Is Your Idea any Good?

Look Before You Leap

Before committing a lot of time and money to a business idea, you must first find out whether your business idea is feasible. In other words, will it work and will it make you money? If you jump into business without checking your idea, you risk wasting a lot of your own money and time. As the saying goes: “look before you leap”.

Sometimes you will find out that your idea is not feasible. Don’t worry: you may still be able to change the idea to make it feasible. It is common for a business idea to change as new facts are discovered. Even if you find that there is no way to make your idea feasible, you still benefit, because you have saved yourself from wasting time and money on an idea that won’t work – you can then start looking for a new idea that will work.

Why Would Anyone Buy From You?

While business is not just about making money, you do need it to stay in business and this money must come from customers. If people won’t buy your product or service, or won’t buy enough of it for your business to pay its own way, your idea is not feasible. So, before you launch, you need to know that there are enough willing customers to support your business.

Unless you can secure your customers in advance, there is no way to be certain that your business idea will be successful. It can be easy to get carried away with an idea when the product or service is something you like. However, this doesn’t mean that enough other people want it to make your business viable. This means that your business idea must be based on something that your target market values.

Factor to Consider

Be very wary about getting into business based on positive feedback from just your friends and whānau – unless they will purchase enough of your products or services to make your business profitable in the long term, what other people think matters a lot!

In other words, you should start by looking at your business from your potential customers’ point of view. Try to put yourself in the customers’ shoes and see your business as they see it. Even so, this will not be enough: you will at some point have to do some market research. That means going out and collecting data from people in your target market. Only when you have completed your research will you really have a good sense of whether your business idea is feasible.

Your basic question is: why would anyone buy from you? To answer this question, you need to consider many other questions as well. For example:

    • Will your business provide customers something they need, and therefore cannot avoid buying? If so, are there other ways they can satisfy this need already?
    • Will you provide something customers will want, but could go without? If so, do they know that they want it? How badly do they want it?
  • Do any other businesses provide similar or alternative products? If so, will your business do a better job than these existing alternatives? If so, how?

Key Point

While it is very tempting to follow your own gut feelings, never assume that you know what customers think or what they like. Never take a risk on a hunch when you can gather evidence to support your decisions.

 

Who Are Your Customers?

Your Future Customers

You need to know who wants to buy your product, and why they choose to buy. It is not enough to simply say that ‘people’ are likely to want your product. Instead, you need to have a clear picture of who these people are. Even if there are many types of people who could be interested in what your business has to offer, it is still very important to decide who your target market will be.

Profile Your Ideal Customer

You can start by forming a picture of who you think your ideal customer would be. Your product or service may have some appeal to a number of people, but you need to think about factors such as:

    • Who would buy it the most? How often would they buy it?
    • Who would be prepared to pay the highest price for it?
    • Who is likely to be the most loyal type of customer?
    • Why would they want your product? What needs would it fulfil for them?

Try to come up with a clear picture of who your customers are. Think about details such as:

    • Their age, gender, and ethnicity
    • What type of job they have (or if they work, are a student, etc.), and how much they earn
    • Where they live
    • What their family situation is (e.g. do they have a partner? Children?)
    • What their values are
    • What problems they are facing and why they would want your product or service
    • Where they currently shop to fulfil their needs
    • The ways in which they expect to be able to buy

If you expect to have several types of ‘typical’ customer, create a profile for each one. Once you conduct further research, you may decide that focusing on one or two of these groups is likely to be more profitable than targeting them all. Having a clear customer profile also helps later on when it comes to developing your branding and methods of marketing.

Tip

Customer profiling should be an ongoing task which continues throughout the life of your business. Markets and customers change, so regularly revise your customer profiles.

Explore Your Market Size

Once you have a detailed picture of your target market, you must figure out how large it is. That is, you will need to conduct research to see how many people fit your customer profile(s).

For instance, if you have decided your services will most likely be purchased by businesses within the surrounding 100 kilometres which have 10 to 50 staff, it will be important to find out how many businesses of that size exist in your area and where they’re located. You can do this through secondary research: that is, looking up existing data which has been collected by other individuals, businesses, or organisations. Often, the best source to use is Statistics New Zealand and, in particular, data from the Census which is conducted every five years.

However, you should also conduct research to check whether your ‘ideal customer’ will, in fact, want to purchase your products or services, and whether they will do this as often as you think they will, and at the prices you expect them to pay. This is best done through primary research: that is, gathering data directly from potential customers through, for example, surveys or focus groups. You may find that you need to adjust your target market, in which case you’ll need to do more research to see how many people fit the profile of the new target market!

Your Unique Selling Point (USP)

Why Would Anyone Buy From You?

To be successful, your business needs to stand out from the competition. What makes a business stand out from its competitors is a reason for customers to choose that business instead of the competitors. In business, this reason is called a business’s unique selling point, or USP for short. Your USP is your final answer to the question: ‘Why would anyone buy from you?’

When your business has a unique selling point (USP) that appeals to customers, your customers have a reason to choose you over the competition. Businesses which do not have a clear and strong USP often have to resort to competing on price – in other words, they make price their USP. It is best to avoid competing on price because it usually means a lower profit margin. This makes a business less feasible because it gives you less room for error.

There are many things which could contribute to a business’s USP. However, make sure yours is based on something the customer values. For example, your USP could be based on:

    • Being first to the market
    • Being more reliable than competitors
    • Having products sold exclusively
    • Having the highest quality
    • Being the most economical
    • Being the healthiest
    • Having skilled or knowledgeable staff
    • Convenience
    • Ease of use
    • Being locally made
    • Selling organic products
    • Being made from sustainable materials
    • Being the most convenient
    • Being environmentally friendly
    • Level of service
  • Being able to respond the quickest

Factor to Consider

Note that as your business succeeds, your USP may change. Having an established product or service in the market can be a unique selling point, because people tend to trust things that have been around for a while. For example, when Coca-Cola was first introduced, it had to compete on factors such as its unique taste. While its taste still matters, Coca-Cola is now the most recognisable soft drink on the market – its familiarity and reliability are now part of its USP.

Your Strengths vs. those of a Direct Competitor

To work out your USP, you need to look at the competition. You cannot assume you have a point of difference (a USP) without actually seeing what other businesses in your industry are doing. Even if you think your product or service is so new and different that you essentially have no competitors, this is extremely unlikely to be true.

