July 2009 Archives

The US is not the only country faced with crippling effect of higher tax rates.

The TaxPayers' Alliance in the UK has just released a new report by Jonathan Scott and Matthew Sinclair that shows that the new 50p tax rate will push the total tax burden on high earnings to crippling levels and argues that will mean fewer entrepreneurs and jobs.  The report argues that government tax changes, which will raise the marginal tax rate, will reduce the incentives to become an entrepreneur.

The UK did not benefit significantly from the entrepreneurial boom that led up to this recession, according to the authors.  They state that business formation in the UK grew only 0.3% from 1997 to 2006.  With these higher tax rates, it is doubtful that entrepreneurs will be leading the way with new job creation in the UK any time soon.

From the report:

When entrepreneurs earn a large amount of money they will often earn
substantial amounts above the various tax thresholds, save and invest that
money then eventually pass it on to their children. That money is therefore
taxed repeatedly before it is spent and winds up facing a very high marginal
rate:

• Under the present tax system that rate is around 90 per cent.
• With the proposed 50 per cent top tax rate, the marginal rate facing successful entrepreneurs could rise to 92 per cent. That means this measure has taken 20 per cent of the money entrepreneurs are left under the present 40 per cent top tax rate.
• Even if entrepreneurs take their initial reward as capital gains and benefit from the Entrepreneurs' Relief, they will still face a marginal rate of 86 percent.

Dear Brett,

First, as a loyal Packer fan let me thank you for the great memories -- the Monday night miracle after the death of your father, the Super Bowl games, the last minute come from behind victories like the one my brother and I watched together in Houston.

But, now that you have decided to retire from football -- at least that is what you are telling us today -- let me offer you a little unsolicited advice.  Learn to define who you are beyond just what you have done for a living.

It was a lesson my wife helped me learn after we sold our business.  She put me in time out -- no deals for at least six months -- which forced me to really stop and ponder who I was beyond what I did for a living.  It helped me remember that I was more than just an entrepreneur.

We should not let ourselves understand who we are only by what we do for a living.  Don't simply define who you are as a person by your career as an NFL quarterback.  Don't get me wrong -- that must be a really cool job!  However, do not let yourself define who you are too narrowly.  

It seems to me as an outside observer that you may be a bit lost.  I worry that you may have fallen into the trap where nothing else in his life has any real meaning without that career to define yourself.

I have warned entrepreneurs that they should not define who they are only by the noun of what they do for a living.  Although they may start and grow businesses, defining themselves as only an entrepreneur seems to crowd out so many other important parts of their lives.  

We have seen evidence of the danger of defining who you are by what you do in your work from others who have also failed their attempts at retirement. Lee Iacocca could not stay retired as a corporate executive.  Dan Rather could not stay away from the teleprompter after he retired from the evening news.  And just like you, Magic Johnson and Michael Jordan could not stay retired as athletes. For all of them, it appeared that they may have let what they did for their work define who they were as people.

Careers can do this to us. If we are not careful, they can consume all that we are. And what gets lost as a result?  Our families, our friendships, and even our souls.

If we are to become all that we were put on this Earth to do, we have to temper the temptation to become consumed by our work. We need to resist becoming the noun of what we do for a living.

So Brett, work hard at being a good husband. Work hard at being a good parent. Work hard at worshiping God if you are so inclined. Work hard at being a good friend to those who know the real you -- not just the guy who wears #4. Work hard at being a good citizen in your community. Remember that none of these alone can fulfill our humanness.

One of the risks of using nouns to describe what we do in our work is that it can reinforce the tendency we all have to get carried away with our work. I loved starting a growing businesses (most of the time, at least). I love teaching and writing. It is indeed a blessing to love what one does for a living and joy the hard work that goes along with it. But, I need to be more than just an entrepreneur or a teacher.  With every virtue there is a vice looming in the background. Although hard work is a good thing, it can be taken to excess and become a vice if it keeps us from all the other things we should be doing with our lives.

American society does not make this any easier. I am reminded of the lyric from a jazz record from the 1980s that said, "Everything in moderation, and moderation is the first to go." We have become a culture of excess.

This is particularly true for the entrepreneurs out there who read this blog. We seem to create folk heroes out of entrepreneurs who expend Herculean efforts to achieve success in their businesses. And while this is good to a point, if entrepreneurial success comes at the expense of our marriage, our families, our faith, and our friendships, it is a hollow victory. If all we have at the end of our lives is our wealth, if that is all we leave behind, that is not a life well lived. As the old saying goes, "you never see a hearse with a luggage rack."

I hope you find fulfillment in the rest of your life on the Earth.  After all, the actuaries tell us that as someone about to turn forty, you have lived less than half of your expected life.  And whatever it is you decide to do next, always keep room in your life for all the things that really matter.

Best regards,

Dr.C.

This week's topic for Forbes magazine's America's Most Promising Companies comes from Brett Nelson, Entrepreneurs Editor at Forbes.  He asked us to comment on the following:

Health care headlines have dominated for more than a week now. And yet the dialogue still seems many steps removed from how all of these proposed changes will help/hurt small, growing businesses.

This blogger has done anything but ignore the impact of socialized medicine on small business.  My post yesterday stressed again the negative impact it would have on job creation due to increased costs and the healthcare mandate that would be faced by any small business with over 25 employees.  I have also warned of the negative impact that higher marginal tax rates necessary to pay for national healthcare would have on entrepreneurs -- on their start-up rates, their exit plans, and their growth strategies.

The interesting thing to me is the steady chorus of small business owners who say that they want nationalized healthcare. They seem to be taking the short-sighted perspective that this will take one more hassle off their plates.

Here is my warning to them.

