From the January 2006 issue of Entrepreneur

Online exclusive: To view the complete results of the "Entrepreneurial Challenges Survey," visit here.

Entrepreneurs may look as though they live in the same world as everyone else, but they apparently inhabit an alternate reality. How else can we explain their widespread concern about the national economy at a time when most economists are positive about the outlook for 2006 and beyond?

"The economy is not even close to being OK," says Pete Radatti, 49, president and founder of CyberSoft Operating Corp., a 12-person security software developer in Conshohocken, Pennsylvania. "There are a lot of things that are not OK." Radatti cites worries about a real estate bubble, finding adequate workers, health insurance costs and more.

Joe Popper, 43-year-old owner of Computer Gallery in Palm Desert, California, agrees: "There's great uncertainty in the marketplace from our perspective. We're very concerned." Rising interest rates, energy prices and uncertainty about the lasting effects of last year's hurricanes figure in Popper's analysis.

And these entrepreneurs are just two individual voices in a crowd of small-business owners who tend to say the same thing. Forty-seven percent of entrepreneurs said an unstable U.S. economy was the most worrisome wild-card factor that could affect them in the coming year, according to Entrepreneur magazine and PricewaterhouseCoopers' first annual "Entrepreneurial Challenges Survey." The survey interviewed CEOs and founders of 340 fast-growth businesses, with an average of $31.5 million in annual sales and a 259 percent compound annual five-year growth rate.

While 62 percent of those surveyed were generally optimistic about the economy, that was down from 70 percent in the sample taken a year ago, notes Pete Collins, director of Barometer Surveys for PricewaterhouseCoopers. "There was definitely a falloff from a year ago," Collins says. "And in the second quarter of 2005, 72 percent were optimistic."

The difference, in a word, is Katrina. Half of the respondents were interviewed before the killer storm struck the Gulf Coast in early September, and half were surveyed afterward. Optimism about the economy was at 70 percent pre-Katrina, but fell to 52 percent afterward. Collins expects the pessimism to be short-lived. "Typically, we bounce back up to normal after events like this, usually in the next quarter or so," he says.

Indeed, entrepreneurs have other business worries. Rising health-care costs, shortages of qualified workers and weak market demand all ranked close behind economic instability as choices for the three scariest wild cards that could harm their businesses. While the economy was the most common item on their top-three-concerns lists, only 10 percent of respondents considered the economy the single most important challenge businesses will face in 2006. Topping that list were finding and retaining qualified employees, and generating enough demand to keep sales growing.

Fast-growth entrepreneurs' concerns warrant special attention, says Collins. "Because they are growing so fast and experiencing change more rapidly than other companies, we think they're a good business barometer for others to look at and follow," he says. "They're typically ahead of the curve."

With that in mind, Entrepreneur spoke to business owners surveyed by PricewaterhouseCoopers to get the view from the ground. We also quizzed experts about how business owners might be able to deal with the problems identified by the survey. The resulting outlook for 2006 shows entrepreneurs both what challenges they're likely to face, and how these can be overcome.

Widespread Worries

One of the most striking findings of the survey is that concern about the economy reached into all sectors of the small-business world. The "Entrepreneurial Challenges Survey" splits respondents into four industry segments--product, service, high-tech and nontech--and many questions drew widely varying responses. Increased global competition, for instance, was ranked a top-three wild-card issue by a total of 12 percent of entrepreneurs. Across segments, however, it was included by 16 percent of high-tech companies and just 8 percent of nontech firms. (For complete survey results, including industry breakdowns, click here.)

The unstable U.S. economy, however, was a consistent concern across the board. Forty-six percent of service and nontech businesses considered it a wild-card factor, while 50 percent of product businesses and 49 percent of high-tech companies did likewise. Rising health-care costs also showed little variation between sectors, being ranked as a wild card by 43 percent of all companies, while the range varied from 42 percent for service and high-tech companies to 44 percent for product businesses and 45 percent for nontech companies.

