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Home Based Business ... Is it For Me?

Home Based Business

Home-Based Business... Is It For Me?

Introduction

The 1990s were called the "Decade of the Entrepreneur." More people are starting home-based and micro businesses than ever before. People are turning their skills, hobbies and ideas into profitable ventures. This can be a satisfying experience. The endeavor is usually something a person enjoys doing or is very skilled at doing. It allows for flexibility so you can work around your family and work schedules. It also gives you the independence of being your own boss.

The words entrepreneur and entrepreneurship come from the French word "entreprende," which means "to undertake." An entrepreneur is someone who organizes, operates and takes the risk in a business venture, expecting to gain a profit. Entrepreneurship refers to the process of planning, organizing and operating a business.

A home-based business is not for everyone. For many people it will be a supplemental income source for retirement or extra income for the family. In fact, only 46 percent of home-based and micro business owners recently surveyed cited that making lots of money was a motivation for starting their own business. Seventy-eight percent of business owners stated that having more control over their lives was an important reason, and 90 percent said they would go into business again. So, even though you may not get rich from such an endeavor, it may be worth the effort to try your idea out to see if it would be successful. Remember, entrepreneurs may not see a profit right away; it will depend on the type of business.

There are several facets to consider when starting a home business. Determine if there will be a market for your products or services and if such an endeavor is possible. This is crucial before a large amount of money is spent. The business may not be feasible. Too many businesses fail because people do not test their market plan and manage the business properly. Information from Link Research in a 1996 survey of 5,000 Home Office Computing readers reported that 20 million businesses found the most challenging business tasks to be 1) marketing to gain additional business; 2) time management; 3) financial record keeping; 4) avoiding overhead when possible; and 5) assistance in managing varied responsibilities.

This publication will identify and address many of these factors. If you decide to pursue a home-based or micro-business, careful planning and consideration of these topics will help increase the chances of success and in some cases prevent you from making an unwise investment or help avoid unnecessary risks.

Choosing the Business

A home-based business can be either product-oriented or service-oriented. Product-oriented businesses are usually two types: a) selling products made by you, family members and/or employees (like raw materials such as fabrics or tanned leather, kits like yarn/pattern and knitting needles, partially finished items like unpainted bird houses or completed articles such as jewelry and belt buckles) or b)selling products manufactured by others and either purchased by you for resale or sold on an order basis. Services may involve performing a service at the place of business (word processing, tutoring, bookkeeping or child care) or at another location (house painting, carpet cleaning or consulting). To determine or confirm your business idea(s), examine your interests, skills and abilities, education/training, and experiences.

You must enjoy doing the work involved. Just because you make super apple pies or wooden toys doesn't mean that you would want to create them six days a week. Perhaps you would rather teach others to make pies or toys! Teaching requires a totally different set of skills and interests than doing the actual work yourself. See (Appendix A) for a list of business ideas.


Spotting Opportunities Among Scams

There are many other enterprises that are operated out of a home. As you consider a business beware of scams. As technology expands and because of the growing interest in the home-based business community, a large number of individuals and companies have organized to meet the needs of budding entrepreneurs. Many of these companies, however, are more interested in selling a worthless business idea to someone instead of helping them develop a real small business opportunity. So check it out! The old adage "if it seems to good to be true, it probably is" holds true. See (Appendix B) "Opportunities Questionnaire." Evaluate all ads carefully, and if you suspect it's a scam notify the Attorney General's Office before investing in a business opportunity.

You must thoroughly evaluate the potential for the business you plan to operate. Obtaining good advice can help prevent you from making expensive mistakes which often lead to failure.

Decision to Start a Home-Based Business

While being in any kind of business has certain basic requirements, a home-based business has additional ones. Self-discipline is very important. Working for others means that many responsibilities are shared with other employees. Being in business for yourself means you carry the whole load. Some people don't want all of the responsibility of licenses, regulations, taxes, insurance, keeping records, advertising and pricing, etc. Are you willing to take on these responsibilities?

Depending on the business, you may find it very confining, stressful, expensive and physically exhausting. On the other hand, being on your own can be very stimulating, financially rewarding and satisfying.

