What does your business idea look like if you were to write it down on the back of a napkin? Let’s say you want to open an organic lemonade stand on your front lawn. If you pay someone $15 an hour and sell a cup for a buck a piece, can you imagine selling 15 cups an hour? If you can’t even cover the labor costs, you know you don’t have much of a business. Maybe you think you can sell 100 cups an hour, and after figuring in all the expenses you can think of (payroll taxes, insurance, lemons, cups, etc.) the math still “pencils out” and it looks like you might have a viable concept. To find out if there’s enough juice in the squeeze, you can start making phone calls and testing your early guesses on the costs of wholesale fruit, insurance, etc.
Remember that just because something will sell doesn’t mean it will sell profitably. In the car business, you hear “there’s an ass for every seat,” which means every car eventually does sell. I can tell you from experience, though, that the wallets in those back pockets don’t always pay enough to generate a profit!
Cost of entry
You must understand the positive correlation between profit margins and cost of entry into a business. Consider a neighborhood pizzeria, a business with relatively few barriers. You can probably open one with less than $100,000. The rent on a little slot in a strip mall might be a modest few thousand dollars a month, you and a few family members can provide the labor, and there’s nothing especially difficult about making the food. A pizza shop is one of the easiest businesses to open, which is why there are over 75,000 pizza restaurants in the United States—one for every 4,500 Americans. And unless you can figure out some kind of chain or franchise model, your potential upside is pretty limited. On the other extreme, compare the pizzeria with a local television station with larger profit margins. Broadcasting requires extensive technical knowledge, significant facility investments, and many governmental approvals. Which business would you rather be in? Look for opportunities where the cost of entry is higher to others but lower to you. John and I were able to open a business with relatively high costs of entry because we had skills and connections in automotive retail, and we were willing to start with a franchise that interested fewer dealership buyers (in 1998, Subaru was a low-volume, niche brand, known in the industry as a “hard work franchise.”)
All in or on the side?
Should you quit your day job and dive head first into a business venture, or ease your way in with a smaller business that you run on the side, scaling up gradually over time and eventually growing it into a full-time deal?
My cousin Dan started a landscaping company as a side hustle while he went to college. He started with his strong back, a lawn mower, and a pick-up truck. He enjoyed many benefits:
· He risked very little at the beginning. When my brother and I opened Planet Subaru, we had to wrangle several hundred thousand dollars in cash, and we were on the hook for millions more in inventory loans. If Dan’s business had failed, his losses would have been much smaller than ours would have been and he could have recovered quickly.
· He gave himself the opportunity to test drive the industry, to decide whether he really wanted to enter into a lawn-term relationship. He educated himself about the opportunities and determined that he enjoyed spending his days doing it.
· He never needed to take on a ton of debt because he could grow organically, using his business revenue to make further investments to grow the business. Borrowed money is a powerful tool that can turbocharge the growth of a business. It’s great to expand your business using someone else’s capital, but you can also blow yourself up if you don’t stay ahead of the payments you owe to lenders.
· He was able to inexpensively develop a minimum viable product (MVP). You usually encounter the MVP concept in Silicon Valley circles, but it can apply more broadly to the most basic product or service you can develop quickly. You can test the practicality of your idea and start getting feedback from customers so you can continue to develop and improve your business, products, and services. In Dan’s case, a mower and a truck got him into neighborhoods to test his assumptions about pricing, demand, and other factors.
· He kept his cost structure compact because he didn’t need a dedicated facility right away, and he avoided many costs that come along with most full-time businesses, such as personnel. Avoiding a big monthly ”nut” meant that Dan could nimbly expand or contract his business as economic or other circumstances dictated. This flexibility makes starting a business more fun because you don’t stay awake every night worrying about all the things outside your control that could wipe you out.
There are also benefits to going all in, right away, the way John and I did.
· Something powerful occurs psychologically when you’ve committed entirely to a project. Failure is no longer an option, and the need to succeed becomes a powerful motivator. There’s nothing like burning all your boats.
· You can focus all your energy on building the business, It’s hard to build momentum in a business using the leftovers of your time, energy, and capital from the other parts of your life.
· Going all-in increases the size of the business you can take on, and bigger businesses generally produce more profit. Side hustles run the risk of trapping you in a situation without enough upside to justify all the effort and risk. Many of the businesses that start as side hustles are basically just buying yourself a job. I think of all the tool distributors who have shown up in their box trucks at the dealership over the years, selling tools to our technicians. Few last very long. Many are former technicians who want to own their own businesses, but they actually end up earning less than they would if they had just kept their original jobs.
· Be bold and mighty forces will come to your aid. I can’t explain why this advice from writer Basil King actually works, but the sentiment did help John and me muster the courage to jump in. And don’t underestimate the power of really believing you can accomplish something. Roger Bannister broke the 4-minute mile barrier in 1954, a record previously considered all but impossible by doctors and so-called experts. As the first human to accomplish the feat, his achievement opened up the floodgates, by showing others that it could be done. Within a year, three people did it in a single race.
