Written by Doretta Thompson, Financial Literacy Leader at Chartered Professional Accountants of Canada
It’s estimated that around 260 businesses are started in Canada every day. That accounts for nearly 100,000 new businesses each year. Unfortunately, around nine out of 10 of these new businesses will close their doors by the one-year mark. Some may argue that the playing field in Canada is unevenly weighted against new business, so any steps you can take to better prepare yourself when entering the startup phase are beneficial.
Is it possible to entirely protect your startup from going under? No. However, avoiding common mistakes that many new entrepreneurs make is key to protecting your business.
1. A poorly thought-out business plan
A fully baked business plan helps clarify whether your business is viable. You get there by asking the right questions and doing your research – identifying the market needs and gaps, defining your go-to-market strategy and charting your business’ operational plan.
It’s not about words on the page. The purpose of the business plan is to appropriately plan for starting and developing your business. Here are some questions that should be answered in your business plan:
• What business need have you identified and how will your business meet it?
• What market research is available to validate the extent of the need?
• What are the profiles of customers that would value the business?
• What specific products or services will be provided at startup and subsequently?
• Where would the business operate? How will it operate online?
• How will the business attract customers?
• What is the market positioning?
• What equipment, facilities, systems and licensing will be needed to service customers?
• What personnel will be needed to service customers?
• What business structure and governance will be required to meet the needs of the business?
• What are the expected financial needs and forecasted results for the first three years?
• What risks are there to the business? What can be done to mitigate or address those risks?
2. Not understanding the difference between sole proprietorships, partnerships, and corporations – and selecting the wrong option for your business.
With your business plan in hand – and with the advice of your team – you should be able to determine how to best classify your business.
Sole proprietorships tend to be the least costly form of startup as well as the simplest to start. Though you will still need to register your business, you likely won’t need a lawyer to file any documents or keep a separate bank account.
If there are losses during the year, you may be able to claim them against other income, which can offer certain tax advantages.
The risk involved comes from mixing your personal and business assets. As an example, if your business is sued, you may lose personal assets if you lose. In other business structures you may be able to better protect your personal assets.
Partnerships are defined as the relationship that exists between persons carrying on business in common with a view to profit. They can be formed between individuals, corporations, trusts or other partnerships.
Partnerships don’t file an income tax return, rather all income and losses are flowed out to partners who report their share of income from the partnership on their own returns.
Typically, in partnerships, the costliest error to make is neglecting the partnership agreement. This document will detail how profits and losses are shared, as well as provide an exit clause for all parties.
A corporation is a distinct legal existence from its shareholders. It is the costliest to set up, but comes with its own set of advantages. You’ll typically pay lower tax, have more legal protections, and you can select any month for your year end.
3. Not planning for rainy days
Every business goes through lean times. For startups, that dry period may be frontloaded from the birth of your business and can stretch longer than you may think. What can you do to manage and protect your cash flow?
• have a line of credit in place to finance lean cash flow
• look for investment tax credits that can help alleviate startup costs
• monitor your cash flow and make your invoicing and billing processes as efficient as possible
• hire a financial advisor who can walk you through this process
4. Ignoring mentorship and talent acquisition opportunities
One of the major mistakes novice entrepreneurs make is wearing multiple hats and taking on more than they can manage. Are you a salesperson, a marketer, an administrator and an accountant? If not – you’ll either need to learn a bunch of new skills quickly or hire people with the right skills. You can hire staff as independent consultants or on a sub-contract basis which can reduce your legal and financial obligations as you’re getting your startup off the ground.
Don’t overlook the value an experienced mentor can have on your business. Having the expertise of someone who’s been through the learning curve of a similar business can help you avoid costly errors and increase your chance of success.
While mentors can be difficult to secure, as an alternative, you could consider gaining experience at a company that is already successful doing similar work to your startup idea.
5. Poor budgeting and money management
One of the biggest mistakes you can make with your startup is to overspend at the onset. Start with a shoestring budget, and don’t commit to heavy expenses until you know you’ll need them. For instance, starting out with co-working spaces or virtual offices can be an effective way of delaying the overhead cost of an office space. When you overcommit your cash flow, you can quickly find yourself in over your head.
When it comes to tax time and business expenses – if you can’t have a separate account, at least use a separate credit card. This helps keep personal and business expenses separate and helps identify which expenses can eventually be written off.
Going into a bit of debt with your startup is natural, but it does need to be paid back eventually. Interest costs can add up quickly – so be careful not to abuse your credit.
If you’d like to learn more about common startup mistakes – CPA Canada offers a financial literacy session designed to help you avoid these common pitfalls. Book your session today.
These are just a few principles that can help you avoid the common pitfalls faced by any startup. CPA Canada offers a suite of resources with your small business in mind. We also offer financial sessions designed with women entrepreneurs in mind.