Four Ways to Start Your Own Business

Bruce Barringer

There are four common ways to get into business: starting from scratch, buying a franchise, participating in direct sales, and buying an existing business. When most people think of starting a business, they think of starting from scratch. This approach involves developing your own business idea and building the business from the ground up. But there are pluses and minuses to each method of getting into business.

Advantages of Starting a Business from Scratch

Starting a business from scratch is the ultimate business start-up experience. You start with a clean slate and are able to shape and mold the business as you see fit. You select (or develop) the product or service you will sell, pick the business’s name, select a location, and build the business. If you’re careful, you can often start and build the business fairly inexpensively. In fact, the average business in the United States is started for about $10,000. Even aggressive growth firms, in most cases, don’t take an arm and leg to start. Every year Inc. magazine compiles a list of the 500 fastest-growing privately owned businesses in the United States. In 2006, the medium amount it took to start one of the businesses on the list was $75,000. That means that half of them were started for less than $75,000. It’s normally more expensive to buy a franchise or purchase an existing business.

Starting a business from scratch, for many people, is also very satisfying. The business is a direct reflection of your efforts, values, work ethic, and skills. It’s also the most practical way for a prospective business owner to bring a new product or service idea to market. While there are many advantages to franchising, participating in direct sales, and buying an existing business, these approaches require you to build on someone else’s product or service idea. Additionally, if you’re starting a business to fill an aspiration gap, such as being home by 3:00 p.m. on workdays to meet the school bus or having Sundays free to participate in volunteer activities, starting a business from scratch may be your best alternative. Many people who buy retail franchises, for example, find the hours of operation and other rules to be so rigid that they have to plan their lives around their business. While starting a business from scratch is in many ways more demanding than other ways of getting into business, the owner has the advantage of setting the hours of operation and the overall tone for the business.

Disadvantages of Starting a Business from Scratch

There are also disadvantages to starting a business from scratch. Starting a new business entails greater risk than buying a franchise, participating in a direct sales organization, or buying an existing business. You must also build your business’s brand, develop a marketing campaign, establish relationships with suppliers, and complete the other chores necessary to build a business from its inception. While many people enjoy engaging in these activities, they are time-consuming and require expertise. One of the principle advantages of franchising and direct sales, in particular, is that the fundamentals of the business have already been worked out.

It’s also more difficult to obtain financing for a new business than it is to buy a franchise or purchase an existing business. There is always a certain degree of skepticism surrounding a brand-new business. The skepticism can be lessened through a well-developed business plan. A new business doesn’t have a track record to rely on. One of the primary advantages of buying a franchise, such as a Subway or a Curves International, is that the business concept is proven, which is reassuring to bankers and investors. The same rationale applies to buying an existing business. As a result of these realities, the same person who is unable to secure a $50,000 loan to start a business from scratch may be able to borrow two to three times that amount to buy a franchise or an existing business. The perceived risk involved with starting a business from scratch is that much higher than the other alternatives.

Making the Call—Is Starting a Business from Scratch the Right Strategy for You?

In general, individuals who have prior business experience are best-suited to start a business from scratch. It also helps to have access to start-up funds through personal savings or via loans from friends and family. These are not hard-and-fast rules, however. Many people have started successful businesses from scratch with no prior business experience and limited start-up funds. The best strategy for making the call is to weigh the advantages and disadvantages of starting a business from scratch against the alternatives for your own circumstances.

Franchising: Buying into Someone Else’s Formula for Success

Franchising is a form of business ownership in which a firm that already has a successful product or service (franchisor) licenses its trademark and method of doing business to other businesses (franchisees) in exchange for an initial franchise fee and ongoing royalties. The total initial investment includes the franchise fee, the costs associated with getting the franchise up and running (which vary by franchise), and any other fees that are part of the franchise agreement. The ongoing royalty fee, which is usually around 6 percent, is based on a percentage of weekly or monthly gross income.