There is an even greater danger to supporting this plan.  It is one more step to diminish our property rights.  Nationalized healthcare would be yet the next step down the road to reaching the tipping point of moving from a capitalistic economy to a socialized economy.  It is one more step toward moving basic property away from private ownership to becoming public goods to be doled out by bureacrats and politicians.

Ultimately entrepreneurship is based on a system of property rights and liberty.  The move toward socialization of healthcare -- and banking, and manufacturing, and insurance, and mortgages -- is eating away at the foundations of entrepreneurship like a cancer.

The healthcare debate, especially as it will impact small business, is all the buzz in Washington and around the country.

 

Rita Gunther McGrath has a well argued post at her blog about the impact of higher taxes needed to pay for socialized healthcare and the inevitable regulatory burdens that it will create.  Here is an excerpt:

 

Well, the first predictable consequence is that an awful lot of entrepreneurial energy is going to be spent, not productively, but unproductively, as small business people and those falling into the higher-tax categories spend their time not producing new innovations but figuring out how not to fall into the maws of increased tax and regulatory burdens.  Following right on that as a predictable consequence is that those who are able to do so will do business in such a way that they don’t fall into the higher-taxed categories.  Rather than pay individual rates, small businesses will incorporate and pay the lower 35% corporate rate.  Further, get ready for the new conglomerates - thousands of businesses employing exactly 24.5 people, all interconnectedly doing business with one another rather than falling foul of the over 25 employee stricture.  And with small business growth having led us out of most recessions in the past, get ready for this sector to add jobs far more slowly and with far greater caution than it had previously - a big blow to an economy that desperately needs a vibrant and growing small business sector. 

 

Thanks to John Wark for passing this post along.

 

The NFIB has dedicated their monthly Top 9 Questions to the topic of healthcare.  Here is what they serve up this month:

 

1. HEALTH INSURANCE - REASONS FOR OFFERING EMPLOYEE HEALTH INSURANCE - Please tell me if the following is a major reason, minor reason, or not a reason why your business OFFERS a health insurance plan to your employees?  It helps employee recruitment. (Vol. 3, Iss. 4, Q#5A.)

 

2. HEALTH INSURANCE - REASONS FOR OFFERING EMPLOYEE HEALTH INSURANCE - Please tell me if the following is a major reason, minor reason, or not a reason why your business OFFERS a health insurance plan to your employees?  Competitors offer it. (Vol. 3, Iss. 4, Q#5G.)

 

3. HEALTH INSURANCE - REASONS FOR OFFERING EMPLOYEE HEALTH INSURANCE - Please tell me if the following is a major reason, minor reason, or not a reason why your business OFFERS a health insurance plan to your employees?  It's the right thing to do. (Vol. 3, Iss. 4, Q#5H.)

 

4. OWNER HEALTH INSURANCE COVERAGE - As the owner of this business, how do you obtain health insurance coverage for yourself?  Do you obtain it:?  (Vol. 3, Iss. 4, Q#1.)

 

5. HEALTH INSURANCE - CONSULTING EMPLOYEES - What was your general sense of what your employees most wanted in health insurance?  Was their priority:?  (Vol. 7, Iss. 3, Q#12a.)    

 

6. DROPPING EMPLOYEE HEALTH INSURANCE - Though you don't offer it now, did you offer employee health insurance at any time in the last three years? (Vol. 7, Iss. 3, Q#1b.)

 

7. HEALTH INSURANCE - REASONS FOR NOT OFFERING EMPLOYEE HEALTH INSURANCE - Please tell me if the following is a major reason, minor reason, or not a reason why your business does NOT offer health insurance to your employees?  Employees prefer wages and/or other benefits. (Vol. 3, Iss. 4, Q#13A.)  

 

8. HEALTH INSURANCE - REASONS FOR NOT OFFERING EMPLOYEE HEALTH INSURANCE - Please tell me if the following is a major reason, minor reason, or not a reason why your business does NOT offer health insurance to your employees?  Business can't afford it. (Vol. 3, Iss. 4, Q#13F.)    

  

9. EMPLOYEE HEALTH CONDITIONS AND JOB PERFORMANCE - How many of your current employees do you believe have had their job performance adversely affected by substantial excess weight or a weight-related condition?  (Vol. 4, Iss. 3, Q#13.)

 

Thanks to Denny Dennis and the folks at the NFIB Research Foundation for their good work on this project.

Finally, check out the Employer Health Benefits, 2008 Annual Survey Kaiser Family Foundation at www.kff.org, which has excellent statistical information on health care with an emphasis on small business.    

To all of you small business owners out there -- be alert for yet another scam that is making the rounds.  This one involves fake checks.  Read about here in an article by Kathy Kristof at MoneyWatch.com. And please pass this along to other business owners.

Don't let the bump in the road in the Senate lull you into assuming that socialized healthcare is in trouble.  That train is still heading down the tracks.  And no matter how you look at it, the model of socialized healthcare now being pushed through will not be good for small businesses and their employees.

First, it will have a huge impact on employment.  There was a very telling e-mail posed at Hugh Hewitt's website (thanks to John Wark for passing this along).  Here is an excerpt:

Now Obama-care is proposing an 8% payroll surtax to finance mandatory healthcare?!  This is INSANITY.  Restaurants are built on after tax cash flow business models of less than 5% (which mind you has already been chipped by about 2% for min wage increases and price discounting to maintain traffic during a recession has hurt profits as well).  Given payroll represents on average 25% of a restaurant businesses sales, an 8% surtax represent another 2 % hit to the bottom line!  The senate version is almost as bad.  And don't let the small business exceptions fool you as restaurants are VERY labor intensive, and even a single small restaurant operation typically employees 20-30 people- practically every restaurant in America will be impacted by the mandate.  Given that most small business restaurant operators survive on scale (2-10 locations) and again at very low margins, the small business exceptions will provide no relief for the those in the restaurant industry who provide the majority of jobs.