If you do end up pushing all your poker chips to the center of the table, I recommend finding a way to start pulling some of those chips back as soon as you can. When John and I opened Planet Subaru, we needed every penny we could get our hands on just to open the dealership. We had no reserves. For financial and psychological reasons, this was not a condition we wanted to continue for any longer than absolutely necessary. Big bets allow for rapid growth, but expose you to serious risk. As we started generating cash, we could have used that money to secure loans for more dealerships, but we chose instead to strengthen the finances of the dealership we already had. We lived by the old army adage, “There are old warriors and there are bold warriors, but there are no old, bold warriors.”
Freelancer or Entrepreneur?
Author Seth Godin makes a distinction between those who just want to work for themselves and those who want to build a business that will pay them when they’re not working. "A freelancer is someone who gets paid for her work. She charges by the hour or perhaps by the project. Freelancers write, design, consult, advise, do taxes, and hang wallpaper. Freelancing is the single easiest way to start a new business. Entrepreneurs use money (preferably someone else's money) to build a business bigger than themselves. Entrepreneurs make money when they sleep. Entrepreneurs focus on growth and on scaling the systems that they build. The more, the better.”
Franchise or Independent?
With our dealerships, we chose a franchise model, where we own our own business but use the products and business model of a franchisor (Subaru and Chrysler/Jeep/Dodge/Ram). Contrast this arrangement with, say, an independent used car store that an entrepreneur opens on her own, and is unaffiliated with any other company or manufacturer.
The franchise model helps a lot early on. The franchisor will give you lots of data drawn from outlets in similar markets, allowing you to create a pretty accurate forecast of your revenues and expenses before committing. The franchisor will give you a template for getting the business started and will usually supply some or all of the products you sell. Many people appreciate this “holding hand” at the beginning to help overcome their fear of starting a business. If you do well with one store, you might replicate the model again and again, creating a chain of stores.
When you buy a franchise, you marry the franchisor. In our case, our success depends largely on the quality of the vehicles that our manufacturers build, and the policies they enforce. Differences between franchisor and franchisee can and do arise, just as you would expect in any partnership. The big franchisor will always command a lot more power than your small business. Even though you own your business, the franchisor has a lot to say about what happens there. And they take their cut of your revenue through fees, mandatory programs, or a percentage of your sales.
You control a lot more when you run an independent business, but it can be harder for a novice businessperson to start. You have to figure out everything on your own. And unlike a franchise which usually brings some brand recognition, you have to build your brand from the ground up.
Buy an existing business?
Buying an existing business saves you a lot of start-up challenges. The phone system is already in place, and most of the permits and vendor accounts update fairly easily with new ownership. Imagine buying an electrical supply store that has been in business for ten years. Customers already shop at the store every day so you have revenue from the beginning. When deciding to buy it, you can make pretty accurate forecasts of costs and revenues based on real data instead of guesstimates. These benefits have value, and the seller will typically want to be paid on some multiple of the earnings the business currently generates. If the shop is making $200,000 per year, you know the seller will likely want at least that much for it, or maybe several times that much.
Don’t forget the real estate
You know the cliché about real estate, “they ain’t making any more of it.” Our first location, which we leased, started out as a facility for Nissan, then Mercedes, then Acura, then Subaru, then Saab, then Lexus, and, as of this writing, McLaren sports cars. Factories keep producing vehicles, and franchises come and go (Saab doesn’t even build cars anymore), but the underlying real estate will always have value. That value generally increases over time, typically at least keeping pace with inflation, sometimes increasing dramatically under the right conditions. Routinely, the value of the real estate that a business occupies exceeds the value of the business itself.
When we moved to a larger facility in 2002, we bought it with a typical twenty-year commercial mortgage and set the property up as its own company. Planet Subaru Inc. paid rent to our property company, just as it previously paid rent to the owner of our original facility. The end of the twenty-year mortgage seemed a long way off when we signed the loan in 2002, but we refinanced a couple of times as interest rates declined after the Great Recession, and we recently paid it off. Now, that monthly rent check flows into our property company with nothing more owed to the bank. It’s an enviable situation—this “mailbox money” shows up monthly with relatively small investments of time and emotional energy compared to the challenges of operating a complicated retail business. As you’re looking at business opportunities, consider the possibilities of owning the real estate immediately or eventually. The real estate might be your retirement plan.
A friend started a flooring store in a mini-mall with five other smaller businesses. Initially, he leased his space, the largest of the six units, but when the owner of the site listed the property for sale, he took out a loan and bought the whole thing. His flooring business was doing well enough that he felt confident that the biggest tenant would remain in place over the long term. His flooring business never grew a lot, but adding the income stream from the real estate increased his overall revenue substantially.
There are defensive reasons for owning your facility, too. When you lease, you’re at the mercy of the property owners when the term expires. They can choose not to renew the lease at all or significantly raise your rent. You might have to move and reestablish your brand elsewhere, a risky and potentially expensive situation. And the whole time you’re leasing, you’re reluctant to renovate because the property owner keeps all your improvements if you leave.
And one last thing…
If you’re not already in the industry of the business you’re starting, I strongly encourage you to talk with one or more people already in the business, to see if they enjoy it and recommend it. As discussed in Daniel Gilbert’s Stumbling Upon Happiness, humans do not generally score high marks for accuracy in predicting what will make us happy, so “test driving” a version of the future can help you compensate for this inherent human frailty. These experts can also share their wisdom for succeeding in that line of work.
Next Bonus Chapter: Why you need a business plan even though it’s a pain.