Advantages of Buying a Franchise

There are two primary advantages to buying a franchise as opposed to starting a business from scratch. First, franchising provides a small business owner the opportunity to own a business using a tested and refined business system. This attribute reduces the time and the amount of experience needed to get a franchise business going. In addition, the trademark that comes with the franchise provides instant legitimacy for the business. For instance, if you’re interested in opening a fitness center for women, you’ll likely attract more customers by opening a Curves or Lady of America franchise than a new, independently owned business. The second advantage to buying a franchise is that the franchisor typically provides training, technical expertise, and other forms of ongoing support. For example, if you buy a Curves franchise, your initial investment gets you a weeklong training program at Club Camp—which is Curve’s training center in Waco, Texas. Additional training is provided at regional events and at the company’s annual meeting, and any franchisee needing a refresher can return to Club Camp for free. This type of support is what attracts people of all backgrounds to the franchise concept, regardless of their prior work experiences. “We get people from all walks of life,” says Cassie Findley, director of continuing education and research at Curves. “We get homemakers who want to become entrepreneurs and run their own businesses. We get retirees who want to help women change their lives, and we get a small percentage of investors. They’re not physical fitness professionals when they come to us.”

Disadvantages of Buying a Franchise

The main disadvantages of buying a franchise are the costs involved and the loss of some of your independence as a business owner. The total initial investment to get a franchise up and running varies from $31,400 to $53,500 for a Curves franchise (depending on the location and other factors) to $74,900 to $222,800 for a Subway. The monthly royalty payments are permanent. While there are similar costs involved with starting a business from scratch, there are no ongoing royalty payments. In regard to independence, many franchise systems are sticklers about doing things in a specific manner. McDonald’s and other fast-food retailers, for example, are strict in terms of their restaurants’ appearance and how their food is prepared. As a result, franchising is typically not a good fit for people who like to experiment with their own ideas and are independent.

“Ultimately, franchising represents an attractive middle ground for many people.” So says Joe Cummings, the purchaser of a PostNet franchise. A PostNet franchise is similar to a FedEx Kinko’s store. After a 21-year career with Bristol-Myers, Cummings took a buyout and spent a year deciding on what to do next. Commenting on why he settled on a PostNet franchise rather than opening his own business, Cummings said, “I wanted to get what I call the best of both worlds—the support of a proven system in an environment that’s really entrepreneurial. I felt a franchise was the best way to do that.”

Caution

One note of caution: You should be careful if you decide to buy into a franchise system. While there are many excellent franchise systems to choose from, some systems never live up to the level of support promised. The best way to check out the merits of a franchisor is to ask for the names, addresses, and phone numbers of several of the franchisor’s current franchisees and then call these individuals and ask them about their experiences. You can also ask for a copy of the franchisor’s Franchise Disclosure Document (FDD), which contains detailed information about the background and financial health of the franchisor.

Believe It or Not: There Are Legitimate Opportunities in Direct Sales

While most people wince or cringe when they hear the words “direct sales” (or “multilevel marketing”), there are attractive and legitimate direct sales opportunities. The industry is dominated by women (85.2 percent), who normally enter direct sales part-time as a way of earning extra income. There are over 15.2 million people in the United States involved in direct sales, and the number keeps growing. Well-known companies include Tupperware, The Pampered Chef, Creative Memories, and Mary Kay. Many direct sales organizations are large and growing. The Pampered Chef alone has over 60,000 independent sales consultants. Its consultants conduct over one million in-home demonstrations, called Cooking Shows, every year.

Many people have negative feelings toward the direct sales industry because they have either personally been subjected to a high-pressure sales pitch or know someone who has. Although the industry as a whole suffers as a result of these types of sales tactics, not all direct sales firms fit this stereotype. The Pampered Chef is an example of a direct sales organization that exemplifies the good in the industry. Started by Doris Christopher in 1980, the integrity and stature of the company is such that it was acquired by Berkshire Hathaway in 2002. Berkshire Hathaway is controlled by Warren Buffett, one of the most respected and well-known investors in the world. In the Foreword to the book, The Pampered Chef, in which Christopher chronicles the history of the company, Buffett writes,

“The Pampered Chef is truly loved by its customers because it has found a need and filled it exceptionally well, helping everyday home cooks to become masters of their own home kitchens and making mealtime preparations quick, easy, and fun. It also offers its consultants an incomparable business opportunity, allowing men and women to build a home-based business of their own, based on Doris Christopher’s personal blueprint for success. You may wonder what you’re doing in your nine-to-five cubicle while these folks are happily cooking their way to fame and fortune.”