For example, if you have created a new type of food which no one else sells, this does not mean you have no competition. Food is required to satisfy a basic need: hunger. People do not have to buy your food to satisfy this need – there are plenty of other options available for people to satisfy their hunger!

By looking at the competition, you will get a broader view of how customers choose businesses in your industry. For example, if you are opening a restaurant, you will want to look at all the restaurants in your town. You will see that there are differences between them, some of which are more noticeable than others. For example, some restaurants will be aimed at family groups, while others will be mainly aimed at adults. Some of the restaurants will have a casual style of dining and others will offer more formal dining. This is deliberate: each restaurant is trying to attract customers by appealing to a specific subset of customers.

Your business may have many competitors, but some of them will be more important than others. A direct competitor is a business that is in the same industry as you and which offers a comparable product or service to yours to the same target market – in other words, they are the businesses that are most like your own. In the restaurant example, two restaurants that offered casual, adult dining would likely be direct competitors.

Your direct competitors will be your closest competitors when you launch your business. They are the ones you really need to watch. Bear in mind that your ‘closest’ competitor is not necessarily located in your area – it could be an online business, perhaps one based overseas! Regardless of where they are, you’ll need to know:

    • what they offer and how much they charge,
    • what they do well and what not so well,
    • if they have a unique selling point and, if so, what this is, and
    • what you expect will be your strengths in relation to them. These are things that will give your business an advantage over them.

Some examples of strengths you might have relative to a direct competitor are:

    • Location
    • Intellectual property
    • Staff
    • You and your experience
    • Technical knowledge
    • New products and / or services
    • Technology
    • Supplier relationships
    • Unique brand
    • Māori uniqueness

After examining your closest competitors, see if there are any ‘gaps’ you can take advantage of. In other words, is there anything they do not do that you believe you can do well? If so, this could be your USP.

Factor to Consider

Your business may have indirect competitors as well. These are either:

    • businesses in your industry which offer different products or services from you, but satisfy the same need, or
    • businesses which offer the same types of products or services as you, but target a different part of the market.

Steps to Identify a USP

    1. Write down what you know about your target customers. Good starting points are what they do, what motivates them, and why they buy.
    2. Write down what you could offer that your target customers need — these are potential USPs.
    3. Remove USPs your competitors are already doing well — you need to be unique.
    4. Match potential USPs to things you believe your business will be able to do well.
    5. Interview 10 to 12 members of your target market about which of the potential USPs best meets their needs.
    6. Ask yourself if the USP is unique, clear, fills a gap in the market, and is something you can deliver.

Key Point

Having a USP is an important part of judging feasibility. It is best not to go ahead with a business idea until you are sure your product, service, or business model adds value that customers cannot find elsewhere.

Market Research

Why Do Research?

Research is essential to finding out if your business idea will work. It is always best to have information from unbiased sources (that is, not your friends) to base decisions on, and it is best you have this information well before you launch your business.

Key Point

Market research pays off. Although the only guaranteed way to find out how the market will respond is to start operating, that is a leap in the dark. Carrying out market research significantly lowers the risks associated with starting a business.

Research Objectives

Before conducting any market research, you need to have clear objectives for it. That is, you need to know exactly what information you are trying to find out and why you need it.

Market research can be used for numerous reasons. For example, it can be used to find out:

    • Whether people actually want the product.
    • Which people are most likely to buy the product.
    • Which group of customers is likely to be most profitable.
    • What prices you could charge for your products and services.
    • How often people will buy – is your product or service a ‘one-off’ purchase, or something that people will buy regularly?
    • The benefits that people want to receive when they buy your type of product.
    • What needs people have which are currently not being met by any other businesses.
    • The best ways to market to potential customers.
    • Where people currently buy from and why they choose to support those businesses.

Much of this information can be used to work out whether there will be enough demand for your business’s products for your business idea to work. It can also be used to figure out how you could change your original idea so it will be viable, perhaps by identifying ‘gaps’ in the market.

Factor to Consider

Through the process of conducting market research, you may discover that only a specific subgroup of your expected target market is interested in your product. If so, you will need to do more secondary research to check whether it will be large enough to support your business.

Research Methods

There are a number of ways in which you can carry out market research. The main ways for new businesses include:

    • Observation: This involves collecting data without interacting with the people from whom data is being collected. For example, if your idea involves selling products in a certain location, you could go to that location at various times of the day, on different days of the week, to count how many people are there or how many cars are driving past.
    • Product testing: If you have created a new product, you can try testing it with members of the target market (or with different audiences to see who is most interested in it).
    • Surveys: This involves collecting data by asking people questions. There are many methods for carrying out surveys including online, by email, and by interviewing people.
    • Focus Groups: This is a type of survey. However, instead of surveying people individually, it is done in a group setting. This is a good way to generate discussion and get thoughtful responses to your questions. Product testing may also be done in a focus group.

Surveys

Surveys are the most popular method of market research. A survey questionnaire can reach many people and produce information that is easy to use. It is just a list of questions that can be done on paper or online, or even over the phone or on the street.

Whilst it seems to be a simple research method, it is important to note that the quality of the results depends largely on the quality of your questions. You should always test your questions on several people before going ahead with your survey. Check for:

    • Unclear questions: Do people understand what they are being asked?
    • Ambiguous questions: Make sure questions cannot be interpreted in different ways.
    • Logical response options: If you give people options for responding to a question, these options should make sense and should cover all possible responses. It is good to include ‘other’ as a response option.
    • Leading questions: Avoid questions which are worded in a way that encourages a certain response over others.

Make sure the questions you ask fully cover your research objectives. However, you also need to be careful about the length of your survey. If it is too long, some people may choose not to participate, may stop partway through, or may rush through it without giving decent thought to their responses. Therefore, base all questions around your research objectives and do not include extra ‘nice to know’ but non-essential questions.

Also, be careful as to how you ask a question. It is easier to analyse ‘closed questions’, but sometimes ‘open questions’ are needed. Closed questions involve ‘yes’ and ‘no’ responses or require someone to choose an answer. You can then add up responses and easily calculate how many people gave a certain answer. In comparison, open questions ask people to explain what they think and feel, so it is harder to summarise responses.