The incremental cost of adding that 25th employee under the proposed mandate will create a permanent cap on employment growth for many small firms.  Some will bite the bullet and add that 25th employee and face the huge burden of healthcare mandates, but many will opt not to grow.  Believe me, many entrepreneurs already are hesitant to add employees due to the hassle of payroll requirements.  This will be yet one more bureaucratic roadblock to employment growth in small business.

Then there is the whole quality of care concern for employees covered under these plans.  Take a look at this graphic, which shows the average wait time for our neighbors to the north in Canada.  Anyone who argues that quality and speedy access to healthcare are not critical factors for worker attendance and productivity are fooling themselves.  Just ask any small business owner how important having a healthy workforce is to overall business performance.

As an advocate of fundamental restructuring of our healthcare system, I have been told that I am naive -- that incremental change is the only practical and politically possible way to create healthcare reform.  Well, the system is indeed headed for fundamental restructuring right under the noses of the compromisers out there who have been coopted into a false debate.  But, it is the polar opposite of the free market restructuring that some of us had in mind.

Thanks to all of you who e-mailed me about my post yesterday on focus versus diversification.  Several folks asked me when diversification does make sense for smaller businesses.

If the core business you have going is stable and mature, it can be a time to consider spreading your wings into new deals.  It is not always a wise thing to do, but this is the point when shifting your attention to something new makes the most sense.

If you do branch out into new deals, the best approach is to think incremental.  Choose deals that build off of what you know and what you are already doing.

However, remember that your ability to spot a good deal and even to execute the start-up has very little to do with your ability to manage an increasingly complex set of operations.  That is what too many people fail to realize.

Starting yet another deal is like getting a new puppy when you already have a dog.  (I am sitting on the back porch this morning with our two dogs AND our daughter and son-in-law's two dogs, one of which is a lab puppy -- so I guess we know where this metaphor is coming from). 

Your old dog has kind of gotten on cruise control in the family.  He is just kind of there -- a great pal, but not much fun and excitement any more.

The thought of a new puppy is exciting.  After all, it will good for your older dog to get a playmate.  And what fun a new puppy is to have around the house.  We do like to rationalize, now don't we?

So you buy that new puppy.  Now you have to deal with all of the challenges of a puppy in the house that you kind of glossed over or shoved into the back of your mind when considering this decision -- the messes, the chewed up shoes and furniture, the middle of night trips into the yard.

On top of that, now your older dog is getting kind of put out.  He needs more attention than he did when he had the house to himself.  He starts to act up -- maybe forgets his house breaking manners or starts to misbehave in other ways just like that new puppy.  So now you are dealing with the demands of the puppy and the renewed demands your older dog has now created for you!

I have to be honest with you at this point.  We have gotten that second dog several times in our lives.  And I have started that next deal several times.  But, every time it has ended up being more work and more stress than I had planned for.

I don't tell you all of this to say never start a second or third or fourth deal while still operating your first deal. 

I say this to make sure that you remember that just because you can start another business does not always mean you should.

This week's topic for the America's Most Promising Companies project from Forbes was submitted by one of my fellow AMPC bloggers.

How do I balance a need for strategic focus versus diversification and expansion of my products/services?

This question gets at the heart of a classic entrepreneurial challenge. 

On one hand, it is essential to adjust the business to meet the changing needs of the market.  This may take the form of expanding or altering the positioning of the business to meet these changes in the market.  This may require expanding or even fundamentally changing what we offer to our customer base.  It may also lead us to change how we define who are customers need to be going forward.  Certainly, entrepreneurs should never allow themselves to become paralyzed within their original business model if the market is telling them that they need to evolve their concept to fit the reality of a dynamic market.

On the other hand, I see many entrepreneurs who suffer from what I call Entrepreneurial A.D.D.  For these entrepreneurs I find myself saying one word over and over:  Focus! 

So why do entrepreneurs lose their focus?  It has to do with opportunity.  While opportunity in the market is what launches entrepreneurs into business, it can just as quickly become their undoing.

What happens is this -- once the entrepreneur enters the market they start to observe many other opportunities that exist in the marketplace.   Entrepreneurs, especially less experienced ones, start to see new business opportunities everywhere.  They feel compelled to pursue those opportunities even if it is not wise to do so.  They feel a desire, even a compulsion, to start additional new businesses even while their first one is still in the start-up phase.

Sometimes the opportunity relates to expanding into new markets.  The entrepreneur sees opportunities to move into additional markets that are not part of their current business operations.  The problem arises when the business and/or the entrepreneur are not yet prepared for this expansion.

For example, a former student of mine had started a franchised business that provides in-home care for the elderly.  During his first year in business, and even before his business had positive cash flow, he was approached about buying a distressed franchise operation of the same business in a nearby town.  When he asked my opinion, I urged him keep his attention focused on the first business he had started - he did not need two businesses that were operating at a loss!

But, he could not resist what he perceived as an opportunity worth a risk and bought the second franchise.  About a year later he called and admitted that it was a huge mistake.  He managed to get both businesses on the road to profitability, but was working 80-100 hour weeks and going much further into debt than he had ever intended.

Even more disruptive is when entrepreneurs pursue opportunities in entirely new businesses before their initial start-up venture is profitable.  I recently met with one entrepreneur who had five distinct businesses operating.  But, not a single one of them had reached profitability.  Luckily, we were able to develop a plan to shut down most of them so he could focus his efforts on his initial start-up business and build it to the point of positive cash flow.

The best way to avoid pursuing too many opportunities too quickly is to write down a clear mission statement and always remember one word:  focus.  If truth be told I believe that mission statements are most important as a tool to keep the entrepreneur on track than as a means to communicate to our team and to the outside world about what we offer. 

Given a choice between strategic focus and diversification for small and medium ventures, I will choose to push for more focus almost every time.

