One Question to Ask When Starting a Small Business: Why?
Not knowing why you’re starting a small business in the first place, not knowing its purpose, is a good way to pile up regret.
Almost everyone who starts a small business does so to create a job for themselves. They trade their talents, knowledge, and skills for income that they can generate on their own terms. A few people are trying to build something else: a successful business that doesn’t entirely depend on their technical skills or knowledge. A business that’s profitable and generates cash, hopefully even without their direct involvement. A very select few aren’t trying to build a small business at all; it’s just a stop on the way. What they’re really after are businesses and business models with high growth and profit potential, and, for that, and unlike the folks in the first two groups, they’ll need to be innovative. These different goals require different resources, aptitudes, mindsets, and behaviors. Getting the differences mixed up when you start is a good way to not get what you want from your business. And not knowing why you’re starting a small business in the first place, not knowing its purpose, is a good way to pile up regret.
Most small business owners can remember the day they left their last (ever) job to start their own thing. Even if it happened long ago, there’ll be things about that day, some scattered words or impressions, still stored in memory. It’s one of those important life changes that comes with a clear marker, like a graduation or a wedding, as opposed to those sneaky, gradual life changes that catch you by surprise, like the aggravating, unanswerable “When did I get old?”
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I left my last place of employment on a spring afternoon, stepping nearly as lightly as when I entered it in the morning. I had just a few personal items to carry off, all of which fit in my coat pockets. Never one for making myself at home in the places I worked, the places I worked never felt like home. This, I think, is a not uncommon attitude among people who start their own businesses: they don’t like working for someone else. It’s the fuel they need to get going, but it also makes them prone to rash decisions. In my case, that meant, despite having a young family, leaving the routine and security being an employee to start a business — while having no clue at all which business to start.
Darren and I eventually decided on something. When that didn’t work, we decided on something else. And when that wasn’t really working either, Darren came up with Origami. Kris and Ashley joined soon after. Both of them, I’m sure, have their own last day on the job memories. I can still picture the lot of us, along with our staff, crowded into an open concept TEC Edmonton office, one of our companies in the main area, the Origami folks partitioned off in a smaller area that looked almost like a compound. Everyone busy, with that happy, hopeful, urgent energy you get mostly at the start of things.
I drifted back to those early days as I was writing the first few posts of Origami’s Small Business 101 series. So far, those posts concentrate on what prospective small business owners should know going in. Later, they’ll focus on what they need to know once they’re up and running. The heading for the series reads in part: “[Small Business 101] draws from lessons we've learned while working with thousands of Canadian small business entrepreneurs over the years. It's the class we wish we'd taken before we started Origami. And the night class we wish we were taking right now.”
One of the lessons I’ve learned is the importance of knowing why you’re starting a small business in the first place — and what you hope to get out of it. And then, thinking through what you’re going to need to make a decent go of it. For me, the main driver was to be my own boss; it didn’t matter how that happened. It just had to. I wanted to have the say. I wanted to decide. Mind you, I hadn’t fully worked out the implications of having a business partner, in terms of how decisions get made, and — because of the sensitivity of partner dynamics — what happens when decisions don’t get made. That awareness took time.
Vaguely, however, I also wanted to be an entrepreneur in the innovative sense, someone at the helm of a startup, a founder in the tech scene — not just someone who “works for themselves.” I had no clue that there was another possibility, a category called successful small business owners: people who don’t IPO or change the world, but who achieve enough in their business to step back if they want to, pursue their other interests and still live a prosperous life. Had I seriously considered this as a viable end state in those first few years, I would have paid much more attention when I crossed paths with these pillars of the community. Instead, I played what’s almost always a losing card in the business deck: I stayed apart and aloof. Trade in small business extends beyond money, goods, and services. Another lesson that came later.
“Knowing what you know now, what would you have done differently when you were first starting out?” A question asked of interviewees in a business book I read a few weeks back.1 Many of the responses were practical: I would have saved more money; I would have hired an accountant; I would have asked for help sooner; I would have done more to be prepared; I would have taken business classes.
Me? I would’ve prioritized having answers to “What exactly do you want to get out of it?” and “What exactly are you bringing into it?” Not having those answers, not having thought those questions through, I realize, was a mistake. It led to me confusing “I want to be my own boss” with “I’m ready to be an entrepreneur” when I wasn’t. But I was lucky to have a second and third chance. Not everyone gets those. So I want to address people starting out — or thinking of starting out — with the three reasons for starting a new business and their respective realities.
Create a job for yourself
One reason people decide to work for themselves is they don’t like what normal working life offers. Dolly Parton sums it up: “Workin’ 9 to 5, what a way to make a livin’, Barely gettin’ by, it’s all takin’ and no givin’…”. So they try to create a situation where they don’t have to answer to a boss, follow someone else’s routine, or build someone else’s empire. Another reason is they have no choice; no one’s offering them a full-time job, and they need money. Some people want to add to household income. Some choose the business to support a lifestyle; the lifestyle comes first and the work in the business is a means to that end. Creative types see their business as an outlet for their creativity, an outlet they wouldn’t have if they took a regular job. Some people with in-demand skills, usually knowledge-based, see that they can make more money working for themselves than they can as employees.