The questions you ask may affect the survey method. Some survey questions are best asked in an interview situation, although this is typically an expensive and time-consuming way of conducting research. Online surveys have the advantages of fast results, low cost, and long reach. They can be a good way for you to send out a short survey about the feasibility of your business idea. A useful online survey service is provided by SurveyMonkey. The free version of this service allows you to send out a 10-question survey to up to 100 respondents.

Very importantly, be careful who you ask. Don’t survey only your friends and family – they might just tell you what you want to hear! In most cases, participants should be members of your target market. Furthermore, as a general guideline, you need to survey at least 30 people from each of your potential target markets. Making business decisions based on a small number of responses is extremely risky!

Factor to Consider

The Unsolicited Electronic Messages Act 2007 prohibits the sending of unsolicited commercial electronic messages. ‘Electronic messages’ include emails, online messaging, and SMSs (text messages). If you send out a survey through any electronic means, make sure you have consent first.

Will You Make a Profit?

Breaking Even

In order for your business to work, it must be able to bring in at least as much money as it spends. When a business earns as much as it spends, it is said to be ‘breaking even’. Before you enter business, you need to know how many sales you must make to break even. This can be on a weekly, monthly, or annual basis. If you can make at least this amount of sales, your idea is financially feasible.

break-even analysis shows the minimum amount of sales that your business needs to make in order to cover all of your costs. If you can make at least this amount of sales, the idea is financially feasible. If your business is service-based and you charge by the hour, the break-even point tells you how many hours you have to charge out to customers each year (or month or week). You will need to see if this number of hours is feasible.

It is important to carry out a break-even analysis even if you intend to sell your products at prices higher than the ‘minimum price’ you calculated when pricing your products. This is because, as you increase your prices, it is likely that the quantity you sell will decrease. You need to ensure that the increase in price makes up for the decrease in quantity, and that the costs of the business are still covered.
Key Point

At the ‘break-even’ point, a business does not make a loss but does not make any profit either. You will need to aim to make higher sales than the break-even point so your business will start to make a profit.

 

How to Conduct a Break-Even Analysis

There are a number of formulae you can use to conduct a break-even analysis. You can calculate the number of sales needed, how much you need to sell in dollar terms, or the number of hours you need to bill for to break even.

1. Calcuate the Number of Sales Required to Break Even

To calculate the break-even number of sales, use the following formula:

This formula shows the number of sales required per week. You can change it to per month or per year just by changing the figure for ‘total fixed costs’ to a monthly or yearly amount.

You can see that the formula requires you to calculate both fixed costs and variable costs.

    • Fixed costs. These include ‘overhead’ costs such as rent, insurance, and administration costs. Also include any fixed salaries or wages you will need to pay and your own salary.

 

  • Variable costs. You are likely to have some costs which will change depending on your sales quantities. For example, if you own a retail store, your variable costs will include the cost of stock you buy to then sell on to customers.

Click here for more information on how to conduct a break-even analysis using this formula.

2. Calculate the Break-even Sales Value

To calculate the value of sales needed to break even, use the following formula:

If your business will sell many different kinds of products or services at varying prices, you might find the above break-even formula easier to use. This formula shows break-even sales required as a dollar amount instead of as quantity of sales. Again, you can change the timeframe from ‘per week’ to ‘per month’ or ‘per year’ by changing the ‘total fixed costs’ figure to a monthly or annual amount.

Your gross profit margin is how much money is left from total revenues (all the money your business takes in) once you subtract the cost of goods sold. For example, if a business receives $120,000 in revenue by selling products and it costs that business $60,000 to buy those products from a supplier, then the gross profit margin equals $60,000.

3. Calculate How Many Billable Hours are Needed to Break Even

If your business charges by the hour, use the following formula:

For example, if you charge $100 an hour, and have total fixed costs of $200,000 per year, you would need to be able to charge out 2,000 hours per year to clients to break even ($200,000 divided by $100 per hour).

Allowing for four weeks of holiday, one week sick leave, and approximately two weeks of public holidays, this works out at 44.4 hours per week (2,000 hours divided by 45 weeks).

Unless you plan to employ someone else, this level of sales is not likely to be feasible. Although you may be prepared to work 44.4 hours each week, take into account that you probably will not be able to charge out every hour worked. For example, you cannot charge your customers for time you spend working on your website, answering email enquiries, or completing your GST requirements.

Forces With and Against You

How Competitive is the Industry?

If you are confident there is a real demand for your product or service, and you believe you are likely to be able to break even, you are well on the way to having a feasible idea. However, you still need to take into account what is happening in the industry.

Why is the industry important? It is because businesses do not operate in isolation. They are affected by external factors, and as a business owner you will need to be able to overcome threats and evaluate opportunities.

Factors Affecting Competition

Some industries are more competitive than others – the higher the level of competition in an industry, the harder it’ll be to earn a profit. 

There are five ‘forces’ that affect how competitive an industry is, shown by the Porter’s Five Forces model.

You will need to work out if the force of any of these factors is so high that it will be difficult for you to operate your business. For example:

    • Competitive rivalry: If there are lots of competitors already in the industry, it is harder to make a profit.
    • Supplier power: If there is only one supplier for a certain product, they could change their prices and force you to pay more. It could get very hard to make a profit.
    • Buyer power: If all products in the industry are very similar, buyers can easily choose to buy from a competitor instead of from you. Similarly, if you rely on one major customer, you may feel you need to keep your prices low or offer extra benefits in order to keep that customer.
    • New entrants: If it is very cheap and easy for a new business to set up and do exactly what you do, competition will be higher.
    • Threat of substitutes: If customers have lots of other options available to them and do not necessarily need your type of product, it can be more difficult to attract customers and make a profit.

SWOT Analysis

SWOT analysis (see below) is commonly used in business to analyse the forces operating with and against you. It looks at the strengths and weaknesses of your particular business (internal factors), as well as external factors (opportunities and threats) your business will face in the industry in which it will operate.

To complete a SWOT analysis, you simply identify and describe the strengths and weaknesses of your proposed business, as well as the opportunities and threats it faces from the external environment.