A home-based business may cause problems within the family. You need the full support of spouse, children and others. They need to take you and your business seriously. What help can you expect or do you need from family members? Use of their money, skills and time often make the difference between success and failure.

Will you have adequate time to spend with your family? Doing work part-time or postponing starting a business a few years may enable you to better prepare for starting a business and allow you more time with your family when they particularly need you.

Lack of planning and insufficient financial backing join poor management as the main reasons why businesses fail. Improve your odds of success by moving slowly and carefully in starting a business and you can join the 95 percent of those who succeeded in their first year and the 85 percent who are still in business and doing very well after three years.

Advantages and disadvantages

Advantages of a home-based business include having a flexible schedule; integration of family and work responsibilities; less involvement with others in a regular work environment, such as power struggles and red tape; no commuting time (unless you travel to a customer's home or place of business); control of your own personal environment (temperature, light, work breaks, etc); self-determination and independence; increasing personal fulfillment; seeking and setting personal goals; enhancing creativity; and remaining in a community or moving with a spouse to a new community even when jobs are scarce or not available.

Disadvantages of a home-based business include needing to know a lot of information to operate a business successfully; the risk involved in operating a business; conflict in ownership of time (When is it my "own" time and when is "business" time?); lack of guaranteed employee fringe benefits; many competing roles and responsibilities (producer, promoter, bill collector, customer service representative); lack of job security; loss of home space use by family; interruptions; lack of self-discipline; little opportunity to delegate tasks to others; long hard hours, and legal requirements including zoning regulations. Being committed to a business may mean lack of freedom to do other things and to go as you please.

Other factors to consider

The decision to go into business is based on a thorough study of factors such as the potential market, sales promotion and advertising, location, making the product or setting up the service, delivery of the product and profit potential. Consultation with a small business expert such as a Small Business Administration Service Corps of Retired Executives Association (SCORE) counselor or the Small Business Development Center (SBDC) staff (1-800-445-7232) will help you decide if the particular small business would be feasible and help find answers to the following and other related questions: How likely is it that the business will be profitable? What is the competition? Is there a long-time need for the product or service, or is it a fad-type item? Are you an expert in producing the product or service?

"Can You Live Where You Work... and Work Where You Live?"

A unique situation occurs when a business is operated out of the home. Conflict can result from the infringement of the customer/business interaction on family functioning. A family and business does not integrate successfully in the same space without some planning. Five areas of family functioning are likely to be affected.

Family cohesion. Each household will need to answer the following: 1)What will the business demand from the home space? 2)What does the family need from the space in the home? 3) How can you develop a management plan for household space use that best accommodates your family and your business?

Personal and family time schedules. If the schedules of family members are fixed and intermeshed (one car and each person needs to be on time for various commitments), a business would have to meet this time schedule. It would be difficult to retail items such as paintings and crafts if customers stop by anytime.

Use of space. Is your business one which requires storage space, an area for customer interaction, specialized tools and equipment, or convenient access for pickup and delivery? Is confidentiality a problem? The arrangement of space may affect ongoing family activities. The most convenient part of the house for customer interaction, pickup and delivery is often the most shared and public parts of the house (kitchen, living room, etc.).

Space separations must be maintained for deductions as business expenses for tax purposes. One must determine if this part of the house has too many uses that are part of the pattern of your family's life to also be used in the business.

There are many different types of home-based businesses, but they can be grouped into broad categories: production/service; consulting or counseling; sales or marketing and mail order. These different types of businesses have different space needs. Thinking about what category describes your business can help you begin to think about space needs. Think about storage space, space for tools and equipment, production space, area to meet with clientele, pickup and delivery and office space.

The Neighborhood. How do your neighbors feel about a business in the neighborhood, and do city and county codes permit your business to be established in the neighborhood? Higher traffic in the neighborhood may cause disenchantment among friends and neighbors. A seamstress may consider fitting garments at the client's house or secure alteration business through a clothing store or dry cleaners in order to preserve the character of the neighborhood, for example.