The common feature in all these cases is that the person starting the business is creating a job for themselves. That job has to provide them income. They’re going to earn it by their direct labor. They’re not looking to innovate or to grow. It could happen; they could stumble on something or there could be more demand than they expected for what they’re offering. If that happens, they’d typically be reluctant to grow their business beyond their level of management comfort. And if it does grow past that point, it’s because they’ve realized they have a real opportunity and decided to get comfortable with being uncomfortable — or they’re getting themselves in over their head. It’s sometimes very hard to tell these two things apart. It could be personal growth, it could be self-delusion.
The more important factor is that, because they’re writing the job description, they can make sure the job fits their other priorities. Like time to pick up the kids after school, winters spent traveling, seeing their creative work accepted and appreciated out in the world, or earning enough to build up a sizeable amount of savings while still relatively young. This, of course, is the ideal case: getting what you want on your own terms. We have many clients who fit into the category. They’re living the dream. But we also have clients that don’t find as great a fit. They’re living something closer to the typical outcome for people who work for themselves: uncertain income, too little demand for what they have to offer, constant competition and price pressure keeping their personal income down.
As businesses go, these are simple. Get the work yourself, do the work yourself is the formula. If there are employees, they’re in a supporting role, handling administrative or apprentice work. The focus is on you, at the center, bringing in the money. The people management overhead stays low, if it’s there at all. There’s networking and some form of self-marketing to get new customers, the next gig. Because you can’t personally take on too much work, there’s no need to scale marketing or business development. There’s rarely need for capital as well, unless you’re starting something like a food truck or a pressure washing business. Even then, the numbers can’t get too big; the point of the job is to pay you, not to saddle you with debt. But if you have enough ambition to personally invest more or take on more capital, then you have to have a true small business mindset — the next category — not just the work for myself grindset.
One thing to watch out for is tax. When people start earning self-employment money, they often forget that they’re going to have to pay taxes on those amounts. A common mistake is to spend everything that comes in, then eventually get a letter from the CRA asking for an overdue return. That leads to a scramble to find an accountant, a bookkeeper, and, eventually, the money to pay the overdue taxes and, now, interest and penalties. Save yourself the headache. Find a small business accountant when you start, sit down with them, understand your compliance obligations as a Canadian business owner, and know what you need to do for your record keeping. I can’t tell you how many folks I’ve met who’ve regretted digging themselves this hole early on. Some are still digging out.
Build a successful small business
The next option is to build a business that doesn’t solely rely on your direct labor to generate revenue. This means employees (in government statistics, a business with fewer than 100 employees is considered small), suppliers, customers, marketing, business development, rent, capital, assets, liabilities, operations… a much more complex undertaking than just working for yourself. There are more moving parts to manage and more potential sources and uses of capital. Why would you choose this route?
Let’s work backwards. You’re not going to start a small business to fail. You’re going to try to build a successful small business. What does that look like? In a post a couple of months back, I wrote about some features of successful small businesses that my partners and I identified after working with thousands of small businesses over the years at Origami. We focus on the financial numbers, because that’s how you keep score in business.
First and foremost, a successful small business has to be profitable. Don’t forget that the profit has to reflect the true costs of running the business. If you or other owners aren’t making a market wage for the work you’re doing in the business, then it’s not quite there.
The business should have some pricing power. If you feel you have no room to raise prices, that you don’t have something unique that customers value and willingly pay a premium for, then you’re in a commodity business. Volume matters when operating a commodity business. At big business scale, you can make it work, but it’s very hard to make money as a commodity small business.
There should be less need to have you directly involved in the running of the business. It doesn’t have to run itself, but it should be mature enough with respect to systems and levels of management that you no longer have to make every decision or be around every day.
We also think you should target at least $300K in total compensation. It’s not just a number; it’s a number that’s pretty close to putting you in the top 1% of income earners in Canada. That seems like a sensible target.
In terms of overall financial health, your small business, in addition to having a relatively high net profit margin, should have good, preferably double digit, year over year sales growth. A profitable, growing business is far preferable to a profitable, stagnant business. When you’re living off of past glory and going nowhere, complacency and bad habits set in. So when a hungry, determined competitor inevitably shows up, you and your business won’t be able to respond.
Finally, your successful small business will have strong operating cash flow (showing that you can finance growth internally) and a solid cash balance in the bank, at least enough to cover two to three months of operating expenses. Call it a margin of safety (for operational missteps or pandemic shutdowns) or a war chest (for the “fat pitch” opportunities you’ll sometimes get thrown your way).
The above relies heavily on financial numbers. If the presentation is hard to follow, it’s probably my fault. But it could be a sign that your understanding of the financial side of business needs work. The goal here is to build a profitable, cash generating machine that works without your direct involvement. This will make you well off, if not rich. In addition, the cash machine belongs to you, but it could as easily belong to someone else and produce the same result. People will recognize this and be willing to buy your business if you’re ever ready to sell. They’ll even pay a premium if it’s still growing. These are the rewards waiting in the winner’s circle for anyone able to build a successful small business. Unfortunately, not many people get there.
