. When I’m talking about investment opportunities, I’m speaking specifically about taking part in new business start ups. I’m not speaking about investing in stocks or loaning money to people at interest. To invest properly in new businesses, you’ll have to do what’s called “due diligence” or simply put you need to do your homework.

Here are some thoughts on doing this:

1) Research the market. All business operate within given markets. You should consider the demand for the product or service that your candidate business would produce. For example, if you might be considering investing in an internet start up. In this case you should consider the demand for the software or service the company is producing. Is it an American company which is feeling pressure from Indian or China? Is the product going to be used by a growing industry? So, to summarize you might consider using the internet to get a sense of the market.

2) Talk to People. An acquaintance of mine took a position in a chain of Buritto restaurants in Louisiana. After hearing about the opportunity from his father he went to the restaurant and talked with the employees and a couple of the customers. In addition to talking with the businesses staff, you might also consider speaking with people you know who are knowledgeable about the industry you’re considering. For example, when my wife and I were thinking about doing a real estate development in Portland, we talked with my uncle, who is a contractor and keeps an eye on trends on real estate on the west coast. With his help we were able to determine that the proposed development wouldn’t be profitable, so we decided to shelve the idea.

3) Go Over The Numbers. You might consider sitting down with a spreadsheet and figuring out what the projected profit and loss numbers look like for the first two years of your prospective businesses. Consider factors like projected profits, the probability of losses, tax implications, staffing costs, etc. If under a set of reasonably conservative expectations your company wouldn’t be make money then you should think twice about investing. The main point here is to put some numbers to the situation to critically about the company’s potential profitability.

Finally, direct investing can be both a challenging but very rewarding experience. However, to avoid losses you’ll need to exercise due diligence. Hopefully these tips will help you think critically about how to do this.

How To Start A Vending Machine Business

If you’ve ever wondered how much money the vending machine guy at your office makes, here’s an excellent post by GeniusTypes on how he got into the vending machine business.

It all started with having an open mind and buying a route from someone who had lost interest for well below what it was worth.

You’ll see this theme repeated in many successful investment stories.

Every so often you’ll see ads in the local paper about the company that sells large office-type vending machines holding a presentation. Apparently, the charge $1000 each and it takes a long time to recoup your investment. Most of the buyers give up and sell them for $100-$200 each and the second owner usually has better luck.

GeniusTypes kept his initial investment low by understanding how to value the business to begin with. He thus guaranteed his success by keeping a large margin of safety. He was constantly following sales of vending machines and vending routes on ebay and when he saw a good deal, he pounced on it.

He immediately saw where he could cut costs to increase his net income. He also followed up on some leads and expanded his route and thus the value of his business.

Also note how he takes the positive aspects from Robert Kiyosaki’s books and doesn’t dwell on whether the book is based on fact or fiction. That’s an important virtue in successful people – they don’t spend too much time maligning others, they just focus on getting their own work done.

Click on this link if you’d like to see what vending machines and coin-operated business are selling for.

Starting An Ecommerce Site

If you’ve ever thought of starting an ecommerce site but don’t know how, a good place to start your research is over at Net Business Blog.

Check out the post on
The Golden Rules of Ecommerce where the author describes his experiences at starting an online memory store.

Its a long post but some of the main points are:
1. Love your customers
2. Implement Just-In-Time inventory management
3. Control your marketing budget, especially for print media
4. Learn about marketing and don’t spend too much on it if you can’t genuinely track the results
5. Have an exit strategy and know what sort of business you’re getting into up front. (whether you’re buying a low-paying job or a scalable business).

And if you want more info on starting an Ecommerce Site, you can check out the real secrets here.

The Ideal Business

Russel Richard of the Dow Letter has a great article on The Ideal Business.

I once asked a friend, a prominent New York corporate lawyer, “Dave, in all your years of experience, what was the single best business you’ve ever come across?” Without hesitation, Dave answered, “I have a client whose sole business is manufacturing a chemical that is critical in making synthetic rubber. This chemical is used in very small quantities in rubber manufacturing, but it is absolutely essential and can be used in only super-refined form.

“My client is the only one who manufactures this chemical. He therefore owns a virtual monopoly since this chemical is extremely difficult to manufacture and not enough of it is used to warrant another company competing with him. Furthermore, since the rubber companies need only small quantities of this chemical, they don’t particularly care what they pay for it — as long as it meets their very demanding specifications. My client is a millionaire many times over, and his business is the best I’ve ever come across.” I was fascinated by the lawyer’s story, and I never forgot it.

When I was a young man and just out of college my father gave me a few words of advice. Dad had loads of experience; he had been in the paper manufacturing business; he had been assistant to Mr. Sam Bloomingdale (of Bloomingdale’s Department store); he had been in construction (he was a civil engineer); and he was also an expert in real estate management.