The shortage of qualified workers, which came in third among wild-card concerns, drew more varied attention. Just 34 percent of product companies felt it was one of the potentially most harmful developments, while 47 percent of service companies took that view. Overall, 41 percent of fast-growth businesses were concerned about finding qualified employees.

Popper says he has developed a sophisticated employee screening process during his 16 years in the computer services business, but that isn't helping him today. "We can't get a stream of candidates," he says. "We've tried it all-newspaper and several online sources. It's not that we don't get respondents; we don't get qualified respondents."

Most Critical Factors
When PricewaterhouseCoopers asked about the factors most critical to business success in 2006, one factor stood far above the rest. Seventy-three percent identified retention of key workers as the most vital area. Service companies were most concerned, with 77 percent choosing "retaining key workers" as the most critical factor; 69 percent of product companies responded likewise. The next big area of concern, developing new products and services, was named by just 38 percent of respondents.

Two other issues occupied a second tier of the factors identified as most critical to success. Expansion to new U.S. markets was named by 36 percent, and 35 percent chose "increased productivity." Increasing productivity was more important to product businesses (39 percent), while reaching new U.S. markets was chosen most often by service companies (40 percent). Technology and nontechnology companies had different views on productivity: 39 percent of nontech firms chose it as most critical, compared to 30 percent of technology firms.

Power Up?
Energy costs were not at the top of business owners' minds when responding to the survey. When PricewaterhouseCoopers asked entrepreneurs to name the single most important challenge businesses would face in 2006, just 8 percent cited rising costs, including energy costs. The biggest top-of-mind challenge was again finding and retaining qualified employees, selected by 18 percent; rising costs ranked fifth, behind increasing sales and demand (15 percent), growing the business (14 percent), and changing economic conditions (10 percent).

When asked to choose the three wild-card factors that could be most harmful in 2006, however, 24 percent of business owners selected rising fuel costs. And for some businesses, higher energy prices are a major issue. "I'm most concerned about energy," says Jon T. McClure, 45, founder of ISO Poly Films Inc., a 55-person maker of plastic sheeting in Gray Court, South Carolina. "It's the number-one component in my product. We've been affected tremendously, even before [Hurricane Katrina]."

Energy costs since the storm-driven disruptions have risen to the point that nonmanufacturers are also feeling the pinch. Popper says higher costs for transporting technicians to job sites, as well as increased shipping costs for the computer components they are installing, are both directly affecting his bottom line. "When you raise gas a dollar a gallon in a place like California, where people commute long distances, that has a huge effect on employees," McClure notes. "That, in turn, has direct pressure on wages."

Searching for Sales
Despite the recent histories of very rapid growth for the surveyed companies, increasing sales and finding new demand for their products and services are at the top of their minds. Fifteen percent volunteered increasing sales and demand as the single most important challenge for 2006, ranking it second. When identifying wild cards, forty percent said weak market demand was a top-three concern. Product companies led the charge, with 46 percent saying it was one of the factors that could prove most harmful to fast-growth businesses.

Tracy Lefteroff, global managing partner of private equity and venture capital at PricewaterhouseCoopers, says the worries about market demand and increasing sales were strongest among technology companies because big companies are their most important customers. "When they go on a capital program, or start building inventory, companies will see stronger demand," Lefteroff says. With many large customers still suffering from a hangover of heavy technology spending a few years ago, demand for those products remains weaker. Also, according to Lefteroff, the implementation of just-in-time inventory management and other techniques that big companies use to reduce their own costs is contributing to larger upswings and downswings for their smaller suppliers.

Going Global

Seeking markets outside the U.S. will be a focus for the 14 percent of companies that identified the issue as one of the most critical for 2006. Twelve percent pointed to increased global competition as one of the big issues. Attitudes varied significantly among company types. Sixteen percent of high-tech firms were worried about global competition, while just 8 percent of nontech firms identified it as a leading wild card. Similarly, 15 percent of product firms picked it, compared with 9 percent of service companies.

