Blogs by William Manchee
4. Defending the Small Business: Suffocation
10/14/2008 7:22:33 PM
In the beginning most businesses can't support their overhead, so it's imperative to keep fixed expenses low to preserve precious cash.
In the euphoria of starting a new business, the temptation is to go first class. Unfortunately, first class is expensive. Most newly formed small businesses can't afford that kind of overhead, unless their business is a real cash cow, which is as rare as ozone over the North Pole. In the beginning, cash will be a precious commodity. This makes overhead extremely important because, if it is too high, the business will be in distress from day one.
You often hear that there are three important considerations in starting a business: location, location, and location. Too often the new business owner is obsessed with this principal and leases prime real estate for a three to five-year period at a cost the new business can't possibly support. By the time the business is up and running it is already in crisis. Each month cash flow is a major problem, distracting the owner from the critical needs of a new enterprise.
I remember a very bright entrepreneur who designed computer chips, Paul Blazer. For years he had a lucrative contract with TI, employed several other engineers, and was doing quite well—until the semi conductor industry went into a recession. His contract wasn't renewed, and there was little hope he could find new customers. Frustrated and depressed, he started looking for a new business. For whatever reason, he decided to open a restaurant. I told him the restaurant business wasn't a good choice as it required an experienced hand to be successful.
He just shrugged at this advice and said he had a new concept that was sure to take off in a hurry. He wanted to open a restaurant that exclusively served salads. It was in the very beginning of the health craze that was sweeping the nation in late 80s and there wasn't anything like it at the time. When he brought a proposed lease to me, I gasped at the huge base rental. The lease also provided for the payment of a percentage of revenue over a fixed amount in addition to the base monthly rental. When I suggested he find a new location, he informed me he and his realtor had decided this was the only location that was suitable for his new restaurant. After all, location is everything.
Fortunately, it's not an attorney's job to be a mother. Sometimes I had to let my clients make mistakes, even if I knew in my heart it was a big one. Nevertheless, this was such a big mistake that I persisted in objecting to the cost of the lease and almost got fired. When the restaurant opened to much fanfare, I held my breath.
Needless to say, the restaurant didn't last six months, but it wasn't because the concept wasn't good. In fact, salad restaurants popped up all over the metroplex soon after my client's enterprise hit the bankruptcy court. From day one the overhead had been so high the restaurant had no chance of success.
In order for the typical under-capitalized small business to survive, overhead must be kept very modest such that a profit can still be made even when times are slow. This is why there are so many small, successful family run businesses opened up by new immigrants. Labor being the most expensive operating expense, they have an advantage because the family members perform most, if not all, of the labor for the business. These family members don't have to get a regular paycheck and often work for food, lodging, and a little spending money, while they go to school or look for other employment.
I recall getting a call once from a man who had opened a Chinese restaurant, Don Chan. It was in a strip shopping center in a growing suburb of Dallas. It was his second restaurant but, unlike his first, he was compelled to staff the new restaurant with outside personnel since his family had its hands full with the first restaurant. Although business was okay, he had fallen behind on the rent and the landlord was threatening to lock him out. When Don came in and we looked at his finances more closely, I realized his business could never be successful because the rent and labor costs were too high. Even if we had filed a Chapter 11 it most likely wouldn't have been successful because the business couldn't make a profit given the rent and labor costs. He finally filed Chapter 7 and moved on.
Several months later I noticed that a Mexican restaurant had opened up in the same space in the shopping center. At the time I thought it was a very dangerous move since obviously this was a bad location for a restaurant. Curious about the new business, I had dinner there with my wife that night and introduced myself to the proud owner. In our conversation he acknowledged that most everyone operating the restaurant was family. The husband ran the wait staff, the wife did the cash register and some aunts and uncles handled the cooking. No doubt this new tenant got a better deal on the rent than the previous one, but I'm sure having much of his labor handled by family members was a significant factor in the new venture's success.
Ten years later we still eat at this restaurant at least once a week, and it just goes to show you that location isn't the only factor to consider in starting a new business. Overhead is as much of a consideration, if not greater.
Next - Starting on a Shoe String
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6 - Defending the Small Business - Giving it away. - Thursday, October 16, 2008
5. Defending the Small Business: Starting on A Shoe String - Wednesday, October 15, 2008
4. Defending the Small Business: Suffocation - Tuesday, October 14, 2008
3 - Defending the Small Business: Looting - Monday, October 13, 2008
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