The Illusions of Entrepreneurship is a 2008 book by Scott Shane, a professor of economics and entrepreneurial studies at Case Western Reserve University. He uses academic research and census and labor data to counter the “myths” most Americans believe about entrepreneurship. Not the kind of book to read if you’re thinking about going into business for yourself and you’re easily discouraged, but not the kind to avoid if you want to be prepared, and you understand the median isn’t the message.
After reviewing academic research and census and labor data, Shane lays out some sobering facts about the typical American entrepreneur.2 He’s “just trying to make a living, not trying to build a high-growth business.” This individual starts a business because his opportunity cost is lower, that is, he doesn’t have good alternatives. The business he starts will require very little capital, but it’ll have lots of competitors. It’s likely to last less than five years. He’ll earn less money than he could have working for someone else. There’s a high risk of downward social mobility if things go bad. He’ll work longer than most. Overall, he’s not going to be happy about any of it. The book is downbeat throughout; I don’t expect it was a bestseller. But it is a warning.
American businesses, in aggregate, are the toughest competitors on the world stage. I expect the competitive nature and growth focus of American businesses leaves fewer niches for small, underfinanced players to start and thrive. Plus, there’s less incentive for high skilled, well trained people to start and run businesses when the rewards they can earn working in the American corporate sector are so great. Scott says this results in a greater proportion of the wrong (low opportunity cost) people starting new businesses, the ones who don’t have the training, skills, or access to capital needed to make it successful.
The Canadian scene is different but not too different. Per capita, we have more small businesses than the States. I think this is because our industries aren’t as competitive. There’s more room and niches for smaller players to set up. Our winners aren’t as efficient and ruthless in expanding. We share the relatively low small business success rate, however, and small business, in Canada like in the States, attracts the relatively ill-prepared, people who later wish they’d taken a business class before starting their business. The takeaway for me, and hopefully for you, is to constantly learn. Building a small business takes a range of practical business skills. You may not have them going in. Recognize that and pick up as much as you can along the way. Or work with companies like Origami that can support you in the critical areas where you need help.
Build an innovative, high growth startup
I used the expression “small business entrepreneurs” earlier. A small business is defined by its size, as measured by employee count. Any business with fewer than 100 employees is considered small in government statistics. Sometimes, like me, people will use entrepreneur to describe people who start and own small businesses. What we’re getting at is that small business owners start something new, they assume the risks, and, to the extent possible, they control its fate.
There’s another Silicon Valley version of entrepreneurship that also involves starting a business. In this view, instead of self-financing, entrepreneurs seek outside investment, angels to start, VC money later on. And instead of pursuing a private, small-scale win that’s still in the small business category, entrepreneurs are looking to rapidly grow and scale, leading to an eventual sale or initial public offering. What makes this trajectory possible is innovation.
I’m not going to get into this version of entrepreneurship. I know I had a misguided understanding back when Darren and I started. Our experience since has given me some insight into the innovation process as well as the hunt for financing. Rather than get into that, I’m simply going to observe that Silicon Valley entrepreneurship represents a tiny fraction of new business formation. That tiny fraction has an admittedly outsized economic impact, but the Silicon Valley entrepreneurial experience itself is reserved for a select few. If you’re about to be one of those few, you certainly don’t need anything from someone so far removed from that action.
Innovation is very interesting. I think it’s valuable for people in small business to understand Joseph Schumpeter’s perspectives on entrepreneurship as well. But as it’s late — and this post has gone on long enough — I’ll save that for a later time.
What contributes to small business success? Certainly, hard work. The resources, financial and otherwise, that you start with. The market you choose, what you choose to offer. Business skills: being good at spotting opportunities, being good at organizing and directing resources in pursuit of opportunities, being good at reading and winning over people... There’s also luck and timing.
Hard work can make up for other things you’re missing, but, in my experience, only to an extent. The result is predictably better when hard work is attached to a position of strength, rather than weakness. Though you can’t anticipate luck, you should be careful in assessing the rest. Try to be honest about the gaps and deficits. This, unfortunately, isn’t a straightforward exercise. When people start a small business, it’s often the case of you don’t know what you don’t know. Plus, people who start a small business have to be optimistic; it’s bad luck to focus too much on weaknesses and what can go wrong. So you learn once you’re in, but the lessons aren’t always easy. Sometimes you go through an experience without learning anything at all, not until much later when the light bulb finally goes off. That’s why, like me, you sometimes need a second (or third) chance in business.
There’s another factor that applies generally to life and not just business: a sense of purpose. The ever present big question that hangs over us: Why? I’ve always found that people who face and answer that question, people who develop a clear sense of purpose, stand apart from those who avoid it. In life, in business, they take bigger steps, they cover greater ground. I think it’s because their work is infused and guided by their sense of purpose; they move steadily and in straighter lines, rather than weaving chaotically, in fits and starts. The shape of their work becomes more coherent. The effects of their work compound.
Shane uses “entrepreneur” to describe anyone who starts a new business, not just the subset of people who are pursuing some form of innovation. Shane also mostly uses “he” because the typical American entrepreneur is male.