RM Online - Refuse to lose!

BY TOL BROOME JR.

You've undoubtedly heard the horror stories about how small businesses fail during their first few years out of the gate. The U.S. Small Business Administration estimates that about 60 percent of businesses fail during their first five years of operation. There are many reasons that new businesses fail. Here are 10 of the most common causes of failure along with some advice on measures you can take to avoid these problems in your rental business.

1. Under-capitalization. This is the No. 1 small business killer. A business can survive for a while with little capital, particularly if it is being operated in a small, rented space, but an under-capitalized business eventually runs out of money, and that means its rental inventory suffers: it's old, worn out, not kept up well. Of course, this leads to dissatisfied customers who stop renting.

There are a couple of critical business stages at which capital is key. First, as you are starting the business, make sure you have a cushion available to get you through the peaks and valleys that inevitably will occur. This can be accomplished out of your own personal funds or through a bank line of credit. And if you don't have much money saved and your bank won't approve you for a line of credit, the next best thing is equity funds from a friend or family member. You may be reluctant to give up some of the ownership of your rental business, but having funds available to help you through cash-flow shortfalls might mean the difference between survival or failure.

The second point at which a capital crisis is likely to occur is two or three years after the rental business has been started. The key here is to anticipate this crunch before it occurs. If your business has been profitable, you might have more success than you did at first in obtaining bank financing. An equity investment might get you through this period as well. The key with either bank financing or an equity investment is to plan ahead. Don't wait until April to attempt to buy a new stock of lawn equipment. You may experience a time delay in getting an answer from your bank or investor, which could cause you to miss the season entirely and threaten the viability of your shop.

2. Inappropriate financing. While we are on the subject of capital, we would be remiss not to address the inappropriate use of financing as a major cause of early failure for small businesses. There is a tendency for the new business owner to use any source of money available to finance the entity, regardless of the interest rate and repayment schedule. This can be disastrous.

No matter how tempting it may be, avoid the use of high-interest-rate credit cards to finance a new business venture. With the onslaught of direct-mail applications we all receive every week, revolving credit is easy to get - far too easy. Credit card debt creates a treacherous money trap for the new small business. Most credit card companies charge 18 percent or more for the use of the money. As the use of credit cards mounts up, so does the monthly interest expense and the minimum monthly payments. Soon, the rental business owner is sinking all of his/her profits into the credit card payments, but the balances aren't going down. If this cycle isn't halted, the business finally fails. Rental Management Editor Brian Alm, in a Financial Management article in the May 1999 issue (page 38), calls credit cards the "hidden horror."

The other pitfall in financing is inappropriate repayment terms. Some banks will readily make available 90-day notes to new small businesses. However, many small businesses continually run short on working capital and need to roll profits from one season into the next. As a result, the short-term bank loans don't get paid off. One day the banker gets nervous and calls the loan(s). The next day the business goes belly-up.

3. Not enough revenue. It is rare for a small business to be started if the owner doesn't think that his/her idea ranks right up there with sliced bread. Unfortunately, if you don't find some customers who agree, the business is doomed. If you are in the beginning stages of starting a rental business, test the waters before diving in. For more on this, look at the primer on getting started in rental on page 32 and test your idea against all the considerations that apply.

I would emphasize these points:

First, talk with prospective customers about your ideas to see if there will be viable renters.

Second, talk with others in the rental industry. Rental business owners generally are quite willing to share information with each other, particularly if they are located in separate geographic markets. If you can't find someone locally who is handling a similar product and is willing to talk with you, you should have no problem finding someone from another part of the country who is.

Third, attend an A.R.A. convention and trade show or two before you get serious about this rental business. This will help you a lot - you will get invaluable information about what rents and what doesn't, what sizes of machines are best for what markets, and what colors and styles are most popular for parties and events, and when and how to rent what. It will be a very valuable trip.

4. Too much revenue. In my 16 years in banking, I have seen nearly as many new businesses fail because of too much success (i.e., sales) as not enough business. Many small businesses are under-capitalized. When an under-capitalized business experiences rapid revenue growth, a tremendous cash crunch can result.