Here’s what my dad told me: “Richard, stay out of the retail business. The hours are too long, and you’re dealing with every darn variable under the sun. Stay out of real estate; when hard times arrive real estate comes to a dead stop and then it collapses. Furthermore, real estate is illiquid. When the collapse comes, you can’t unload. Get into manufacturing; make something people can use. And make something that you can sell to the world. But Richard, my boy, if you’re really serious about making money, get into the money business. It’s clean, you can use your brains, you can get rid of your inventory and your mistakes in 30 seconds, and your product, money, never goes out of fashion.”

So much for my father’s wisdom (which was obviously tainted by the Great Depression). But Dad was a very wise man. For my own part, I’ve been in a number of businesses — from textile designing to advertising to book publishing to owning a night club to the investment advisory business.

It’s said that every business needs (1) a dreamer, (2) a businessman, and (3) a S.O.B. Well, I don’t know about number 3, but most successful businesses do have a number 3 or all too often they seem to have a combined number 2 and number 3.

Bill Gates is known as “America’s richest man.” Bully for Billy. But do you know what Gates’ biggest coup was? When Gates was dealing with IBM, Big Blue needed an operating system for their computer. Gates didn’t have one, but he knew where to find one. A little outfit in Seattle had one. Gates bought the system for a mere $50,000 and presented it to IBM. That was the beginning of Microsoft’s rise to power. Lesson: It’s not enough to have the product, you have to know and understand your market. Gates didn’t have the product, but he knew the market — and he knew where to acquire the product.

Apple had by far the best product in the Mac. But Apple made a monumental mistake. They refused to license ALL PC manufacturers to use the Mac operating system. If they had, Apple today could be Microsoft, and Gates would still be trying to come out with something useful (the fact is Microsoft has been a follower and a great marketer, not an innovator). “Find a need and fill it,” runs the old adage. Maybe today they should change that to, “Dream up a need and fill it.” That’s what has happened in the world of computers. And it will happen again and again.

All right, let’s return to that wonderful world of perfection. I spent a lot of time and thought in working up the criteria for what I’ve termed the IDEAL BUSINESS. Now obviously, the ideal business doesn’t exist and probably never will. But if you’re about to start a business or join someone else’s business or if you want to buy a business, the following list may help you. The more of these criteria that you can apply to your new business or new job, the better off you’ll be.

(1) The ideal business sells the world, rather than a single neighborhood or even a single city or state. In other words, it has an unlimited global market (and today this is more important than ever, since world markets have now opened up to an extent unparalleled in my lifetime). By the way, how many times have you seen a retail store that has been doing well for years — then another bigger and better retail store moves nearby, and it’s kaput for the first store.

(2) The ideal business offers a product which enjoys an “inelastic” demand. Inelastic refers to a product that people need or desire — almost regardless of price.

(3) The ideal business sells a product which cannot be easily substituted or copied. This means that the product is an original or at least it’s something that can be copyrighted or patented.

(4) The ideal business has minimal labor requirements (the fewer personnel, the better). Today’s example of this is the much-talked about “virtual corporation.” The virtual corporation may consist of an office with three executives, where literally all manufacturing and services are farmed out to other companies.

(5) The ideal business enjoys low overhead. It does not need an expensive location; it does not need large amounts of electricity, advertising, legal advice, high-priced employees, large inventory, etc.

(6) The ideal business does not require big cash outlays or major investments in equipment. In other words, it does not tie up your capital (incidentally, one of the major reasons for new-business failure is under-capitalization).

(7) The ideal business enjoys cash billings. In other words, it does not tie up your capital with lengthy or complex credit terms.

(8) The ideal business is relatively free of all kinds of government and industry regulations and strictures (and if you’re now in your own business, you most definitely know what I mean with this one).

(9) The ideal business is portable or easily moveable. This means that you can take your business (and yourself) anywhere you want — Nevada, Florida, Texas, Washington, S. Dakota (none have state income taxes) or hey, maybe even Monte Carlo or Switzerland or the south of France.

(10) Here’s a crucial one that’s often overlooked; the ideal business satisfies your intellectual (and often emotional) needs. There’s nothing like being fascinated with what you’re doing. When that happens, you’re not working, you’re having fun.

(11) The ideal business leaves you with free time. In other words, it doesn’t require your labor and attention 12, 16 or 18 hours a day (my lawyer wife, who leaves the house at 6:30 AM and comes home at 6:30 PM and often later, has been well aware of this one).

(12) Super-important: the ideal business is one in which your income is not limited by your personal output (lawyers and doctors have this problem). No, in the ideal business you can sell 10,000 customers as easily as you sell one (publishing is an example).

