Cover Story

 

Look Before You Leap

Why Does Utah Have High Business Churn and Failure Rates? 

 

By Colin Kelly Jr.

 

In its "2007 State New Economy Index," the Kauffman Foundation ranked Utah No. 12 overall in the nation and the No. 1 state in its economic dynamism category. One of the six factors relating to Kauffman's economic dynamism rating is the degree of "churn" in the state's economy. Kauffman defines churn as, "A product of new business startups and existing business failures."

Churn can be a good or bad thing depending on how you look at it. Obviously, if you're one of the business failures contributing to the churn, you don't think churn is a good thing. However, an active churn rate means a vibrant economy (as long as the churn is associated with positive job growth).

Luckily for us all, Utah is currently in the middle of an economic boom. At the time of the writing of this article (August 2007), Utah has the fastest job growth (4.5 percent) and lowest unemployment rate (2.6 percent) in the nation.

Utah also has the second highest growth rate in the nation (7.6 percent) for self-employed individuals. The latest data (2005 numbers) places the number of self-employed Utahns at 175,121.

"You have to look at the picture on the whole," says Jason P. Perry, executive director of Utah's Governor's Office of Economic Development (GOED) and former deputy director of the Utah Department of Commerce. "As long as you have high job growth with lots of opportunities, there is churn. If at some point you have low job growth and lots of churn, then it becomes negative and a reason for concern."

Richard Nelson, president and CEO of the Utah Technology Council, agrees. "Technology and life science companies in Utah are being created at the rate of 10 percent more per year right now," Nelson says. "While it causes pain for the people who go out of business, right now, the net positive churn is good for this economy."

While it's difficult to get exact numbers (all Utah cities and municipalities don't always report the number of failures), there's no denying that Utah has a proportionally large number of startups and failures related to the rest of the nation.

Why is this the case? Why do so many of our startups go under? If you take a straw poll of members in the business community, you'll find a variety of contributing factors. Some of these factors are Utah's portion of nationwide issues and some are likely locally based Utah-specific cultural issues.

 

National Reasons

According to a study by the SCORE program and U.S. Bank, over 70 percent of business failures are related in part to the following five reasons: 1) Not recognizing or ignoring weaknesses and then not seeking help; 2) Poor cash flow management skills/understanding; 3) Lack of a solid business plan; 4) Starting out with too little money; and 5) Being overly optimistic about sales and required funds.

Businesses in Utah certainly mirror those national findings, but there are also some theories regarding cultural or social factors involved in the state adding to the problem.

 

Utah-specific Reasons

The "Pioneer mentality" as I like to call it is still alive and well in the West. People here have a fantastic, just-do-it, do-it-yourself mentality. That's not necessarily a bad thing (in fact it's often one of our greatest strengths), but it can cloud one's judgment at times.

Ever walk past a $1,500 pre-built playground set at Home Depot and say to yourself, "I could build that for my kids all by myself for about $700 in materials and one weekend of my time." That's your Pioneer mentality kicking in. If you're like me, you'll find out quickly that it really takes $1,200 and 60 hours of your time to build the $1,500 playground. It's this mentality however, that sometimes encourages people to become entrepreneurs prematurely without much thought.

Another issue is related to religion. Utahns of all religions (especially some members of The Church of Jesus Christ of Latter-day Saints) occasionally will start businesses based more on faith or personal feelings rather than facts. People are sometimes blinded by the belief that if they just do everything their religion requires, God will take care of them.

"It's the equivalent of diving headfirst into an empty swimming pool and expecting the Lord to put water in the pool before you hit bottom," says John E. Richards, local entrepreneur, angel investor and associate director of BYU's Center for Entrepreneurship. "You can't ignore basic business principles just because you pay your tithing each month."

Remember, bad things do happen to good people all the time regardless of how religious they are. Good people die and good people have problems. Business is no different. Your business can thrive or fail regardless of how well you practice your religion.

 

Cutting the Failure Rate

What can we do here in Utah to prevent some of the failures? Simply put, if future entrepreneurs wait until they know the facts (or after learning the facts decide entrepreneurship isn't for them) before getting started, we'll see a big drop in the failure rate. Education is one of the keys. There are many state and private resources would-be entrepreneurs don't take advantage of. Local organizations and Small Business Development centers have information and mentors. More entrepreneurs need to take time to understand the realties of business before taking the plunge.

If you are considering starting your own business, please study the "Before You Dive In" advice section and "Are You an Entrepreneur?" quiz below.

 

Before You Dive In

No matter how confident you are in your business plan, it's a good idea to make sure there's water in the pool before plunging headfirst into the deep end. Here are some basic concepts to fully consider before starting your own business:

 

Family

Are your spouse and children aware of and OK with the probable long hours and lower initial salary many entrepreneurs are required to endure during the early years of a startup?

 

Mentors

Many local organizations, incubators and business schools can provide you with the opportunity to speak with someone who has been through the startup process before. Make sure to run your ideas past someone with entrepreneurial experience.

 

Can You Pony Up?