Shipping and deliveries could be made to a U.S. postal service box or parcel service branch office to avoid unwanted truck traffic.

Risk handling behavior. Another aspect of family functioning which relates to a business at home is the family's attitude toward risk. Some are risk seekers who look for opportunities to be tested, willingly take financial risks, and promote novelty and change in their lives. Others tend to avoid change and desire a secure environment at home and around the family.

For complete information and worksheets order, "Can You Live Where You Work...And Work Where You Live?", publication 354-306, from the Virginia Cooperative Extension Service, Distribution Center, Landsdowne St., Virginia Tech, Blacksburg, VA 24061-6192. Publication cost is $1.50.

Searching for Financing

Inadequate capital is the cause of many home business failures even though most home-based businesses require a limited amount of start-up money. There are several sources to consider when looking for financing for your business. But first you need to consider how much money you are going to need. Consider all of the expenses of starting up your business and add on at least three months of operating costs. Do a cash flow analysis as given in Appendix I (6KB PDF) to determine capital needs. The SBDC (1-800-455-7232) can assist you with developing and completing your cash flows. When you know what you need, start looking for sources of capital. Experienced business owners recommend that at least half, if not more, of your business investment should come from personal savings. This can include profit shares or early retirement funds, real estate equity loans, cash-value insurance policies, or credit card advances. (Note: credit card interest rates may be very high compared to other sources of capital.) If you do not have enough startup money, consider borrowing from friends and relatives who believe in you and your business plan. But remember to do it on a business-like basis by writing up a loan agreement that specifies the amount borrowed, the length of the loan period, the interest rate, schedule of payments, and any collateral.

Banks are sometimes reluctant to lend to owners of new businesses because the business has no background of proven success. If you are persistent, have a good business plan, demonstrate through market research that there is a market for your product or service, and can prove your worthiness as a business owner, you will find many ways to finance your business. Possible loan sources include commercial finance companies and savings and loan associations. Following are other sources for loans:

Local banks

Banks generally limit loans for start-up expenses to 50 percent of the money needed. Loan officers look for borrowers with good credit ratings and sound business plans. Interest rates and repayment plans vary from bank to bank, so comparison shop for the loan that is best for your circumstances.

Government programs

Federal, state and local governments have several programs designed to help finance new ventures and small business. Local programs differ from community to community, so check with your local economic developer, SBDC, chamber of commerce or the Regional Planning Council in your district. In addition, a good source of information for capital in North Dakota is the One Stop Capital Shop Business Information Center located in the Bank of North Dakota (call 1-800-544-4674).

Small Business Administration

The best known source for small business assistance is the Small Business Administration (SBA).

SBA doesn't provide direct loans but guarantees loans. The loan is made through a commercial bank, but SBA may guarantee up to 90 percent of the bank loan if repayment ability is indicated from the potential earnings of the business. A business must prove that it is unable to secure reasonable financing from other sources to receive financial assistance from SBA. Women and minorities may qualify for special loan programs. Contact the SBA office to get more information at: Small Business Administration, 657 2nd Avenue North, Fargo, North Dakota 58102.

Loan request review

A loan officer's primary concern when reviewing a loan request is whether or not the loan will be repaid. Lenders usually use the five C's of credit when evaluating your credit-worthiness: these are character, capacity, capital, collateral and conditions.

Character centers on the borrower's integrity, trust-worthiness and attitude toward honoring outstanding credit obligations. Do you intend to repay the loan?

Capacity deals with you or your firm's repayment ability. This is frequently evaluated on the basis of past history, income and in-depth credit analysis. The most useful measures of the ability to repay are a cash flow statement (Appendix I - 6KB PDF) and a projected business income (profit and loss)statement (Appendix J - 7KB PDF) which can help determine if the business will generate enough income to pay expenses and cover loan payments. These should be provided along with a personal income statement (Appendix K) covering one year's operation.

Capital refers to your general financial position with special emphasis placed on tangible net worth or financial health. A lender needs to know what is owned (assets) and what is owed (liabilities). After the required amount of capital is determined, the lender will analyze where this money will come from. A personal balance sheet (Appendix L) and a projected balance sheet (Appendix M) for the business should be submitted to the lender. Lenders need evidence that you have personally made a sizable financial commitment. They know from experience that it is easier for you to back out if you do not have your own money at risk.