    • Strengths are features internal to your business that are valuable and could potentially create an advantage. They include your own expertise and knowledge, as well as other factors such as your business assets and anything unique that your business has that others do not.
    • Weaknesses are features internal to your business that create a disadvantage. They include factors such as areas of expertise that you do not have, as well as resources you lack.
    • Opportunities are positive things (which are not already part of the business) which you can use or pursue to improve your business or create an advantage. They include things like possible business partnerships, new markets, grants being available to buy equipment, and so on.
    • Threats are things outside of your business that have the potential to negatively impact your business. They include factors such as your major customer relocating, changes in laws which are not favourable to you, and new competitors entering the market. You will need to avoid or overcome them so you are not at a disadvantage.

Strengths and weaknesses are internal factors: that is, they are things in your business. As such, you may have some control over them.

On the other hand, opportunities and threats are external factors: that is, they are things in the environment that you have much less control over. The basic idea behind SWOT analysis is to use your strengths and the opportunities available to you to counter weaknesses and overcome threats.

By completing a SWOT analysis you will be more aware of the challenges your business will face, and the opportunities you could pursue to make your business succeed. Based on this, you may decide that operating in the industry will be very difficult, and your business may not be viable. Although this is not the outcome you are probably hoping for, remember that it is best to find this out before you spend money to start your business.

Factors to Consider

Keep in mind that your competitors’ strengths and weaknesses create threats and opportunities for you.

    • A competitor’s weakness creates an opportunity that you can take advantage of. For example, if a competitor has problems completing work on time, you can make your business more attractive by being efficient and punctual.
    • Similarly, a competitor’s strength will present a threat to your business. If it is the competitor who is efficient and it is you who has the problem completing work on time, you will need to overcome this weakness or use one of your strengths to make up for it. At the very least you will need to improve your planning so you can give customers realistic estimates of when work will be completed.

It is a good idea to carry out a SWOT analysis for each of your closest competitors so you are aware of their strengths and weaknesses.

How Much Money do you Need to Get Started?

Should I Buy a Business or Start a New One?

Your Options

The costs involved in setting up your business depend on which path you take into business. The main options are:

    1. starting up a brand-new business from scratch,
    2. buying an existing business, and
    3. purchasing a franchise.

Starting from Scratch

Many people prefer or need to start a business from nothing. In some ways this is the most difficult option, but it also gives you the most control over how the business will develop and operate.

What are the Main Advantages? 

    • Building a business from nothing gives you the most freedom. You decide on every aspect of the business, and build the business to be exactly how you want it.
    • It is usually cheaper to get started: you do not have to come up with an amount to purchase the business.

What’s the Downside?

    • You will not have an existing customer base, meaning that you will not receive money from sales straight away.
    • It is unlikely you will know with certainty exactly when your business will be able to provide you with the income you need to financially support yourself.
    • There is less certainty that your particular business will work, or that it will work in the location you want to operate it in.

What about Finance? 

When starting a brand new business, it is likely that you’ll need to rely on your own money and assets. It is more difficult to get a loan or attract an investor since the business will not have a track record of being successful – it is very risky to invest in a business which does not yet exist! A bank may lend you money if you have assets (such as a house) to use as security, but otherwise it is common for banks not to offer business loans until the business has already been up and running for six months or more.

Many small business owners therefore ‘start small’. They use what resources they have to start operating, and then build the business as more money becomes available. You may be able to start in this way, however, there may still be a need to call on others for funding. This is especially likely if you need to fit-out premises or buy expensive equipment. Although there are some forms of financial assistance available, these are limited.

Also bear in mind that starting small with little funds and very few assets may also mean it will take time to build a customer base. It can be even longer before your business gets to the point where it can financially support you! You therefore need to make sure you have enough money available, or another source of income, to support you over this time.

Buying a Business

In some cases it makes more sense to buy a business. Opportunities for purchasing can happen in many ways. Sometimes an employee is offered the chance to buy a business they work for, or sometimes a family member will sell a business to another family member. Often, however, there is no pre-existing relationship between the seller and the buyer. In these cases, the purchase is more risky, as the buyer knows less about the business.

Even so, buying a business is a useful way to get into business for yourself. You at least know that the business model has worked up until now, so it is not as risky as starting a new business from scratch. On the other hand, you may not be able to make all the changes you want straight away and you might have to live with the consequences of some of the previous owner’s decisions. For instance, you may need to continue offering certain products and services to keep the existing customers happy, even if you do not really want to offer them long term.

What are the Main Advantages? 

    • Buying an existing business allows you to avoid the risky start-up period.
    • You can check the business’s past performance, ensure you have loyal customers, and confirm there are skilled employees who intend to stay with the business.
    • You can be reasonably confident the business will operate well with the assets which are all included in the purchase price – it is less likely you will be surprised with unexpected costs.
    • You are likely to have immediate cash inflows and should be able to pay yourself a decent wage right from the start.

What’s the Downside? 

    • The initial cost. You will somehow need to be able to finance a lump-sum purchase price.
    • It may not be as easy to make changes as you would like.
    • The possibility of hidden problems. You might not find out until after you purchase the business that it has some serious problems. This is why due diligence is important.
    • If the business has a bad reputation, it can be difficult to change it.

Factor to Consider

Keep in mind that a business with an excellent track record might have completely relied on the skills of the owner: without the owner, it may be worthless.

What about Finance? 

Banks are more willing to lend money for someone to buy an existing business than they are to lend money to start a business from scratch. This is because the business has a track record, and is therefore less risky. The bank can look at past financial statements and make their own estimates of whether the venture is likely to be successful. Nonetheless, buying a business can be very expensive and lenders usually require business owners to contribute about 40% in equity.

What is Due Diligence?

Due diligence basically involves carrying out a detailed background check to make sure everything is as it appears. Check factors such as:

    • If it is likely the owner is selling for the reasons they have told you.
    • Whether anyone is taking legal action against the business.
    • That the business owns the key assets it needs to operate and that these are in good condition.
    • The real value of the inventory which is being purchased.
    • All contracts the business has entered into, including employment agreements.
    • Who the key staff are and whether they will stay after the sale.
    • Changes in the industry.
    • The level of competition and whether this is increasing.
    • How loyal customers are, and how likely it is they will stay around following the sale.
    • The business’s finances.

You are looking for a business which will provide you with a reasonable return on your investment. In other words, you want to eventually get your money back, along with a profit.

Factor to Consider

How easy would it be to get your money out if your situation changed? Could you sell the business quickly and easily?

How much should you pay to buy a business? 

