Chapter 3   The business,
Chapter 3   idea
Chapter 3

The objective of this chapter is to help the new or prospective owner-manager to make a realistic, and hopefully objective, assessment of the viability of the proposed or new business venture. This chapter also relates to Unit A1 of NVQ Level 3 Business Planning, ‘Assess the potential of the proposed Business’, which in Element A1.1 is concerned with describing the business, how it will operate, and the goods and services it will be offering. Element A1.2 carries out an initial review of the marketplace and Element A1.3 encourages the evaluation of the likely success of the business. Whether or not the reader is pursuing the NVQ qualification, each of these three exercises offers a great deal of value in its own right in setting the scene for the ensuing parts of the business plan.

The business idea section of the business plan, the structure of which was outlined in the previous chapter, plays a key role in introducing the proposed venture to any banker or potential investor. It is intended primarily as an overview of the business plan, and as such, it does not have to be crammed full of detail – that can follow later – but it must be regarded as a principal opportunity for promoting and selling your business. The fact is that, unless the introduction can provide a concise, positive and optimistic (but still realistic) summary of the business opportunity that will whet the appetite of the reader, then the chances are that any potential banker, financier or investor will simply not bother to read any further. It must, therefore, project and reflect the proposer's confidence and belief in the proposed business, and emphasize and justify that same belief. It is simply no good stating ‘Well, I think that it might work’, as the bank manager would be quite justified in saying ‘Then come back and see me when it has’. It is important, therefore, to think positively and to use positive language throughout the business plan: you do not hope to succeed, you expect to succeed; you will do something, rather than might do it.

In my experience, most new or aspiring entrepreneurs tend to overlook two fundamental points. First, bank managers do not have unlimited funds to lend, so your proposition needs to stand out from the crowd and justify the bank manager's decision to lend to you. Second, the business plan is not just a factual document. One of the primary skills that any owner-manager needs in order to succeed, is the ability to sell their goods or services to the customers. Naturally, when a bank manager is appraising any business plan, he or she will be looking for evidence of those selling skills. So for that very reason it is important that the initial part of the business plan not only grabs their attention, but also starts to demonstrate the presence of those selling skills. Put yourself in the bank manager's shoes – if you are unable to project to the bank manager your own belief in the viability of the business, then why should he or she believe in it?

NVQ candidates who are working on Unit A1 will need to evidence the following items:

•   The nature and purpose of the business, new business, purchase of existing business, franchise etc., discussed below.

•   The way in which it will operate, i.e. the trading status, again examined below.

•   Any legislation which will affect the business. This is examined in detail in Chapter 5.

•   The intended market(s), range of products or services and the customers’ needs, the potential size of the market, identifying your competitors and any potential barriers to entry into the market. These aspects are covered in detail in Chapter 9.

•   Any external factors which might influence the business, e.g. economic factors.

•   The financial requirements to set up and operate the business. These are examined in Chapters 6, 7, and 8.

•   The management and technical skills that will be needed for the business, which are assessed in Chapter 4.

•   The likely profits which will be generated by the business. This is also considered in Chapter 6.

So, having recognized that each of the above areas will be covered in more detail elsewhere in the business plan (or the NVQ portfolio), at this stage the evidence primarily comprises a statement summarizing those key points.

The purpose of the business

The very first point that must be explained is the nature of the business activities. It may well be that the business will focus on providing just one type of goods or service – a chiropodist, for example, carries out medical treatment to people's feet. However, in some cases, the central goods or service may be accompanied by a secondary line, for example, some chiropodists also carry out reflexology (foot massage) treatments.

It is important from the outset that the primary and secondary activities are clearly defined in an initial statement, so that the reader is immediately informed of the nature of the business. For example: ‘I intend to set up in business as a mobile caterer specializing in private functions such as weddings and parties. Alongside the provision of food and drink for weddings, I can also offer secondary associated services. These will include the supply of wedding cakes, licensed bars, chauffeur-driven cars, discos, flowers, and wedding photography, which I will arrange as part of a complete package for my clients and for which I will receive a percentage commission from the specialist suppliers.’ In this case, the primary service of food and drink for functions is clearly stated, and the secondary income from supplementary services is also explained.