Most experienced entrepreneurs learn that opportunity comes from change that disrupts markets.  Change creates new needs and leaves many current players in that market with outdated business models.

The challenge in turbulent times like these is that change has kicked into hyper-drive.

We are now seeing whole industries being shaken to their core.

For example, the modern restaurant industry in the US owes much of its success to a social changes that happened over thirty years ago.  First, it was around that time that women entered the workforce in large numbers as a result of the push toward equality between the sexes.  Second, around that same time we experienced a significant spike in divorce rates in this country.

As more and more families had two working parents or just one single working parent, dining out became less of a special occasional treat as it had been when I grew up, and more of a necessity for busy families with little or no time to prepare meals at home.

However, the current recession is so deep that it has altered the behavior of many families.  We are seeing a sudden and sharp decline in dining out in this country, as can be seen in an article by Zachary Wilson posted at Fast Company yesterday:

According to the latest numbers coming from the restaurant industry, some version of this one-act play is taking place all over the country. Total traffic declined 2.6% this past spring versus the same quarter last year, the biggest decline in 28 years, says the NPD Group. And it's households with kids who are beating the hasty retreat from eating out. One-third of dining traffic is groups with children, and this marks the third quarter in a row families are cutting back. (Adult households with no kids were stable this spring.)

Change both creates opportunity for entrepreneurs and it can take that same opportunity away in what can seem like a blink of an eye.

Know what forces in the economy and society drive your business.  They are the ones that gave you success.  Keep a careful eye on those forces throughout the life of your business, for in times like these opportunity can be quite fleeting. 

In my column in this week's Tennessean, I offer a path to help create a true bailout for small businesses:

Each year during the 20 years leading up to this recession, small businesses generated 75 percent to 80 percent of all new jobs. This was a remarkable transition in our economy that created a fundamental shift in employment.

The Fortune 500 went from employing about 20 percent of all American workers in 1980 to less than 5 percent by around 2000. Small businesses grew to make up half of the gross domestic product and half of all employment during this same period.

The most recent employment report from ADP, a human resources outsourcing firm,showed that 177,000 small business jobs were lost just last month. Joel Prakken, who compiles the data, said:

"Despite a notable improvement over the first three months of the year, when monthly losses averaged 260,000, employment among small-size businesses is likely to decline for at least several more months. Since reaching peak employment in January 2008, small-size businesses have shed nearly 2.3 million jobs."

Just in the past 18 months, small businesses shed as many jobs as the Fortune 500 did during the entire decade of the 1980s.

History has shown us that it has been entrepreneurs who have led us out of almost every previous recession. However, most experts now agree that a large number of entrepreneurs need an infusion of cash if we are to have any hope of them leading us to an economic recovery.

The simplest and most direct way to do this would be through implementing lower tax rates. This has been shown in studies from around the globe as being a strong stimulus for new business formation and growth.

But rather than enact tax cuts, it now looks like we can expect some form of an expanded small business loan program funded by tax dollars as the likely choice for any small business financial bailout.

The downside of this strategy is that not all the funding ends up in the checkbooks of business owners. Instead, it adds additional governmental costs associated with distributing loan funding and monitoring any new loan program. Since many of these loans will be quite risky, expanded government-backed small business lending also exposes the taxpayers to future additional costs due to the risk of a high rate of default.

A second challenge facing many entrepreneurs is increased regulation. Governments all around the world are cutting the red tape that affects small businesses to try to spur entrepreneurial activity. But in our rush to re-regulate business in the U.S., small employers are beginning to feel the effects of these expanded government regulations.

This will certainly increase costs to small businesses, making earning a profit that much more of a challenge.

The best small business bailout would be for government to do less, not more -- take less in taxes out of the pockets of entrepreneurs and impose less regulation. However, I just do not think that such an approach can be found anywhere in Washington these days.

The standard approach for funding any new program coming out of Washington these days is to "tax the rich."  Take for instance the plan now in play to fund socialized healthcare.  This approach, although appealing for sound bites and bumper stickers, will soon have a devastating impact on our economy.  A return to a much more progressive tax structure will inhibit job creation for years to come.

Let's start with who creates jobs in our economy.  For the past twenty years it has been overwhelmingly entrepreneurs -- over 75% of all new jobs came from small businesses during this time period.

One of the incentives to take the risk to create a new business is to build wealth.  Most entrepreneurs take a significant hit on their short-term income potential, but are willing to do this with the hope that at the back end their will come a big payday as a reward for their hard work and personal risk-taking.

When an entrepreneur sells his business, we must remember that much if not all of the proceeds from the sale are treated like ordinary income, which like all profits from the business pass directly to the owner.

With all of the "soak the rich" plans in place to pay for our new found fascination with socialism in the US, I would not be shocked to see marginal rates soon top 50% or more.  Maybe not immediately, but as the true costs of all of these new programs become real the answer to soaring deficits will undoubtedly be to tax the wealthy even more.

Remember, capturing the wealth out of a private business is usually a one time event at the time of the sale of the business.  These are almost always asset purchases that result in a huge one-time bump in income.

With higher marginal rates, we will see fewer entrepreneurs willing to take the risks and put in the effort to launch new ventures.  In fact one study I have used often in class suggests that for every one percent increase in marginal tax rates we see a 1.4% decrease in start-up activity in the economy.

So in the frenzy to pass program after program that will be paid with higher taxes on "the rich", you can bet that we will see fewer entrepreneurs starting businesses that would create the jobs we need to revitalize the economy.  On top of that, there will be fewer of these one-time "rich" people who get a one year bump in income when selling a business.  This will create tax short-falls that will only further escalate the deficit.

I have been arguing for some time that it is time to fundamentally restructure our immigration policy in this country.  We need to create a path for aspiring entrepreneurs to come in and help fuel our entrepreneurial economy.  A new study from the Office of Advocacy of the SBA reinforces my point.