The value of a business can be broken down into two parts:

    1. Assets. The sum total of everything the business owns, minus whatever it owes (liabilities).
    2. Goodwill. This is the value that the business has in addition to its assets. For example, a business might have a large, loyal customer base, great staff, or an exciting future.

A common method of valuing a business, and working out if the amount of goodwill asked for by the current owners is reasonable, is the capitalisation rate method.

The capitalisation rate method involves dividing the expected profits of the business by a percentage called the ‘capitalisation rate’. The capitalisation rate is basically the rate of return you expect from the business.

Capitalisation Rate Method Formula

The lower the capitalisation rate, the longer it will take for you to earn back the purchase price of the business. If profits are constant over time, a capitalisation rate of:

    • 100% means you only pay for one year’s worth of profits – you will earn back your investment in one year.
    • 50% means you will earn back your investment in two years.
    • 10% means you are paying for 10 years’ worth of profits! It will take you 10 years to earn your money back!

Get professional advice from an accountant when working out an appropriate capitalisation rate. However, in general, it should be at least 20%. The lower the rate, the higher the purchase price. You need to make sure that the rate reflects the risk you are taking on. Expect to pay more for an established business in a profitable market and less for a recent business in a newer, untested market.

Factor to Consider

When buying a business, check carefully to see if you would get a better return from another investment, even if that is just leaving your money in a savings account. If another option would give better returns, do you still have a good reason to buy the business?

Operating a Franchise

If you don’t want to start from scratch or buy an existing business, you can take a middle path by buying a franchise. Franchises are a hybrid business model, halfway between working for yourself and working for someone else.

When you buy a franchise, you are generally buying the right to operate a proven business model. Popular examples of franchises include fast food restaurants, supermarkets, cleaning services, and gardening services.

The franchise system involves two levels of people: the franchisor, who offers their trade mark, business name and systems, and the franchisee, who pays an initial fee, and then royalties, to operate under the franchisor’s business name.

Factors to Consider

Buying into an established franchise is less risky than starting from scratch because of:

    • Proven strategies and processes
    • An established brand
    • Skipping the risky start-up phase
    • Support and advice from the franchisor (franchise seller) to get you started

If the franchise you are considering does not offer all of the above factors, be extra cautious about becoming a franchisee.

If the franchise you are considering does not offer all of the above factors, be extra cautious about becoming a franchisee.

Since the strength of a franchise rests on its business model being the same in all cases, franchise agreements heavily restrict what you can do. Franchise ownership limits your freedom to change branding, expand the business, or branch out into new areas of operation. It even affects operational matters such as the way you promote the business. Rules are set by the franchisor and set out in the franchise agreement.

As such, franchise ownership is not recommended if you would rather ‘do your own thing’. Buying a franchise is quite like entering into a partnership. Both franchisor and franchisee must be able to work together for success.

Choosing a Franchise

Buying a franchise does not automatically mean business success. The franchise needs to be right for you and the area you intend to open in, and you will have to put in a lot of work. Also note that there are several types of fees you must pay – you typically pay a large initial franchise fee, plus ongoing fees. Some franchises which appear attractive may require you to pay so much in fees that you cannot make a decent profit.

Factor to Consider

With a franchise, you buy rights to use a brand and business model for a particular period of time. Keep in mind there is a chance that after this period of time has ended, the franchisor may not want to renew the agreement. You need to be confident your initial investment can pay off within this timeframe.

Just as with buying a business, you should do due diligence before investing in a franchise. Talk to other franchise owners to get their opinion on how well the business model works, how profitable it is, and what level of support the franchisor offers. Also make sure that you understand the industry.

Pay special attention to who is responsible for marketing. The franchisor typically provides national marketing, but it is left to the franchisee to see to local marketing. Furthermore, as noted previously, there may be restrictions around what you can and cannot do. This can be a significant cost.

Tips

Avoid franchisors whose business success is based on the competence of the original owner: it is likely to be hard to replicate this success without that person.

Avoid franchisors who are willing to allow anyone to buy a franchise: the actions of a few bad franchisees will reflect on the others.

Funding the Business

How Will You Fund the Business?

There are a number of options for funding a business, each with their own advantages and disadvantages. New businesses have fewer options than existing businesses, and options available to some business owners may not be available to everyone.

The main options include:

 

Bootstrapping

Bootstrapping (which comes from the phrase “pulling yourself up by your own bootstraps”) is starting a business using only your own money and any money coming in from the new business. Many small business owners use personal savings, credit cards, take out personal loans, or borrow against the value built up in their home or other personal assets to bootstrap their way into business.

You can also use personal assets in the business. For example, using your personal vehicle for the business means the business does not have to buy its own. Even operating from home instead of leasing or buying premises is a kind of bootstrapping.

Key Point

Using personal finances means you keep control over all decisions and don’t need to give up any control to investors. If you decide to seek investors later on, they are much more likely to back you if you can prove you’ve invested your own money. On the other hand, it can take a lot longer to develop and grow your business if you are solely reliant on your own money for funding.

 

Friends and Whānau

Many business owners also approach whānau and friends for funding. This could be a loan in exchange for interest payments or an investment in return for a share of the business. Make sure they know which it is! You don’t want them to think they own part of the business when they don’t. Another option is to ask someone to be a guarantor for a loan: however, this exposes them to risk with no reward – think carefully before you ask anyone to do this.

A benefit of borrowing from whānau or friends is that the terms are likely to be better than borrowing from a bank. Even so, you need to make sure the terms are fair. For example, if your parents own a house and choose to borrow against their house to lend you money, make sure the interest rate you offer them is at least as high as the interest rate the bank is charging them. This is still likely to be a lot lower than the interest you would have to pay on a personal loan, for example.

However, you need to take care that personal relationships are not affected. You will need to communicate frequently and honestly with anyone you receive money from so they are clear about when they can expect repayment or dividends.

Loans from Banks and Financial Institutions


The main advantage of borrowing is that you keep full ownership of the business. Once you have paid off the loan, you have no more responsibilities to the lender, and they don’t own any of your business. However, you will have to pay interest and repay the loan within a certain time limit.

When deciding whether they will lend to you, the lender will consider:

    • Why do you want the money? Does your business idea have merit?
    • How feasible is your business idea?
    • Have you prepared a cashflow forecast? Does it show if your business can afford the loan repayments?
    • What kind of character do you have? Do you behave with honesty and integrity? What’s your previous credit history?
    • Do you have previous business skills and experience?
    • What kind of assets do you have that could act as security?