Is this a new or existing business?

This is an obvious, but still important, question to answer for the benefit of any potential financier as the answer to it will invariably raise a series of further questions:

•   Is this a new business that you are setting up from scratch? If so, assuming that you have done your market research and justified the viability of the prospect, then you must identify the lead time between start-up and reaching an ongoing operating profit. This leads to the questions: ‘Are your financial resources adequate to cover that period?’ or ‘What could possibly go wrong that might delay your trading at a profit?’ and ‘How would you cope with that problem?’ You need, therefore, to be in a position to answer these questions if asked, and ideally your business plan should demonstrate that you have considered them.

•   Are you setting up a franchised business? If so, you should be able to demonstrate the type and level of support available in the early stages from the operators of the franchise, and confirm their reputation as franchisers. How well known are the franchised products or services? Have you spoken to other franchisees to investigate their experience in the early stages? Do you have any exclusive operating area rights to protect you from neighbouring franchisees? Are you tied in to a long-term contract? Do you face any penalties if your franchise fails?

•   If you are buying an established business, are you sure of its long-term viability? Is it threatened in any way by new developments in the area or by incoming competition? Will it be affected by any economic or legislative factors? Are you paying a fair price? Has your contract to buy been checked by a solicitor and the financial books examined by an accountant? Why does the vendor want to sell in the first place, and is the reason given genuine? Will you be able to make a reasonable return on the capital invested?

The legal format of the business

In the process of describing the proposed business, the reader will need to have made some basic decisions about the format of the business, e.g. whether it will be operated on a sole trader basis, as a partnership or a limited company. In doing so, the reader may also need to consider some of the legal aspects described in Chapter 5. First, however, it is worth examining the various options of trading status in more detail.

Sole trader

Being a sole trader is not simply a case of being a one-man band, as many sole traders actually employ quite a few staff – just think about some of the local builders or trades people in your vicinity. Sole trader status means that the person who owns and runs the business is solely responsible for its profits, losses, legal and statutory obligations, liabilities etc.

On the positive side, this means that the sole trader does not have to answer to anyone else (unless married!), and is solely responsible for decision-making. It is easy to start trading, as all that is necessary is to inform the local Inland Revenue office by completing a standard form which is available from the tax office, Department of Social Security or the local Customs and Excise (VAT) office. All profits are retained by the proprietor and he or she can determine the hours worked, duration of their holidays, etc. With the aid of a good accountant, they can also minimize tax liabilities, as they are taxed on the profits of the business rather than the wages or drawings taken from the business. In fact, the overall operation of the business can be quite simple.

This all sounds very attractive, but naturally there is also a downside. As well as retaining all profits, the sole trader is directly liable for all losses, without any limit to the liability. If the business folds, then creditors can pursue the sole trader's own personal assets: home, car, jewellery, savings, and all but the very basic possessions. Attachment Orders can also be made against future earnings. Unless the business is sufficiently large to employ staff, working hours can be long, holidays are often few and far between, and there is often no backup in the case of illness or accident. It can also be lonely having to make decisions without anyone with whom you can discuss issues or problems, or ask for an objective and honest opinion. Capital is also hard to raise without security, although that problem can be true of most new businesses.

Legally, unless they are subject to special registration or reporting requirements for a particular trade or industry (e.g. environmental health registration for caterers), the statutory reporting requirements are quite simple. If sales turnover is less than £15 000 per annum, then a simple three-line tax return is sufficient (sales less expenses equals profit), and above that level the sole trader need only complete the appropriate parts of the annual self-assessment form for tax purposes, profit and loss account details etc. Once sales turnover reaches £50 000 per annum then, like any other business, it is necessary to register for VAT with HM Customs and Excise, and to make the necessary quarterly returns and payments, as described in Chapter 5. Also, if employing staff, then income tax and National Insurance contributions (NIC) must be deducted from their wages or salaries under the Inland Revenue pay as you earn (PAYE) system. Sole trader accounts do not have to be audited by a chartered accountant, but all records do have to be retained for a period of six years. Profits, less legitimate business expenses and personal allowances, are taxable and every sole trader must pay Class 2 NIC, unless income is low. Class 4 NIC is also levied by the Inland Revenue according to the level of profits.