Collateral is represented by assets that you can pledge as security for the loan. A list of collateral to be offered should be provided. These can include home, vehicles, or stock shares. Before pledging them, think about the effects of losing them if the business fails.

Conditions refers to market conditions, including trends in the overall business economy, trends in your community, the seasonal character of your business, the nature of your product or service, and the amount of competition in your trade area.

Lenders look more favorably on loan applications when the people applying for the loan have done their homework and provide them with the necessary personal and financial information.

All business owners, large and small, should develop a working relationship with their primary lenders, establish a credit history and keep your lenders current on information concerning your business.

Business Structures

One of the early considerations for people starting a small home-based business is to determine the best form of organization and ownership. There are five basic types of business organizations: sole proprietorship, partnership, limited liability company, corporation and cooperative. The form of organization used depends on the type of business, how many owners or investors are involved, and how tax and liability issues will be handled. The basic forms of business organization including advantages and dis-advantages are discussed here.

Sole proprietorship

The sole proprietorship is a business owned and operated by one person for profit. The business owner is responsible for all financing, management decisions and liabilities of the business. Special trade names used to do business must be registered with the Secretary of State.

Advantages:

  • Owner in direct control (your own boss)
  • Low start-up (organizational) costs
  • Least government regulated
  • Ease of formation and simple structure
  • No double taxation
  • Business losses can offset personal income
  • Owner receives all profits

Disadvantages:

  • Total (unlimited) personal liability
  • Limited financial resources (capital)
  • Lack of continuity as a result of disability or death of owner
  • Owner may have limited managerial expertise
  • All profit is taxed as personal income
  • Can expand with only "after tax dollars"


Partnership

A partnership provides the opportunity to pool the capital and management resources of two or more individuals to conduct business. If a spouse is joint owner of the business you have a partnership. The two types of partnerships that exist are general partnership and the limited partnership.

A general partnership is fairly easy to establish. Special trade names used to do business must be registered with the Secretary of State. Although not required by law, a written partnership agreement drawn up by an attorney should be used to clarify business arrangements and avoid misunderstandings. The partnership agreement should include a list of the rights and responsibilities of each partner and their heirs, the management and continuity arrangements for the business in the event of death or disability of one of the partners, the profit distribution plan, a buy-out agreement, expulsion or addition of partners, appraisal of assets, and any special conditions or arrangements that may affect any of the partners through operation of the business. When signed by all partners, the agreement is an enforceable contract.

Advantages:

  • Simple organization
  • Additional personal resources (financial and managerial)
  • The right to select partners
  • Low start-up (organizational) costs
  • Limited outside regulation
  • No double taxation

Disadvantages:

  • Costs more than sole proprietorship
  • Unlimited liability for all partnership obligations
  • Lack of continuity in event of death or disability of one partner
  • Sharing of profits
  • All profits are taxed as personal income
  • Difficult to raise additional capital
  • Hard to find suitable partners
  • Divided authority (limited decision-making)

The limited partnership permits investor involvement with liability limited to the amount of the investment or the amount agreed to in the limited partnership agreement. The partnership must include at least one general partner who has general liability for the debts of the limited partnership. The general partner usually manages the business. The limited partner usually exercises no control over the business of the partnership but is merely an investor.

Advantages:

  • General partner maintains control of the business
  • Limited partner can invest with a limit on personal liability
  • Easy way to secure capital
  • Business not taxed directly

Disadvantages:

  • More complex to organize
  • Limited partner has no control over the business
  • General partner has unlimited personal liability for the obligations of the business
  • Lack of continuity in event of death or disability of one partner
  • Must maintain certain records according to state laws

Withdrawal of one partner or the addition of another automatically terminates a partnership unless the partnership agreement provides otherwise. Business liquidation can be avoided by a partnership agreement covering ownership transfer and continuity of the business operation. You must file a Certificate of Limited Partnership with the Secretary of State.