If you aren't willing to put up some of the startup capital yourself, then your idea isn't likely a worthwhile venture. You'll be hard pressed to find someone willing to invest in your idea if you don't have at least some skin in the game.

 

Plan B

Some entrepreneurs are willing to bet the farm and lose everything if their business doesn't succeed. If you don't fall into that camp, what's your early exit strategy if things go south? Can you close down or get out with acceptable losses while staying married in the process? This is important to consider if you or your family can't financially or emotionally handle a total business failure.

 

Need a Paycheck?

Any business owner will tell you how severely labor costs contribute to cash flow problems. Can you operate your new business with few or no employees on the payroll? Can you afford to not pay yourself for the first six to 18 months? Many a startup with great promise has died due to the high burn rate related to monthly payroll. Remember to factor in payroll taxes and employee benefits when estimating future total payroll costs.

 

Willing to Lose Your House?

It's almost impossible for a pre-revenue startup to get an SBA loan without a hefty chuck of collateral. For most, that means putting your home on the line. Do you have enough equity in your house (and faith in your enterprise) to put your house on the line?

 

Idea vs. Opportunity

Take off the blinders for a moment and ask yourself, "Do I have a good opportunity or just a good idea?" Learn to tell the difference. Just because an idea is original, creative or life changing doesn't mean you can build a viable company around it.         

 

Funding Sources

Only one percent of companies nationwide receive venture capital sometime during their lifespan. Don't plan on VC money — ever. Do you have a backup plan if you can't find angel money? Even better, can you start your company without needing a huge influx of capital?

 

Can You Bootstrap to Revenue?

Equity-based funding for pre-revenue startups in Utah is almost nonexistent. Even most angel investors in the state shy away from pre-revenue deals. This means three things for the great majority of entrepreneurs: 1) You need money to cover expenses until you start making cash; 2) You must soon start selling something to someone; 3) Mastering the art of bootstrapping is critical — justify every penny. One-third of the companies on the Inc. 500 started with $1,000 or less and 41 percent bootstrapped it with an initial investment under $10,000.

 

Do the Research

Is your industry oversaturated in your desired markets? Example: Utah has plenty of ice cream shops already. Your new ice cream endeavor better have something really special going on if you want to stand out.

What's the competition like? Example: FedEx, UPS and DHL pretty much have the overnight shipping industry locked up. Think of something else.

What kind of profit margin can you realistically expect within your industry?  No mater how good your idea is, it won't play if you can't eventually make money. Example: Ever wondered why you don't see many new mom-and-pop grocery stores popping up? That's because today, anyone in the grocery space has to be large and lean. Typical grocery store chains are lucky to garner a 5 percent profit margin even with years of streamlining experience under their belt and multi-store buying power.

 

Get a Black Belt in Excel

Savvy entrepreneurs build elaborate spreadsheet models taking into account multiple variables to predict whether an idea for a business could eventually make money or not within an acceptable time frame. Take the time to master Excel and run every possible scenario to profitability (using realistic and conservative numbers). At the very least, take advantage of online resources such as entrepreneur.com/calculators or similar sites.

 

Quiz: Are You an Entrepreneur?

While this test is by no means exact, it will give you some idea of whether you're cut out to be an entrepreneur or not. Ask yourself if you agree ("Yes" or "No") with the following 25 statements.

 

1)         I communicate with others easily and clearly.

2)         I can focus on more than one task or topic at a time.

3)         I often can persuade people to agree with me.

4)         I can work alone without direction.

5)         Family and/or people I'm close to understand that sometimes work has to come first.

6)         I enjoy trying to meet or beat a deadline.

7)         I can generate ideas/solutions from little information.

8)         My concern for other people is obvious to the outside world.

9)         When I read a book, I find it hard to focus only on the subject at hand and outside thoughts tend to creep into my mind.

10)       I have no problem listening to or acting on advice from a mentor or investor.

11)       I can quickly and easily adapt to a changing enviroment.

12)       I don't need the security of paychecks at regular intervals.

13)       I am willing to take responsibility in any situation necessary.

14)       I tend to look for the simplest solutions.

15)       I constantly look for opportunities and then act on those I'm capable of handling.

16)       I assess risk and determine the best action before committing to act.

17)       I can think of creative solutions to real problems.

18)       I like to start projects on my own and usually complete them.

19)       I don't mind working hard with the promise of a distant reward.

20)       Once I make up my mind to do something, I don't let anything stop me.

21)       like to build things (physically or conceptually).

22)       I enjoy planning and working on long-term strategy.

23)       I'm willing to learn and can admit my shortcomings.

24)       I often think of ways to do something better.

25)       Work to me is always more than just a job.

 

If you answered, "Yes" to at least 20 of the above questions, you may be entrepreneur material.

 

You may also want to click here to take a very good Entrepreneurial Quotient Test developed by Northwestern Mutual Life and published on the BYU Center for Entrepreneurship Web site.

 

Launch - Fall 2007

 

 

For the full "digital magazine" version of Fall 2007, visit: http://www.nxtbook.com/nxtbooks/growutah/launch_2007fall