Factor to Consider

Many lenders will not offer business loans to new businesses. It is common for them to require the business to have been trading for at least six months. One option may be for you to secure a personal loan and use this money in your business. However, if you do this, ensure you will be able to make the required payments on the loan during the start-up period.

Many small business owners borrow money at one time or another, but that doesn’t mean it’s always the right decision.

Generally speaking, taking out a loan can be a good idea if you:

    • need the money to grow, rather than as a bailout,
    • are confident you can make repayments on time, every time,
    • are likely to pay it off early, reducing the amount of interest owed, and if you understand all the terms and conditions.

Common borrowing mistakes include:

    • Borrowing money without (or inaccurately) forecasting your income.
    • Taking out a loan which requires you to start making loan payments before you receive any income from customers.
    • Not understanding the terms and conditions of your loan, or being aware of the interest rate you’ve agreed to pay.
    • Getting a loan and spending up large – it might feel like easy money, but have a plan for what to spend it on.
    • Not having a plan in place to pay back your loan – it’s important to budget for regular repayments.

Factor to Consider

Make sure you can afford the loan repayments, even during slow months and at tax time. Banks and other lenders aren’t very lenient when it comes to late payments, so be confident you can pay on time, every time. Prepare a cashflow forecast and think carefully about when you can expect to start receiving money from customers.

Loans and Grants from Other Organisations


Banks and finance companies are not the only organisations which offer loans. You may be able to secure a loan from an organisation which aims to support small businesses. Some organisations even offer grants or equity finance. A few examples of organisations include:

    • Māori Women’s Development Incorporation: Offers loans to support Māori women and their whānau to start or grow a business.
    • Poutama Trust: Provides grants of up to $10,000 to investigate and grow a business, as well as to receive business training. These are on a 50:50 basis, meaning you must contribute at least the same amount that the trust contributes.
    • Just Dollars: Provides small business loans to people in the Canterbury area.
    • North King Country Development Trust: Provides loans and equity finance to businesses which support economic development in the North King Country.

Government Assistance


The New Zealand Government provides many kinds of support for small business, including mentoring, skill-building, and financial assistance.

The Ministry of Business, Innovation and Employment (MBIE) has information on government grants and assistance.

Government assistance is available from:

    • Work and Income. Has support available for people to start their own business, including the Business Training and Advice Grant and the Flexi-Wage Self-Employment Subsidy.
    • New Zealand Trade and Enterprise. Has a range of services to help businesses – including those which are starting up and who want to export.
    • Callaghan Innovation. Provides assistance to innovative and high-technology businesses, including start-ups. Services provided include access to experts, technology and product development, and a Getting Started Grant.
    • The Regional Business Partner Network. Provides advice on the types of help you might be eligible for. Local business advisors can give you information and tools to help build your skills and knowledge, connect you to business networks and advisors, and advise you on other kinds of government assistance.
    • Te Puni Kōkiri. Offers services to help Māori business owners to identify their growth needs and to support them to realise their growth potential.
    • Energy Efficiency and Conservation Agency (EECA). Offers various types of support, including grants, to help your business save energy and make greater use of renewable energy.

Factor to Consider

You usually have a better chance of securing grants and funding assistance if your business is innovative, technology-based, and has significant export potential or the ability to compete in world markets.

Investors

You can also get funding from investors. This is called ‘equity financing’ because money is given in return for a share of ownership (equity) in the business.

Finding investors takes planning and careful thought. You must be able to show potential investors that your business is a good investment – and have the data to back it up. An investor is hoping that your business will make money and that they can share in the profits. Having a detailed business plan will definitely come in handy.

Investors can provide money when banks may not be willing to lend. In addition, unlike a loan, you do not need to repay the money, and do not pay interest. This is extremely beneficial when you are starting a new business and have yet to build up a customer base.

Tip

Investors may also provide expertise, access to new networks and markets, and other support.

However, equity investment also comes with loss of control. Depending on what sort of agreement you have with your investor, you are essentially giving up a share of your business and of the profits you make. Investors may also want to be involved in running the business and in making business decisions.

One type of investor is an ‘angel investor’, someone who uses their own money to invest in high-risk, innovative businesses. They are not interested in long-term ownership – instead, they want a return as quickly as possible. Attracting angel investors can be difficult for new businesses because you need to demonstrate you can provide a large return on investment in a short time.

Another option is venture capital. Venture capitalists are groups or organisations that invest in high-risk businesses which have high profit potential. Unlike angel investors, they use their organisation’s funds as opposed to their own personal funds. The actual money that they use may come from numerous individual investors.

New Zealand has a few organisations that support venture capital and angel investment. Examples include:

Crowdfunding and Peer-to-Peer Lending


Crowdfunding allows businesses the freedom to raise finance from members of the public without having to be a public company (one which has its shares listed on the stock exchange). This money could come from whānau, friends, peers, customers, suppliers, and even complete strangers. Anyone can be invited to invest in your business through an online crowdfunding provider.

Equity and Debt Crowdfunding

There are two main forms of crowdfunding available to businesses in New Zealand:

    • Equity crowdfunding (this is usually what is meant by the term ‘crowdfunding’). This involves attracting investors who will own part of the business.
    • Debt crowdfunding (also called ‘peer-to-peer lending’ or ‘crowdlending’). This involves borrowing money from members of the public, and then repaying that money with interest.

In order to raise money through crowdfunding, a business uses the services of a crowdfunding provider. The role of a crowdfunding provider is to provide an online platform which brings together businesses who need equity or debt finance with individuals and entities looking for investment opportunities.

Providers of these services must be licensed by the Financial Markets Authority. You can therefore find lists of licensed service providers on their website at:

Tip

If crowdfunding interests you, you may wish to consider using Tā Koha. This is a kaupapa Māori crowdfunding platform launched by the Māori Women’s Development Incorporation and PledgeMe.

Factor to Consider

Equity and debt crowdfunding is suitable for small businesses – it is not something that only large businesses do. In fact, New Zealand law places a limit on how much money someone can raise in any 12-month period ($2 million). In addition, it is suitable for all types of businesses, regardless of how innovative they are or which industry they operate in. It is therefore much more likely a business can raise money using crowdfunding than from angel investment.