That’s it. If you use this list it may help you cut through a lot of nonsense and hypocrisy and wishes and dreams regarding what you are looking for in life and in your work. None of us own or work at the ideal business. But it’s helpful knowing what we’re looking for and dealing with. As a buddy of mine once put it, “I can’t lay an egg and I can’t cook, but I know what a great omelet looks like and tastes like.”

How to become a Billionaire

Donald Trump wrote a book called “How to think like a billionaire’, which is by far the worst piece of crap ever written on Investing.  A far better book is The Art of the Deal which you can buy for under a buck! [Warning: None of the Donald’s books are on humility. They’re on creating a larger than life image and full of self-promotion and bragging. But then he’s not known for being modest.]

Anyway, I digress. The main focus of this post is this article, 7 ways to join the billion-dollar club. It essentially focused on businesses, but I realized with applies just as well to Real Estate Investors.

Here’s the gist of it:

1. Create and sustain a breakthrough value proposition.
Only buy value. Don’t go for those speculative deals and risky investments. Like buying in San Diego after everyone and their mother has gotten into investing there. Buy in places were the locals are still skeptical.

2. Exploit a high-growth market.
Find out which places are set to explode in terms of population and job growth.

3. Focus relentlessly on cash flow.
Hell yeah! Don’t buy property which doesn’t cashflow even after you put 20% down. That’s speculation. You’re not buying the value, but the hope that’ll it continue to appreciate and some other fool with take it off your hands.

4. Leverage big-brother alliances.
Find people like you and band together to get better pricing with builders and property managers. Even if you don’t always get better pricing, you usually get better service.

5. Pack your board with industry experts.
Always read up on the experts like WSJ.com and John Burns. Listen to the “gurus” but don’t follow them blindly. They always have something to gain so they’re advice is always biased.

6. Use marquee customers to build credibility.
Once you’ve done a few deals with partners, use them to promote your credibility. This is particularly useful when you want to raise money for a new project.[In my previous post I mentioned that buying foreclosures requires a lot of cash. This is where your credibility comes in handy].

7. Build an inside-outside leadership team.
You’ll need great people to handle the inside business[lawyers and CPAs] and the outside business[agents and property managers].

There you now know how to create a billion-dollar empire!

Check out my bookstore.

Buying a Cold Stone Creamery

A friend approached me over the weekend asking for advice on buying a Cold Stone Creamery.

We went over the numbers. They looked okay. The Seller was selling 5 of his stores for 1 times gross revenue [about 4 times net profit] or approximately $350-$400k each. He was willing to finance with only 20% down plus $20k franchise transfer fee which is a great way to get into it if you don’t have the money, or enough to qualify for an SBA loan.

The stores were located in good neighborhoods with 80,000+ people living in a 2 mile radius and in retail business centers doing over $1 billion worth of sales per year. The company requires a population of only 20,000 in a 2 mile radius and an average income of atleast $35k, but I don’t think these are enough to sustain the business. You want a LOT of people stopping by the store and they shouldn’t be too rich. Rich people live in population spare neighborhoods, have fewer children and are less likely to walk to the icecream store every night in summer since they’re out travelling the world. They’re kids are also less likely to work for $7 per hour so finding cheap manpower might be tough.

Apparently the seller claimed he was selling the stores because his brother was supposed to be doing the marketing and wasn’t pulling his weight. So he was getting rid of them. He said that there was minimal supervision required by the owners and it was ideal for absentee owners. I find that a little hard to belive that someone would sell 5 stores pulling approximately $100k each that required minimal supervision. Doesn’t matter how rich you are, $500k/yr is always a good chunk of change. I warned my friend that it could turn into a 2nd job that he wouldn’t be able to quit.

I advised calling up the Area Development Managers and asking them to have existing owners talk to them. They’re usually pretty honest about the requirements and efforts required to keep the stores operating successfully.


I kind of got interested in the deal and thought about partnering with my friend on it.

I had my CPA look at the numbers. Since I’ve referred him a ton of business and got him in some good investments, he doesn’t charge for this kind of stuff. He looked at the financials and said 2 things.

  1. Don’t pay more than 2.5 to 3 times the net income.
  2. He’s not making the $100k per store that he’s telling you.

So I passed on the deal. My friend was still interested and he got a potential partner who’s already in the business but was outside the area. But as soon as he found out who the seller was he said that guy’s a crook and bailed. So we both ended up bailing on it.

Doesn’t matter what franchise you’re buying, always show the financials to a competent CPA and try find out the background of the seller.

If you’d like to see listings of various retail businesses for sale, be sure to check out my business & investment store.

Update: As it so happened, after I posted this, a couple from Hawaii contacted me and told me how they had gotten fleeced by a seller of a Cold Stone Creamery. They over-paid for it based on fraudulent numbers and had both bought themselves low-paying jobs (minimum wage for 11 hours a day) that they couldn’t quit.

related post:

What To Look At When Buying A Dry Clearer Business