The study authored by David Hart, Zoltan Acs and Spencer Tracy found that sixteen percent of high-impact, high-tech firms have at least one immigrant founder.  Although these firms are concentrated in states with large immigrant populations, in most other respects they resemble high-impact, high-tech firms founded by native-born entrepreneurs.

Moreover, these immigrant entrepreneurs are highly educated and appear to be strongly rooted in the United States.  Roughly 55 percent of the foreign- born founders hold a masters degree or a doctorate.  In addition, they are more than twice as likely as native-born founders to hold a doctorate.

Furthermore, 77 percent of the foreign-born high-tech entrepreneurs are American citizens and, on average, they have lived over 25 years in the United States.  Two-thirds of them received their college degrees here, as well.

"Immigrant entrepreneurs clearly contribute a significant amount to our country's cutting edge high-tech firms," said Shawne McGibbon, acting Chief Counsel for Advocacy.  "This report outlines these contributions and delivers important new data about immigrant entrepreneurs."

This week's topic for the Forbes America's Most Promising Companies:

 

How can I prevent my business from being too dependent on one or two key personalities (e.g., founders) so it can continue to grow after their departure?

The biggest roadblock to building a team that sustain a business even after the departure of the founders is their hesitancy to delegate. 

Letting go is tough for most of us. We have been with our business all the way through its growth, through the good and the bad times. But at some point, if we want our business to grow successfully, we have to begin to delegate. At first it will seem that no one can do what you do as well as you can. But just like raising a teenager, at some point you have to begin to let go so they can learn and grow up. Your business will go through this same difficult transition. If you don't begin to let go, you business may never successfully move into its next stage of development.

Out of the challenge of delegation comes a second issue -- "What exactly is the job description for a CEO, any way?"

For many entrepreneurs, this may be their first time as a CEO. That title means very little in the early days, but as the company grows it takes on more meaning. Defining your role and your style as the CEO of your company takes planning and specific effort on your part. It may even feel a bit awkward at some point, but you have to establish what your role will be as the CEO. Play to your strengths.

This is often due to the fact that many entrepreneurs start their businesses because they like the hands-on part of their business. Engineers like to engineer. Furniture makers like to build stuff. As some point in the growth of the business, the entrepreneur begins to move away from the hands-on part of what they company does. This can be a painful and frustrating period. Keep this in mind when you decide how far you want to grow the business. It is OK to keep it at a size that allows you to stay in the hands-on part of what you do.

When building the management team that will take over much of the running of the business, the most common mistake is to hire solely based on people's skills and experience.  The technical ability of the person to perform the job should be the minimum criteria that get them to the first interview.  After that, pay most of your attention to their fit with your culture and their ability to continue it into the future.

This requires that you have a clear and concrete understanding of what makes up your culture.  Then use this to develop several open ended interview questions that can give you insight into how well they fit with your culture.  Don't asking questions that lead them to answers.  Make them vague enough so they have to use their own values to build their response.

For example, assume that bootstrapping is a key part of the culture of your business that you want to ensure will continue into the future.  You might ask them the following: "Tell me about a time when you had to accomplish a task when limited resources were available."  If the interviewee answers the question by saying that she always had more than enough budgetary support in her old job, it might be difficult for her to adapt to a bootstrapping environment not having worked that way in the past.  Or, if she answers by complains about the availability of resources in her old job, or about how her old boss was always cheap, that is a good signal that the employee is not have bootstrapping as a part of her work ethic.  On the other hand, if she speaks with enthusiasm and pride about how she got the job done within the limited resource available, she would more likely fit into the bootstrap culture.

According to the NFIB, the current recession has been harder on small business profits than any time over the past 35 years.  And profits slipped again this past month.

"When profits are bad, like now, small business owners cannot reinvest, except to replace things," said Bill Dunkelberg, NFIB chief economist.

Plans to make capital expenditures fell again to 17 percent, continuing a run of historically low readings.  One consequence of this has been a huge reduction in inventories, with record numbers of firms reducing their inventories to line up stock with lower customer spending.  In June, the net percent planning to add to inventories over the next three months was negative 6 percent, indicating further planned reductions.

A major cost-cutting activity has been focused on one of the largest costs - labor.  Over the past six months, owners have reduced employment at a record pace.  Plans to expand employment got a boost in June (up four points to a net negative 1 percent of firms planning to hire in the next three months). The number of firms with job openings to fill increased two points to 11 percent in June.  However, small employers continue to hold wages and other employee compensation in check, with 11 percent of owners raising compensation while 12 percent reduced it, the worst showing for a "raise" in survey history.

Expanding small business loan programs is not the answer to this problem.  It is time for policy makers who support free markets to step forward and push for income tax cuts.

Since most of these small businesses are pass through entities for income taxes, cutting taxes will have an immediate impact of profits, which will alllow them to reinvest, build inventories, and begin to hire again
 

John Tozzi at Business Week offers a great suggestion in tough financial times.  Open your books to your employees so they can understand the challenges you are facing.  Open book management improves accountability for all in the business, enhances decision making by gaining insights from those involved in the day-to-day management, and builds a unity of purpose toward surviving the current economic times.

But open book management must be implemented carefully.  From Business Week:

Business owners can't change to open book systems overnight. First, they have to create a culture where employees want to be involved, and they need tp understand the numbers they'll be measured on. "When a company is struggling, they do need to be careful how they present this to the employees. They want to lay out the reality, but in a careful way so they're not just scaring people," says Kent Forsland, founder and chairman of Designer Doors, an 80-employee, $17 million custom garage-door company in River Falls, Wisc.

From the Wall Street Journal:

The Obama administration is discussing ways to expand assistance to struggling small businesses, but there is some disagreement among top officials over the best approach, according to people familiar with the matter.