Project Crowdfunding

The term ‘crowdfunding’ is also used to refer to fundraising for projects or non-profit causes using donations or by offering rewards to supporters. In New Zealand, two popular crowdfunding platforms for social and community causes are Givealittle.co.nz and www.pledgeme.co.nz (Pledge Me also offers equity and debt crowdfunding for businesses and is licenced by the Financial Markets Authority). An example of a well-known US-based platform which provides project based crowdfunding services is Kickstarter.

Whilst this type of crowdfunding is not covered by financial market laws in New Zealand, it is legal. It is especially appealing for businesses which have a particular project in mind. For example, a business may raise money from the public for a new product by offering anyone who gives a certain amount of money one of their products as soon as it is ready (and before it is made available to everyone else to buy!).

Advance Payments from Customers


For some types of businesses it is acceptable, and perhaps even normal, to ask customers to pay a deposit on products or services ordered. This is especially the case if products are custom made, take a long time to make, or are very expensive. Getting advance payment from customers finances the cost of supplying a product or service, and assists cashflow management.

Supplier Credit


It is common in business for suppliers to supply goods on credit. This means they will supply you with items, along with an invoice, but will not expect immediate payment. If you do not pay the invoice straight away, you are essentially using your creditor’s resources to finance your business. This is of benefit to you, because your cash can stay in the business longer or be used for other purposes in the short term.

This does not mean that you should pay them late! What it does mean is that you can make the most of their terms of trade to benefit your cashflow situation. For instance, if a supplier requires payment by the 20th of the month following invoice, scheduling your payments to be made on the due date can give you up to 51 days of interest-free finance (if these goods or services were supplied on the 1st of the month). You may even be able to negotiate more favourable credit terms with your suppliers. This is more likely if you will be a major customer for the supplier.

Choosing a Business Structure

Laws and Regulations

Staying on the Right Side of the Law

To save yourself a lot of unnecessary and sometimes expensive hassle, you need to make sure that your business is legal. That means checking what licenses or permits you’ll need, understanding the laws that apply to your business, as well as making sure you’re compliant with health and safety regulations. Understanding business taxes and keeping business records are all part of being legal as well.

Licences and Permits

Some business activities require licences and / or permits. Typically, these must be in place before the business starts operating. What you’ll need depends on the kind of business you’re running. For example, if you’re going to be disposing of chemical waste, you’ll need a permit to do so. If your business is particularly noisy, you might not be able to operate in your chosen location and will need to look somewhere else.

Tip

Since regulations and compliance differ between industries, the licences and permits your business need will depend on the type of work you will be doing. The easiest way to find out what laws apply to you is to use the Ministry of Business, Innovation and Employment Compliance Matters tool.

Health and Safety

As a business owner, it is your duty to provide a workplace that is safe for all workers, visitors, and customers. The Health and Safety at Work Act 2015 (HSWA) is New Zealand’s main law which covers workplace health and safety.

Under the law, you must do what is ‘reasonably practicable’ to manage health and safety risks at work — this means doing what a reasonable person would do in your situation to create a healthy and safe workplace. In addition, your business must make sure all workers can contribute to health and safety decisions at work.

The WorkSafe website contains the information you need to ensure your business meets health and safety requirements.

The Consumer Guarantees Act

The Consumer Guarantees Act 1993 protects consumers (people buying products for personal use) against faulty products and ensures that the products they buy are fit for purpose. The act applies to anyone who is ‘in trade’ and applies to both products and services. As a business owner, you need to have an understanding of this law so you know what to do if a customer wants a refund or replacement.

Under the act, any products you sell must:

    • Be yours to sell – that is, your business must have the right to sell the goods, so that the customer will then have the right to own the goods. For example, if you’re a car dealer, you can’t sell a car if the previous owner still has a loan for that car and is using the car as security for the loan.
    • Be delivered within the time agreed – if you did not tell the customer when to expect their product, it must arrive within a ‘reasonable’ time. It must also arrive in good condition.
    • Be of acceptable quality – products should be safe, durable, of a reasonable quality for the price paid, and look the way they’re supposed to. They should also be free of defects. An exception to this is if the customer is well aware of the condition of the product and choses to purchase it. For example, a business may clearly label a product as ‘damaged’, and sell it at a discounted price to reflect this.
    • Be fit for purpose – your products must do what they are supposed to, and be able to be used for the purpose they were purchased. For example, if your customer wants to go mountain biking and you sell them a road bike, they’ve got a good reason to complain.
    • Match the description – if a customer chooses to buy a product based on a picture or description they see on your website or on other advertising material, the one you supply them must match up. For instance, if you’re advertising a barbeque that has a spit-roast function, and you sell a customer one that doesn’t have one (and you haven’t mentioned this), your customer has grounds for a complaint.
    • Match any sample shown – if a customer purchases a product based on a sample you’ve shown them, or perhaps a product you have on display in your store, you must supply them with a product that matches that sample. You cannot supply them a different, but similar model even if you think the model you are giving them is better!
    • Be at a reasonable price, if the price is not already known to the customer – if a customer agrees to buy a product without knowing the price or how the price will be worked out, you must sell that product to them at a reasonable price.
    • Have available parts and repairs – if the product you are selling can be repaired, you need to be able to provide spare parts and repair options for a reasonable period of time. Alternatively, you need to tell customers they are not available before they buy.

If you sell services, you must ensure:

    • The service is carried out with reasonable care and skill
    • The service will be fit for purpose – your service must be suitable for the purpose for which the customer is buying it. For example, if a customer asks an electrician to install a power outlet outside their house so they can put a spa pool outside, the power outlet must be suitable for a spa pool as opposed to normal household appliances.
    • You complete the service within the time agreed – or if no time was agreed, it must be completed within a reasonable time.
    • The price is reasonable, if the price is not already known to the customer.

In addition, problems are your responsibility – it’s up to you to deal with faulty goods you’ve sold or services you’ve provided. If the customer has asked you to sort it out, then it’s your responsibility to do so by fixing it, replacing it, or refunding it. However, the customer is responsible for is to report a faulty product as soon as possible. They can’t ask you to deal with it a year down the track.

It’s also important to be aware that if you’ve sold something faulty and it’s had consequences, you could be liable for any damages. So, if the faulty toaster you’ve sold causes a fire in the kitchen, you could be responsible for paying the costs of the damage caused by that fire.