Partnerships

A partnership is a business involving two or more partners who are trading together as a single business. Typically the business relationship will be formalized under a legally constituted and legally binding partnership agreement (see Partnership Act 1890 in Chapter 5), and the Inland Revenue have to be informed when the partnership starts or is closed down.

Many people find the added security offered by a partnership to be attractive. For example, with two or more people working together, there is usually a better interaction of ideas when it comes to decision-making – two heads are better than one. There is also the mutual support available in the event of illness or accident, and to facilitate more flexible working hours and holidays. Profits are retained by the partners and, whilst shared, will often be greater than the same individuals could achieve by working separately, because of the savings gained by sharing administration and overhead costs and by using specialist skills and expertise. For example, one partner may have strong sales skills, whilst the other may have better financial and administrative abilities. A partnership may also provide an easier means of raising finance or of providing a greater sum of available finance; where, for example, available monies are pooled or security for loans is shared.

Again, however, there is a negative side to partnerships which should not be underestimated. It is often said that there is nothing like a business partnership to test a friendship, or to divide a family in two! Differences of opinion can arise over what direction the business should take, or over who is working the hardest or longest hours, or drawing the biggest income from the business. The cracks become more noticeable when the business is under financial pressure or when individual partners come under pressure from their own spouses or families. It is hard to convince your spouse that you cannot afford a holiday this year because the business needs a new van, and then to see your business partner go off to the Costa del Sol a week later.

The biggest drawback of partnerships is the personal liability of the partners for the debts of the business, that is, the ‘joint and several liability’ wherein each partner is liable for their own proportion of any debts plus the liability for the debt as a whole. Consider the following cases.

Case studies

True, legal redress can be obtained, but the cost, aggravation and lengthy timescales involved often do not justify the effort.

The moral is to be very sure of the person or persons with whom you are going into partnership. Can you fully trust them? Are they honest? Are they reliable? Are their objectives for the business the same as yours? Do they also regard it as a long-term prospect, or is it just a ‘get rich quick’ idea in which they will lose interest when the going gets tough? How does their level of investment compare with your own, i.e. who is taking the most risk? Do they have any business skills or experience? What can they offer you that you cannot get by employing someone? These are just a few of the questions you may need to ask yourself before making a full commitment.

From the point of view of legal reporting, the requirements for a partnership are very similar to those for the sole trader. The same accounting returns have to be made on turnover, expenses and profits for tax purposes. The PAYE and National Insurance requirements are the same, as is the VAT threshold, which is more likely to be reached when two or more people are generating income for the business.

Limited company

Limited companies are generally regarded as being of a higher status than sole traders or partnerships. They can be purchased quite readily ‘off the peg’, via weekly publications such as Dalton's Weekly or Exchange & Mart. The new companies are set up en bloc up by specialist firms, offered for sale for approximately £200, and then renamed as required to start trading. Assuming there are no anticipated problems with the proposed trading name, once the company has been purchased and company officers nominated the company can start trading almost immediately. Alternatively, they can be set up very cheaply from scratch, under the proposed operating name, in about four to five weeks without much legal advice. In reality, to avoid the time delay and administration involved, it is much simpler to pay a little more for a company from a specialist supplier and then simply change the name.

The main documents required in order for the company to operate, are the Memorandum and Articles of Association which define the company's legitimate trading activities and powers to raise finance. The company must also maintain a Minute Book in which to record the share capital, issue of shares, details of company officers, minutes of annual general meetings etc. Every limited company also has a company seal which is affixed to official documents and contracts. Responsibilities and duties of company officers are established in law, and necessary statutory returns (and penalties for non-compliance) are specified by the Companies Acts.