Most people start with an organization like The Pampered Chef part-time and only make it a full-time job if they do extremely well. The sales typically take place through in-home sales demonstrations or parties, although an increasing percentage of direct sales are taking place online. In addition to selling the product, you recruit others to sell the product for you. You then receive a percentage of your recruits’ sales. This facet of direct sales is one of its biggest lures. It allows you to earn income from your efforts along with the efforts of the people you recruit. It also incents the person who signed you up to provide you ongoing mentoring and support, since that person also receives a percentage of your sales.

If you go the direct sales route, make sure you pick a company that sells a product or service that you’re passionate about. Since the majority of your sales will come through one-on-one product demonstrations or home parties, you’ll need to convey a genuine interest and passion for the product you’re selling to be successful. The biggest mistake that people make when they go into direct sales is to become more enamored with the “financial opportunity” than the product or service they sell.

You should also be careful about the specific direct sales organization that you sign up with. Avoid organizations that require you to buy a ton of product upfront or promise that you’ll get rich with little effort. One way to minimize the chances that you’ll select a company you’ll later regret is to restrict your selection to organizations that are members of the Direct Selling Association (www.dsa.org), a highly respected industry trade group. To become a member of the Direct Selling Association, a firm has to go through a rigorous one-year application process and abide by the organization’s Code of Ethics. Currently, only 213 of more than 1,000 direct sales organizations that exist are members. If an organization is not a member of the Direct Sales Association, and you’re still interested in joining, you should, at a minimum, check the company’s history with your local Better Business Bureau, your state’s Attorney General, and the Federal Trade Commission.

Buying a Business

If you’re intrigued by the idea of owning and operating a business but don’t want to start a business from scratch or pursue franchising or direct sales, a final option is to buy an existing business. Although there are many rewards associated with building a business from the ground up, there are distinct advantages to buying a business that’s already established. There will also be an increasing number of businesses for sale to choose from. An estimated 65 percent to 75 percent of all small businesses in the United States—some 10 million—will likely go up for sale over the next five to ten years as a result of the retirement of baby boomers.

There are two primary advantages to buying an existing business. First, you avoid the time and expense involved with selecting and testing a business idea. Second, you start, on day one, with a business that has customers and an established cash flow. You’ll also have an easier time obtaining financing or funding. Bankers like to see three to five years of proven performance before they lend money to a business. This reality works to the advantage of the buyers of existing businesses and to the disadvantage of businesses started from scratch.

All told, there are ten primary advantages to buying a business versus starting one from scratch:

• Established customers

• Established products or services

• No time invested in picking and testing a business idea (at least initially—new products or services may be added later)

• Proven business concept and processes

• Trained employees

• Business generates cash flow from day one

• Established suppliers

• Easier to obtain financing or funding

• Seller may lend support and assist with financing

• Lower risk of failure

An existing business may also offer amenities, like an ideal location, which you’d never be able to replicate starting a similar business from scratch.

The primary disadvantage to buying an existing business is the cost. The hard work involved with starting and building a business, along with the customers and cash flow that come with it, is built into the purchase price. This intangible is often called goodwill, which is the excess of the purchase price over the value of the assets of the business. So it’s generally more expensive to buy an existing business than it is to start a similar one from scratch. There is also the possibility of hidden costs. For example, some of a business’s best employees may leave once the business changes hands, even if they indicated they would stay. Similarly, receivables that were thought to be collectable may turn out to be uncollectable. You can anticipate these types of complications and build them into your offer price to a degree, but it’s hard to anticipate everything, and disappointments often occur.

It’s also hard to find a profitable business for sale at a reasonable price. Business owners often have an inflated idea of the market value of their business. In addition, it’s not uncommon for the owners of businesses with fading potential to try to unload them, regardless of how good they try to make them appear. Still, thousands of businesses are bought and sold every year with good results. The most common places to look for businesses for sale include

• Newspaper classified advertising under “Business Opportunities”

• Business opportunity magazines, which are available at major bookstores

• Business brokers (identified through yellow pages advertising and Internet searches)

• Word of mouth through friends, family, and business acquaintances

• Internet searches (listed under “business opportunities” or “businesses for sale”)

Proceed cautiously and thoroughly check out the businesses that spark your interest. If you get serious about a particular business, hire an attorney to represent you. You may also want to hire an accountant to help you go over the business’s books. While you’ll have to swallow hard when these professionals quote their fees, it’s normally small potatoes compared to making a major mistake in the process of buying a business.