Factor to Consider

If you offer a guarantee on a product, then you must abide by that guarantee. Even so, no guarantee you offer can ever replace a customer’s rights under the Consumer Guarantees Act – you cannot opt out of the act. Even if you have a sign up saying ‘no refunds or exchanges’, this does not override a customer’s rights.

Other Useful Acts to Be Aware Of

There are a number of other laws that cover common business activities. Just how much these apply to your business will depend on the industry you are in.

Resource Management Act 1991 (the RMA)

This is New Zealand’s main law covering environmental management. It covers where businesses can be based and what sort of business activities can be undertaken.

It is particularly important to be aware of the RMA if your business is likely to have an impact on the environment. For example, if your business uses chemicals, these need to be disposed of properly. In some cases, your business might even need to get a resource consent to operate where you want to operate, and to carry out certain activities.

Fair Trading Act 1986

The purpose of this act is to ensure you do not mislead customers. It prohibits, among other things, deceptive pricing, misleading statements about research conducted, and falsely promising to supply prizes for competitions.

This act also applies to recruiting staff. You cannot place a job advertisement that makes a job sound a lot better than it really is.

Food Act 2014

If you will be making or selling food there are strict rules you must abide by. You have to register your business with your local council or the Ministry for Primary Industries. You may also need to have a written food control plan.

Taxes and Levies

Understanding Taxation

Anyone going into business needs to be aware of what taxes they need to pay and when they need to pay them. There are two types of taxes – the ones you must pay, and the ones you may have to pay depending on what you do in your business.

Business Income Tax

Every business must pay tax on its net profit. This is the profit the business has earned once expenses have been subtracted from all revenue. You need to be careful though, as not everything you spend money on in your business will be counted as an ‘expense’.

Some examples of business expenses include:

    • Vehicle expenses, transport costs, and travel
    • Rent paid on business premises
    • Depreciation on assets
    • Interest on borrowing money for the business
    • Some insurance premiums
    • Work uniforms
    • Cleaning costs
    • Software subscriptions (e.g. accounting software)
    • Repairs and maintenance on business equipment
    • Home office expenses
    • Work-related mobile phones and phone bills
    • Stationery
    • Wages

The IRD has strict rules about what does, and does not, count as a business expense. Areas to be particularly careful about are food and drink, entertainment, purchase of assets, staff gifts, and reimbursement of mileage. Sometimes only a portion of these costs are expenses, and sometimes they are not considered expenses at all. Getting advice from an accountant is a good idea.

Key Points

To claim an expense, you must have a proper record of that expense. In most cases this means having an invoice.

Fixed assets (items costing over $500 which have a useful life of more than a year) are not expenses. Instead, a percentage of the cost (depreciation) is counted as an expense each year.

The rate of tax you pay will depend on your business structure – a company pays tax at a set rate of 28%, whereas sole traders and partnerships pay tax at the relevant personal tax rates. You can find out more about this on the business income tax section of the IRD website.

Factor to Consider

Note that most businesses do not pay their tax in one lump sum at the end of the tax year. Instead, they pay provisional tax in instalments during the year based on estimated profits or actual profits made so far during the year. Although businesses do not have to pay provisional tax payments in their first year, this does not mean the first year in business is tax-free!

ACC Levies 

In New Zealand, workplace injuries are covered by ACC. This is a type of compulsory insurance – you pay an annual levy to the Accident Compensation Corporation (ACC), and in return they provide cover for any workplace injuries. Even if you are self-employed and have no staff, you will need to pay ACC levies to cover yourself. The amount you pay depends on the industry you work in, how much you pay your staff, and your business’s history of work-related injuries.

For more information, consult the ACC website.

GST

Goods and Services Tax (GST) is a tax that you collect for the government. You add GST onto the prices you charge customers, and then you pay Inland Revenue the difference between the GST you receive from customers and the GST you’ve paid on all purchases. If you do not register for GST, you cannot charge customers GST and you cannot claim back the GST your business pays on its purchases.

You are only required to register for GST if your business will have a turnover of more than $60,000 in the upcoming 12-month period (or you have exceeded the $60,000 threshold in the previous 12-month period). Note that ‘turnover’ is sales revenue, not profit! If your turnover is less than $60,000 you are not required to register, but can choose to do so if you want.

Key Point

It is very important to remember that the GST you collect from customers is not your money and should never be treated as such.

PAYE

PAYE stands for ‘Pay as you Earn’ and applies if you employ staff or if you are paying yourself a salary or wage from your business. Before paying any employees, you are required to deduct the correct amount of PAYE from their salary and wages. This is to cover their income tax and personal ‘earner’ ACC levies. You then need to pay this money to Inland Revenue and ‘file a return’ so Inland Revenue knows how much each employee earned, and what deductions you made.

Using payroll software will help ensure you deduct and pay the right amount of PAYE, as well as keep track of all holiday and leave owing to staff. It can also make the process of filing returns much easier.

Fringe Benefit Tax (FBT)

If you or your employees are receiving ‘perks’ these benefits may be liable for they might be liable for FBT. Common examples of fringe benefits include using a business vehicle for personal use and giving staff discounts on goods and services. Find out more about FBT here.

KiwiSaver

You will be responsible for deducting any employees’ KiwiSaver contributions from their wages or salary, as well as making employer contributions to your employees’ KiwiSaver funds. These amounts must be paid to Inland Revenue. Find out about your obligations here.

Keeping Business Records

Keeping accurate, up-to-date records of business income and expenditure is essential. You must keep:

    • Bank records as it proves what money actually came in (sales) and went out (expenses)
    • Invoices you’ve sent to clients for sales or received as expenses. There are minimum requirements as to what information is on these invoices.
    • Invoices you’ve received for purchases
    • Cashbook, petty cashbook and wage book records
    • Records of dividend payments
    • Records of interest paid during the year
    • Records of fixed assets
    • Records of all liabilities (debts)
    • Returns filed with Inland Revenue

For more information, refer to the Inland Revenue record keeping checklist.

Tip

It is best to use accounting software to help you maintain your business records. There are low-cost options available, and the benefits offered typically far outweigh the cost. Some accounting packages can be used to file your GST, provisional tax, and PAYE returns for you.