The key difference between sole traders and partnerships, and the directors who own or manage limited companies, is that the former are self-employed but directors cannot legally be so as they are employees of the company. This is because the limited company is a ‘body corporate’, i.e. it has a legal existence in its own right, irrespective of the persons who own it, invest in it or manage it. Similarly, whereas self-employed sole traders and partners are taxed as individuals and pay income tax, a limited company having a corporate identity, is liable for corporation tax. It is the same corporate status that makes the liability of its owners limited. This means that unlike sole traders and partners whose liability for business debts is total, the owners, investors, shareholders etc. of a limited company are only liable for the sums which they have already invested in the company, or which they have guaranteed on its behalf. (That liability also includes the value any shares which are issued but not fully paid up.) If, therefore, the company becomes insolvent, the creditors can only pursue the assets of the company and cannot take action against the shareholders or directors, except in the case of fraud or negligence by those same persons.

On the face of things, this seems a very attractive and low-risk way of setting up a business, as the limited company approach ostensibly takes the owner one step back from potential creditors. However, things are not that simple. I heard of a retired middle manager from a water authority who had no direct experience of small firms, but who was telling a business startup group that if they wanted to be taken seriously they must set up a limited company. This was because ‘sole traders and partnerships have no real credence in the business world’. In reality this is total nonsense where new businesses are concerned, because a newly established limited company with no financial track record, and with only £100 of issued share capital, is totally unattractive.

For any start-up business the two foremost problems consist of finding the finance to get started, and then obtaining credit from suppliers to trade and expand the sales of the business. It matters not whether you are a sole trader or a limited company if you have no proven track record and no tangible assets or security to offer, in which case borrowing money or obtaining credit will be hard. This is because you will be unable to provide any necessary trade references and, in the case of limited companies, a search via Companies House will show no accounts as having been returned. Quite often, suppliers of goods to limited companies will take a harder line than that taken with sole traders, simply because they know that it is easier to recover debt from a sole trader than from the owners of a limited company. It is quite common for initial terms of supply to be based on cash with order, or cash on delivery, with credit facilities being withheld until the buyers have proven their reliability. Even then, credit may be limited to a fixed monthly maximum figure, or to payment within a fixed period of time, until a good working relationship has been established.

In terms of legal and statutory reporting requirements, owners of limited companies have more onerous obligations than their self-employed counterparts. For those with a relatively low turnover (under £2.8 million) the submission of abbreviated accounts is permissible, but for the majority, it is necessary annually to submit full audited accounts to the Registrar of Companies. The annual returns, etc. are examined in more detail in Chapter 5. In addition, as all directors are employees of the company, all staff come under PAYE and National Insurance regulations, plus the additional requirement to provide the Inland Revenue with details of all expenses for each director and higher paid member of staff. Value added tax thresholds are the same as for any other business.

In summary then, the limited company option is probably more suited to the type of business which foresees steady and continuous growth and employment of staff, whereas the smaller business which is not looking for substantial expansion would probably benefit from remaining as a partnership or sole trader status. Having said that, the government's 1999 Budget contained tax incentives to effectively encourage sole traders and small partnerships to trade as limited companies, as those are easier to monitor and control via the Registrar of Companies.

Co-operative

The fourth trading status option for smaller businesses is to become established as a co-operative or joint ownership venture, wherein the business is owned and controlled by a minimum of seven members, normally but not necessarily its own employees, as there can be non-working members. This is usually described as a ‘workers co-operative’ to distinguish it from the various Co-operative Retail Societies (Co-op shops) across the UK which are in effect customer-owned co-operatives. Although co-operatives are normally limited companies, they can be societies or even partnerships (the John Lewis Partnership of department stores is a good example of this) as they are regulated and registered under the Provident Societies Acts (1965–75). This means that all the business policy, assets, and profits of a co-operative are controlled by its own members (or staff) who all have equal voting rights in how the business is organized and managed. Wages are paid to staff, and surplus profits (dividends) shared between them according to their level of participation in the business. Like limited companies, registered co-operatives are classed as a ‘bodies corporate’ and are subject to corporation tax although, if unregistered, they are treated as partnerships with unlimited liability for the losses or debts of the business. When registered in the form of a limited company, their reporting requirements will be the same as those of normal limited companies, as will be the operation of PAYE, tax liabilities, VAT registration, etc.