The typical scenario in the rental business goes something like this. A rental business enjoys some early success. Gaining confidence, the entrepreneur begins advertising more heavily. Demand is very strong; in fact, it is overwhelming. Customer interest doubles overnight. This creates stress on two things: (a) the funds available to buy and/or replace the needed inventory and (b) the time and resources to meet market demand. Customer service problems arise, and the rental business' reputation is seriously or even fatally damaged.

The best suggestion I can offer to avoid this trap is to manage your growth. This may actually mean turning down business at times. But you will be much better off with a bunch of people on a waiting list than you will with a bunch of people complaining about your deteriorating quality and/or turnaround time. (See the Rental Management cover story on Fiesta Rental in West Palm Beach, Fla., in the August 1999 issue, for a look at a company that made a conscious decision to control growth.)

5. Lack of financial understanding. Many rental business owners go into business solely on the strength of their respective creative talents or technical expertise. This works fine at first, because the numbers are pretty simple: it costs you X-dollars to buy a tiller that you can rent 20 times in a season for X-dollars a day. But as the business grows, the numbers get much more complicated.

Regardless of the scope of your business, you need to invest a significant amount of time in understanding the financial side. You can accomplish this over time by asking questions - ask your banker, your CPA and other financially astute rental business owners. You also might take some accounting and finance classes at a community college. The more financial competence you have, the more profitable and efficient your business will be.

6. Economic problems. This is a tough one because there is little you can do to control the national or local economy. Still, economic problems often are the cause of business failures. The U.S. economy has been strong, but there have been pockets around the country that have suffered. There is always someplace that is suffering from cyclical conditions.

A recession is inevitable sooner or later. Of course, a new rental business can survive in an economic slowdown. If you see one coming, avoid any heavy capital expenditures and extensive new hirings. And if your rental business relies primarily on a few key customers, diversify.

7. Disaster without a plan. Disasters, too, are out of your control. But your plan to deal with a disaster can mean the difference between survival and failure.

The first suggestion is to ensure that you are adequately insured. Don't try to cut costs by under-insuring. If your inventory, computer system and other equipment aren't adequately covered and you have a fire, you might not recover. Also, make sure you have the proper level of insurance for flooding, workman's compensation and liability.

Back up your computer files regularly and store them offsite or in a fireproof safe. Don't doom yourself by having no backup in case of a computer crash or fire in which critical files may be destroyed.

8. Death or disability of the owner. This is a major cause of small business failure that often is not considered as a risk.

Let's first deal with disability. If your family is dependent on the income generated by your business for day-to-day expenses, you should carry long-term disability insurance. Unless you are 60 or older, you are far more likely to file a claim on a disability insurance policy than you are on a life insurance policy.

Adequate life insurance is critical, of course - it protects your family from financial hardship in the event of your death. If you have a small company, your death may spell the demise of the business, as well.

If your company is a larger one, "key man" life insurance just might provide the cushion needed for the business to survive the death of the owner.

9. Expanding the business/ owner burnout. Many businesses fail as a result of a major expansion. Increased expenses (rent, insurance, utilities, taxes, etc.) that result from a larger location can mount up and sap the profits that were coming in when the business was operated at a hole-in-the-wall level. Owner burnout is a common result. Running a one- or two-person rental operation was fun. Managing 10 or more people becomes drudgery.

Two suggestions: first, count the cost of commitment before you expand - a larger business may require an even bigger commitment of time and resources on the part of the owner; second, run the numbers. Share these financial projections with your CPA, banker and other business owners to make sure you haven't forgotten anything. Your business simply may not support the increased expenses that will result from the expansion. And it is certainly better to find this out ahead of time!

10. Lack of long-term financial planning. Whether you run a multi-million-dollar, multi-location rental company or a small two-person shop, long-term planning is essential. If you focus all of your efforts as the owner on putting out the day-to-day fires and none on looking out toward next month,

next year or the next decade, you just might wake up one morning to find that one of those fires has engulfed your business entirely.

From the time a business is started, a long-term financial plan should be maintained and updated regularly. Long-term planning will help you with such important decisions as choosing which trade shows to attend, what rental items to buy and when to buy them, when to go see your banker and when to consider expanding. As the saying goes, if you fail to plan you might just be planning to fail.

Even if the rental industry is hot and continues to climb, most new rental businesses will face challenges along the way that will prove critical - the fine line between success and failure. If you're new at this, look at these key pitfalls closely; if you're an old hand, you might review them anyway, just to be sure you've covered all the bases.