Washington has it half right -- we need to get some cash in the hands of small businesses to help stimulate the economy. 

The easiest and most effective way to achieve this would be an income tax cut, since most small businesses are flow through entities (the businesses pay no income tax and the profits flow directly to the owners to pay this tax as personal income).  This would put the maximum amount of working capital in the hands of business owners -- no overhead cuts for the bureaucracy to collect, distribute, and track the money.  It would let the business owners keep more of the money they are creating through their efforts to grow their ventures.

Instead, those in power now in Washington want to play a much more active roll in the process.

The two ideas being bantered about are to:

1. Have the government directly underwrite small business loans
2. Use part of the bailout money as targeted funds for banks to lend to small businesses

Both of these approaches  expose the taxpayers to too much risk.  Both of the plans also have the potential of creating a small business bubble in the economy.

However, I am reasonably certain that one of these approaches will be implemented.  Both plans are consistent with the new paradigm in Washington, which views all property as ultimately the people's collective property to be doled out as politicians and bureaucrats see fit.

Tax cuts are policies for those who view property as an individual right.  That paradigm seems to be rather scarce these days in Washington.

Business Week is taking nominations for their annual America's Best Young Entrepreneurs roundup through Aug. 16. If you know of companies run by entrepreneurs age 25 or younger, you can nominate them at http://bit.ly/BWYoung.

They are looking for ventures that are fully operational - not just idea stage - and all of the founders must be 25 or under at the time of nomination. Feel free to nominate more than one company, and there's no need to submit the same firm more than once.

Pope Benedict XVI has released his latest encyclical Caritas in Veritate (Love in Truth), which addresses many pressing issues related to the world economy.

As with all documents of this complexity and depth, there is much room for interpretation.  Much of the media is focusing on the discussion of common good.  Take for example the New York Times piece on that they titled "Pope Urges Forming New World Economic Order to Work for the 'Common Good'".

One has to be careful to understand what is meant by terms like new world order and common good.  Those who favor more government control and/or more socialistic policies assume that this plays right into their hands.

The writings of both Benedict XVI and John Paul II favor capitalism over socialism.  Their discussions of common good and economic reform are not open doors for centralized economies.  They are directing their words to each of us as individual actors.

It took me a while to fully understand this as Mike Naughton and I worked on our book, Bringing Your Business to Life.  When I first heard Mike talk about common good I found myself brissling, getting ready to defend against the onslaught of socialism.

But I soon learned that common good is not about economic structures, but rather about the moral responsibility we have as individuals to others as we go about our business starting new ventures, buying stocks, working, and managing others.

This quote on the newest encyclical from the Acton Institute makes this point very clearly:

Rev. Robert A. Sirico, president and cofounder of the Acton Institute, said the new encyclical will disappoint those who had hoped that Benedict would attack the free economy. Instead, the pope rightly focuses on two practical applications of the principle of "truth in charity." First, this principle takes us beyond earthly demands of justice, defined by rights and duties, and introduces essential moral priorities of giving, mercy, and communion. Second, "truth in charity" is always focused on the common good, which Benedict defines as an extension of individual's good who lives in society and has broad social responsibilities.

"If people are looking to this document as a blueprint for the political restructuring of the world economy, they will fail to find it," Rev. Sirico said. "If they look to it as a means for the moral reconstruction of cultures and societies, which in turn influence economic events, they will find plenty."

We should listen to Michael Novak's caution on the potential evils that lie in assuming that government is the key to a new economic reality.

For moralists, it is essential to see how often (not always) government itself sins grievously against the common good, out of a lust for power and domination over others. Furthermore, government often (not always) generates foolish and destructive regulations, and often dispenses justice that winks rather than justice that is blind. Government is more frequently the agent of injuring the common good than the ordinary lawful actions of free citizens. During the twentieth century, governments too often destroyed the common good of their citizens for years to come.

Do not assume that all small government advocates root for a survival of the fittest, every man for himself.  In fact, small government only works well when it is in the context of a deep moral culture in which man is challenged to be truly good.  Man is at his best when he performs good acts because he understands it is what is expected of him by God.  We should never let man off the hook by abdicating morality to governmental authority.

A newly release report called The Anatomy of an Entrepreneur, supported by the Ewing Marion Kauffman Foundation, suggests they have discoverd what makes entrepreneurs tick.

Here is what they say they discovered about entrepreneurs in their study:

The findings dispel the common notion that entrepreneurs are young college kids starting companies in their dorms or basements. The reality is that most company founders are experienced, well-educated and married with children -- and they come from middle-class or upper-lower-class backgrounds.

Here is the problem with that conclusion -- they only surveyed 549 founders of successful businesses in high-growth industries.

So entrepreneurs are only founders of high-growth ventures?  No way.

So we should base our decisions on what programs to create to support and foster entrepreneurs based on their findings?  I don't think so.

Are high growth ventures important?  Sure, but so are small ventures that usually are started in dorm rooms, at kitchen tables, or out of people's basements.  And there are a lot more of this type and they have been much better job creators than their larger counterparts that are the focus of this study.

High growth firms in high growth industries are usually backed by venture and/or angel capital.  These folks only put money behind experienced entrepreneurs.  So of course they are going to be older, more educated, and more experienced.

This week's topic for the Forbes America's Most Promising Companies project is from Brett Nelson, Entrepreneurs Editor at Forbes.com:

 

At its core, the America's Most Promising Companies project is about getting capital to entrepreneurs who need it. Many go wanting, especially in this credit-starved economy. With that in mind, how does America's financial infrastructure need to change---if at all---to make sure deserving entrepreneurs have access to precious funding? For that matter, what are the keys to raising money, in this or any economic environment?