Involvement in a co-operative does usually generate a high level of commitment from its members, as they are effectively working for the good of themselves as well as the co-operative and they participate in the management and decision-making processes. At times, however, this democratic process can be counterproductive, when business decisions are based on personal feelings or interest rather than sound business practice. Where co-operatives have been created as worker buyouts of failing businesses when faced with possible redundancy, the result is often the continuation of inefficient labour-intensive working methods to maintain employment for members, which can threaten its own success or survival.

The government's Co-operative Development Agency exists to advise any potential co-operatives how to set themselves up. These days, apart from special areas of mutual interest (e.g. organic farming, social or environmental interests), co-operatives are relatively uncommon, and certainly there is little or no commercial advantage to be gained from setting up as one.

External influences

It is relatively easy to identify the factors which will impact on the viability of a business from within the business itself (staff, management skills, available finance, etc.) and from the market environment (size of market, demand for goods and services, competition, etc.). However, most aspiring owner-managers find it much harder to focus on the broader influences, particularly if they are not familiar with economics or do not have a great deal of interest in politics or current affairs.

One of the most widely used methods of analysing these factors is the PESTLE analysis, which categorizes the factors under the six main headings of Political, Economic, Social, Technological, Legislative, and Environmental influences. The precise relevance of these will of courses, depend on the individual organization, its particular geographical location, and the market in which it operates; so these are best illustrated with a few examples.

Political influences

These would include such things as government policy on transport, unemployment, regional development, education and training, etc. So, for example, there may be financial incentives to locate a new business in a rural development area; or perhaps on a site close to where a new motorway junction is to be built. Foreseeable changes in policy may also present a threat, such as the heavy taxation of petrol and diesel to persuade people to use public transport. This will obviously create an ever-increasing overhead cost to any business which is involved in producing or transporting bulky goods over long distances. Can you identify any government policies which might influence or impact on the operation of your business in the near future?

Economic factors

These can take on many different aspects, and can be hard to forecast in the longer term as the international economic situation is influenced by a multitude of national policies, changes in demand, recession, inflation etc. For example, high interest rates and a steady and relatively low level of inflation in the UK has resulted in a strong pound during the late 1990s, making imports cheap but exported goods expensive, so exporting companies have noticed a general decline in sales. At the same time, financial problems within countries in the Pacific Basin made their currencies weak and their own exports cheaper to buy in the UK. Interest rates are often used as a mechanism to control inflation, but invariably also impact on rates of exchange of currency so that the combination of higher interest payments on loans coupled with falling export sales could seriously damage cash flow for a small firm. Higher interest rates can also reduce the amount of disposable income for consumers, who then focus their spending on necessities rather than luxury goods. This is not so good if you are planning to set up as a producer or importer of those same luxury goods. The question is, which of these economic influences might be relevant to your particular proposal, if not immediately, then over the next few years?

Social influences and trends

These tend to occur more slowly and are therefore a little easier to forecast than economic trends. Since the late 1970s there has been an increase in public awareness of environmental and conservation issues, and a move towards reducing waste, recycling etc. Corresponding to this, there has been a similar reaction against products which are not regarded as environmentally friendly, so producers and suppliers have had to respond to these trends and modify their goods and services accordingly. A parallel trend has been the change in attitude to healthy living, with fewer smokers, more people taking regular exercise, and a proliferation of organic foods and health products. This change in lifestyle has accompanied a change in expectations of the goods and services people buy, particularly in terms of the brand image and quality of the goods and services on offer. So how do these recent trends impact on your goods and services? Can you identify any other changes that are now, or might in future, be relevant to you?