Limited liability company

A limited liability company is a cross between a partnership and a corporation, with mostly partnership characteristics. The owners of the business are called "members."

Advantages:

  • Moderately easy to set up and operate
  • Profits are taxed once
  • Moderately easy to liquidate
  • Limited legal liability

Disadvantages:

  • Some formalities are required in setup
  • May or may not terminate upon death or withdrawal of member, depending upon operating agreement
  • Must prepare and adopt an operating agreement

Corporation

A corporation is a separate legal entity (artificial person) distinct from its owners, the shareholders. It can enter into contracts, be liable for any obligations, and must pay taxes on earnings.

A corporation attracts capital investment funds by selling shares of stock in the company to investors or by trading stock for assets. Generally, stockholders are not liable for claims in excess of the current value of their shares. Corporate officers may be required to personally guarantee bank notes or loans and, therefore, are personally liable for the obligation. Other creditors can generally only lay claim to the assets of the corporation.

Advantages:

  • Legal entity
  • Specialized management
  • Transferable ownership
  • Perpetual life
  • Easier to raise capital
  • Many tax advantages
  • Limited personal liability

Disadvantages:

  • Closely regulated
  • Most expensive to organize and liquidate
  • Charter restrictions
  • Complex organization and management
  • Extensive record keeping necessary
  • Double taxation

One corporate form to consider by small businesses is the "S" corporation (Sub-chapter S Corporation). The "S" corporate structure should be considered when the following factors are present:

  • Owners expect operating losses
  • Large dividends are anticipated
  • The owner's individual tax rates are lower than the corporate rates
  • There are 35 or fewer stockholders
  • The corporation has only one class of stock
  • It is a domestic corporation

The "S" corporate structure, for smaller businesses, allows a tax burden shift to shareholders. It is not taxed, but it must file an informational return allocating profits or losses to shareholders.

An attorney and an accountant should be used to help draw up the articles of incorporation. Their expertise can help to avoid the many problems and possible pitfalls of establishing a legal corporation.

Cooperatives

A cooperative is a type of business formed by a group of people to obtain services more effectively or more economically than they can get on their own. Members of cooperatives own, finance and operate the business for their mutual benefit.

The need for assistance with the following problems has prompted some home-based business people to form cooperative organizations:

  • Limited access to markets due to rural isolation that may result in a lack of awareness of what is marketable in metropolitan areas and having to accept whatever price is offered locally.
  • Limited access to sources of supply due to the same rural supplies for production. This may result in supplies having to be purchased in relatively small quantities and at retail prices.
  • Lack of business training to turn a producer into a successful business person. Training in design skills and business management is needed.

While the cooperative approach does not assure success of any enterprise, it does provide a method to bring together the resources needed to overcome many problems.

Like a sole proprietorship, partnership or corporation, a cooperative must operate as a business if it is to succeed. Competent planning and management are essential for an effective cooperative. The members of a cooperative must work together and manage (or oversee management) for the cooperative to be successful.

Cooperatives are similar to corporations with a few exceptions, which are:

  • Ownership benefits in proportion to use
  • Democratic control one vote per patron
  • Service at cost
  • Limited return on equity capital

All income is distributed to members on a participation basis. Therefore, cooperative organizations come under no state or federal income tax liability.

The needs of home-based business people differ somewhat, depending on location, type of product, skill levels and other factors. Each cooperative membership must determine what is needed and how those needs can be met. Some of the questions that need to be answered before forming a cooperative include:

  • Does a need exist for an income-producing activity, and if so, could a cooperative provide a possible solution?
  • Does sufficient interest exist in the community or region to make formation possible?
  • Is a cooperative likely to be successful and beneficial to its members?

Surveys may be used to identify potential members, producers, benefits and needs. If there is sufficient interest, an organization committee should be formed to set up the cooperative. Some of the responsibilities of this committee are to: sign up potential members, draft the bylaws and other legal organization papers, file the articles of incorporation, and arrange the first meeting of members. An attorney should be retained by the committee to ensure that proper legal procedures are followed in setting up the cooperative.

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