I find it very worrisome that there is movement toward more government intervention in financial markets that serve entrepreneurs.  Pumping more money into the SBA to prop up businesses that cannot support that debt is bad policy and a bad business decision.  And now we hear that venture capitalists are trying to get their cut of government funding through the bailouts.  Venture capital investment is, by definition, a high risk affair.  If VCs can't raise money through private offerings it seems to me that there is a good reason -- their expected returns have become too risky.  We don't need to throw tax payers' hard earned money into poorly performing funds.

Truly deserving ventures can still get funding, although it has gotten a bit more complicated and challenging. 

Equity funding is still flowing.  The amounts are less and the money can be harder to find, but it is still out there.  Entrepreneurs need to be prepared to be able to offer more proof of concept.  The giddy times of dreams and ideas getting money thrown at them are over for now.  Do what it takes to prove you have a viable business -- find customers who will buy your products or services.  This will take more self funding for seed money and more bootstrapping to get the business off the ground so you can demonstrate to investors that your business really works.

Debt markets for entrepreneurs are going back to basics.  This is a good thing, I must say.

Traditionally, bankers have operated with a business model that tries to minimize risk.  They are responsible with protecting the deposits held in their banks.  Many banks strayed too far away from this in the recent past, but they are returning to their old ways of doing business.
 
Businesses must be able to qualify for bank credit on their own standing.  This has very little to do with the things that get entrepreneurs excited about their own business, such as opportunity, upside potential, and vision. To a banker, a bankable business is one that will pay back its loans with very little chance of anything going wrong. So rather than getting excited about untapped markets or product innovations, bankers look to three main factors:

Is there adequate cash flow?

Bankers define "adequate cash flow" not as being just enough excess cash each month to cover monthly loan payments, but significantly more than enough excess cash flow.  Also, bankers want see this cash flow already occurring, not projected in the future within a business plan.  That is why bankers are usually not the best source of funding when you first open your business.  Get a track record and some cash flow and you will find that bankers are much more receptive.

Can owners pay back the loan if the business cannot?

Personal guarantees from the entrepreneurs who have the personal net worth to pay off those loans is the second line of defense for banks. 

Is there collateral?

The reality is that banks don't want to try to collect your accounts receivable, sell your inventory, or liquidate your equipment - and they certainly don't want to run your business. Don't assume that such collateral is what banks like to see in a business loan proposal. Collateral is considered the last resort for covering a loan from a banker's perspective.

The financial markets will improve for entrepreneurs as the financial prospects of their ventures improve.  Private sector efforts to improve the efficiency and effectiveness of financial markets for entrepreneurs, such as angel networks, web resources, and projects like America's Most Promising Companies can help, but the wounds in this economy will take a long time to heal. 

For the second year in a row I am teaching in a program put on by Advance Innovative Education put on in Baton Rouge, Louisiana.  The program is called "Redesigning Lessons, Re-envisioning Principals (RPRL)."

I am conducting a two day workshop that is part of a year long program.  My sessions are on how entrepreneurial practices and principles can be applied to educational organizations.  The participants include some new and many aspiring school principals.  Yesterday they learned how to think like an entrepreneur through identifying and assessing opportunities. 

I made them just not "think out of the box," but actually "throw away the box."  When we only think out of the box we stay too close to our old ways and keep really close to the box that represents our old thinking.  And it is too easy to jump back into the box as soon as things get just a wee bit uncomfortable.  We cannot open our minds to real opportunity for change if we stay tethered to old ways of acting and thinking. 

Being with these highly motivated educators gives me hope for the future of educational in the US. 

There is a growing interest in how business principles -- such as competition and entrepreneurial innovation -- can help fix what is ailing the educational system.  Of course we are seeing a huge resistance from teachers' unions and many schoosl of education in universities. But, parents, business owners, and civic leaders are beginning to say "enough is enough." 

Blogger James Pethokoukis offers five alternative stimulus plans to the one we are getting from Washington right now.  His alternative plans, all of which would spend about what is being spent on the current plan, include:

1. An investment stimulus plan that would cut capital gains and corporate income taxes to stimulate investment.
2. A worker stimulus plan that would give workers a massive tax cut.
3. A couple of variations of a housing stimulus plan that would support creating a large pool of 30 year fixed rate mortgages.
4. A deficit hawk stimulus plan to cut the tinder box that is about to ignite inflation and help calm bond markets.
5. A do-nothing plan, that would roll back all of the stimulus plans already enacted.
   

I vote for a modified "Do-Nothing Stimulus Plan."  I would opt to not only do nothing, but actually do a lot less.  By slashing government spending and programs we can not only cut the deficit, but hopefully give real tax relief, thus creating a long term, sustainable recovery. 

I know, I know, I can hear you now -- "Get out of your ivory tower and quit dreaming, Professor."  But, look how much of their agenda the socialist got done in only six months by dreaming big plans and then getting the right people in office.  It could happen.....

Scott Shane is at it again.  Shane is a professor of entrepreneurship at Case Western Reserve.  He is well respected in academic circles, but as of late has taken up the cause of dismissing the importance of small business in our economy.

Interestingly, he was chosen as one of the bloggers for the New York Times new on-line small business site called You're the Boss, where they say that he "writes about the economy from a small business perspective."

Here is what Professor Shane had to say about small business in an article at CNN Money:

From a societal point of view, if you have a group of people who do something that makes them happier but less productive (which the data support), and you aggregate that, then entrepreneurship is an economic drain. If the goal of the policymaker is to make everybody in your country happy, then let everybody start businesses.

But most policymakers seek to create jobs and promote growth. If that's your goal, you want to stop all these people from starting marginal businesses that don't go anywhere and devote the resources to encouraging high-growth companies. In terms of tax policy, for example, you could argue that the government should eliminate the home-office tax deduction - which doesn't differentiate between high- and low-performing businesses - and beef up R&D tax credits.

This does not sound like a voice of support for small business to me.  Not surprisingly, these and similar comments from him of late have created quite a buzz.