Technological change

The first electronic calculators came on general sale in the early 1970s, with limited capacity but very expensive compared with other consumer goods. These sold for £25 each at a time when petrol was 50p per gallon, beer 20p per pint, and only large organizations could afford a computer for their accounts. Within ten years, stand-alone computers arrived, featuring a huge 10 megabytes of memory and costing as little as £5000 each! Now they cost a tenth of the price, run 500 times faster, and have 1000 times as much memory. In the 1960s and 1970s everyone spoke of the time before the end of the century when we would all be working just twenty hours per week for the same level of income. The 1990s would be the Leisure Age. In reality, technology via robotics and computers has chopped the number of people now working, and those who are working tend to work longer hours under much more pressure – particularly amongst small firms. People increasingly work from home, or away from the central business locations, using electronic communications systems. The point is that technology changed must faster and in different directions in the last twenty years of the twentieth century than had originally been forecast. Although it is virtually impossible to predict the rate or direction of change for the future, it is important that the owner-manager stays alert to the effects of possible change, and that this awareness is made apparent within the business plan.

Legislative changes

As a result of closer involvement with the European Union (EU), there have been dramatic changes in legislation in recent years. For example, the EU Social Chapter has improved the rights of both full-time and part-time employees and, in 1998, the Working Hours Directive increased the rights to paid holiday each year, and substantially reduced the maximum average working hours each week. (This is discussed further in Chapter 5.) A change in UK food hygiene regulations in 1991 forced many catering outlets to scrap and completely change their refrigeration systems. This in itself was a positive move in the public interest, but a year later the EU introduced further regulations, imposing tighter limits and additional costs to modify and change the recently bought equipment. Some of the biggest impacts on small businesses have come from the imposition of milk quotas under the EU Common Agricultural Policy, and restricted fishing quotas under the Fisheries Policy. The farmers who invested in dairy herds, and the trawler owners who took out long-term loans to buy boats, had done so in good faith assuming that there was no foreseeable short-term threat to their livelihoods. Health and safety is another area where changes in legislation can have heavy financial implications for business owners and operators.

The point about these examples is that it is important to be aware of changing legislation, and not just the changes going on within the UK. It is particularly important when you are planning to buy an existing business to check on any forthcoming legal changes that might have prompted the sale. Just before the advent of the abolition of restrictions on duty paid import of beer and wines in 1993, there was a large number of public houses up for sale in East Kent at attractive prices. Within the next two years, there was also a large number of less astute public house landlords in the same area, who were declared bankrupt as a result of a sharp decline in local trade.

Environmental issues

Some of these have already been mentioned in connection with social trends which often tend to arise as a result of philanthropy or social awareness, but there are other much more practical examples. In Chapter 5 reference is made to the impact of the Clean Air Act and the Control of Pollution Act. These are constantly being modified and standards upgraded to improve the environment. When waste disposal tipping licences were introduced in 1974 there was still a fair amount of space (primarily holes in the ground resulting from mineral extraction) available for tipping. More recently that space has been in short supply and the cost of transporting waste over longer distances has spiralled. Now the emphasis is increasingly on the reduction of use of packaging materials and the compulsory recycling of those materials in many industries. Along with the reduction of exhaust emissions, and tighter control of use and disposal of toxic materials, this is an aspect of environmental control that will inevitably expand. So how will these affect your business now, or in the future? Have you allowed for the possible increase in overhead costs within your business plan? Is your particular business likely to be subject to any other changes in environmental controls in the near future?

Further reading

Burns, P. and Dewhurst, J. (eds) (1996). Small Business and Entrepreneurship. Macmillan.

Clayton, P. (1998). Law for the Small Business. Kogan Page.

Stokes, D. (1998). Small Business Management: A Case Study Approach. Letts.

Williams, S. (1998). Lloyds Bank Small Business Guide. Penguin.