One of his favorite arguments is based on looking at various measures of rates of entrepreneurial and small business activity rather than absolute numbers and their true economic impact.  Here is a quote from his latest post at the New York Times blog.

Most Americans would like to believe that this country is getting more entrepreneurial over time. While I wish this were true, the data don't agree. Policy makers need to take a look at these data and acknowledge the pattern. More important, they need to understand why the rate of entrepreneurship is declining over time.

As I explain in greater detail in my book, "Illusions of Entrepreneurship" (Yale University Press, 2008), one reason is what one might call the Wal-Mart effect. Large, efficient companies are able to out-compete small start-ups, replacing the independent businesses in many markets. Multiply across the entire economy the effect of a Wal-Mart replacing the independent restaurant, grocery store, clothing store, florist, etc., in a town, and you can see how we end up with a downward trend in entrepreneurship over time.

No, Professor Shane, measures of actual entrepreneurship are not declining and it is still a vital force in the economy.  And if we don't turn loose small businesses, the recession will last even longer than it might otherwise.

It is clear that you are one of those who would love to steer and shape the economy from a policy viewpoint.  Please, just keep your hands off our economy and let free markets work!

My column in this week's Tennessean looks at key financial information you need on your dashboard to help you navigate these challenging times:

It's beginning to look like we may be in this recession for quite some time. Even if your small business has survived to this point, it still could be financially vulnerable to the continued sluggishness in the economy.

Unfortunately there is no single number or financial measure that can fully assess the threat a business faces. It is important to keep your eye on several key numbers and ratios. When put together these are referred to as a financial dashboard -- an easy-to-read series of figures that gives a good overview of how a business is faring.

The first category of figures that should be on your dashboard each month helps assess how well you are managing debt. A ratio that bankers pay particular attention to is times interest earned, which assesses how well your business can cover its loan payments owed to the bank.

The percentage of your assets financed through debt is another key ratio. Finally, the overuse of credit card debt can make a business more vulnerable.

The second category on your dashboard should assess the strength of the cash position of your business. Never forget that "cash is king." Monitor your cash reserves carefully.

Vic Alexander of KraftCPAs recently advised a class of entrepreneurs that I was teaching to have enough cash on hand to cover at least 45 days of expenses. If customers pay on account, monitor the average age of your accounts receivable.

Finally, looking at the ratio of cash to current accounts payable each month is another good test of the strength of your cash position.
Watch your suppliers

Your business is also dependent on the financial health of suppliers and customers. Add some measures to your dashboard that help you monitor them, which can include:

• The number of suppliers that still let you buy from them on credit.

• The increase in new customers you are able to attract each month.

• Your ability to attract returning customers.

• Your dependence on a few large customers.

• Revenue trends from month to month and compared to the same time last year.

• If you carry inventory in your business, watch it closely from month to month to ensure that you are not building excessive inventories.

My friend, Dr. George Solomon, a professor at George Washington University, and I have put all of this together in an online assessment for Entrepreneur magazine that walks you through each calculation.

It is available free of charge at www.entrepreneur.com/quiz/threatindex/index.html and will provide you with an overall score that helps you evaluate your financial vulnerability.

So, pull out your financial statements, grab a mug of coffee and take an honest look at the financial health of your operation.

Each and every year during the twenty years leading up to this recession, small businesses generated 75-80% of all new jobs. This was a remarkable transition in our economy that created a fundamental shift in employment.

The Fortune 500 went from employing about 20% of all American workers in 1980 to less than 5% by around 2000.  Small businesses grew to make up 50% of the GDP and 50% of all employment during this same period.

But rather than enact tax cuts, which is the best single stimulus for entrepreneurial activity in an economy, we are now obsessed with propping up the large corporations that have already seen their best days, and to artificially try to stimulate new industries that cannot exist one their own in the market without massive government subsidies (i.e., almost every business with any "green" theme).  And we are going to pay for all of this through higher income taxes and a whole new class of taxes created by Cap and Trade.

Our inattention to what really benefits entrepreneurial economic development has had a devastating impact on jobs.

The ADP Small Business Report showed that 177,000 small business jobs were lost in June of 2009. According to Joel Prakken, who compiles the report:

 

"Despite a notable improvement over the first three months of the year, when monthly losses averaged 260,000, employment among small-size businesses is likely to decline for at least several more months. Since reaching peak employment in January 2008, small-size businesses have shed nearly 2.3 million jobs."

In about eighteen months, small business employers shed as many jobs as the Fortune 500 did during the entire decade of of the 1980s.

A small business bailout cannot succeed if it is an interventionist approach by Washington as we have seen in their approach to the auto industry, the banking industry, and who knows what next.  We should not infuse tax dollars into targeted industries or businesses if we want to restart the small business job engine that created so much of our prosperity of the past 20 years. 

The best small business "bailout" would be for Washington to do less -- much, much, much less -- than it is doing now.  But, alas, I just do not think that such an approach is found anywhere in the paradigm of either political party in Washington.

James Pethokoukis who writes for Reuters offers an interesting analysis on who gets credit or blame for the economy going forward, and why:

It's not so much that a more negative forecast would have prevented Obama from spending large amounts of money, it's that he would have been forced to tilt the stimulus more in favor of tax cuts which work a lot of faster  than government spending (though both are pretty inefficient as "stimulus").

And Obama wanted to spend billions on his "investment agenda (healthcare, education, infrastructure), not tax cuts.  (And if he had spent the $2 trillion that some liberals wanted on stimulus, it surely would have crowded out the rest of his agenda, plus rattled the bond markets.) So he gambled that monetary policy would keep the economy from getting as bad as it has. And he lost. Did Team Obama purposely give a bad forecast, or did its old fashioned Keynesian approach merely lead it astray? Good question. Either way, it's the Obamacrats' economy now.