Global competition isn't an overriding issue for ISO Poly Films, says McClure. Using cost-effective technology, being close to his markets in the U.S., and concentrating on customized products and short production runs makes it easier for him to compete against overseas rivals. "You could buy the technology and install it in China," he says. "But then you have to ship it here, and in the end, we have the shipping advantage."

Eric P. Straus, founder of RegionalHelpWanted.com, a Poughkeepsie, New York, online job board that has 35 employees and $20 million in annual revenue, sees opportunity rather than obstacles in international markets. "I love to be overseas," says Straus, 46, who partners with local radio stations to offer employers alternatives to newspaper help-wanted ads. "I'd love to be in the [United Kingdom] and Australia, but we've not been successful at signing up radio groups yet."

Unhealthy Care Costs
While the survey found no big differences across sectors on another key issue-health-care costs-individual entrepreneurs showed widely differing viewpoints. "Health care has been a major pain," Radatti says. In 2005, for the first time in its 15 years in business, CyberSoft stopped paying 100 percent of health-care coverage premiums for employees due to the rising cost of coverage. "We're working with our providers to get the best plans at the best prices, but we don't think we'll ever be able to pay 100 percent again," Radatti says.

For Straus, however, paying for health-care coverage is vital enough that he finds a way. "We moan every year about the rate increases, and we pay them," he says. "We have no brilliant solutions, but we think it's pretty important to have a good health-care plan for employees, and we do that."

Silver Linings
One entrepreneur's poison may be another entrepreneur's meat. For entrepreneurs and VCs operating in the clean-energy field, Lefteroff sees good news in higher energy costs. "One of the emerging bright spots is alternative energy sources that would provide solutions to some of the problems we see," says Lefteroff.

Even more good news came in the fact that financing appeared to be a nonissue in the survey. Only 11 percent identified decreased access to capital as a wild-card factor. "Right now, I have private equity groups and public companies chasing me, trying to give me money," says McClure.

Lefteroff says a current overabundance of venture capital makes it easy for entrepreneurs to find funding for the right business plan. "The bar has been raised compared to the internet period," he says. "You have to have a good deal and a good plan. But the positive is there's plenty of venture capital, and that should make it easy to get funded."

And while entrepreneurs overall may seem more worried than many economists would say the data justifies, not all are gloomy about the future. "I'm pretty bullish," says Straus. "I'm looking for slow to moderate growth over the short term."

Straus believes he'll profit in good times and bad. Tighter job markets drive help-wanted advertising, and an advertising recession would encourage radio stations to look for alternative sources of revenue by partnering with him, he reasons. More important for this entrepreneur is that he feels he is in the right business--one that will prosper independently of economies, competitors or other macro concerns. "There are billions of dollars in recruitment advertising in print," Straus says. "I believe that's moving online in the next decade or so. So I'm going to benefit from that regardless of where the economy goes."

The outlook of most entrepreneurs is probably similarly optimistic, or will be unless more unforeseen disasters strike. "Even in the case of a huge devastation like 9/11, within two quarters we were back to the same level of optimism we had before," says Collins. "People get used to dealing with tough circumstances and factor them in, but they're not swayed by them. Long term, the basic business fundamentals seem to hold."

Growing Pains
What are entrepreneurs' biggest challenges for 2006? We asked entrepreneurs to choose the three factors most critical to their business success in 2006. Here's what they said:

  1. Retention of key workers--73%
  2. Developing new products and services--38%
  3. Expansion to markets inside the U.S.--36%
  4. Increased productivity--35%
  5. Upgrading technology--28%
  6. Creating business alliances--23%
  7. Better management of cash flow--21%
  8. Expansion to markets outside the U.S.--14%
  9. Improving risk management--13%
  10. Finding new financing--11%
  11. Buying another company or launching a spinoff--11%
  12. Preparing company for sale--7%
  13. Going public--2%

Source: Entrepreneur magazine and PricewaterhouseCoopers' 2006 "Entrepreneurial Challenges Survey"

Danger Zone
What would be most harmful to entrepreneurs in 2006? We gave entrepreneurs a list of several wild-card factors that could affect business in 2006 and asked which three would be most harmful to their businesses and industries. Here's what they said:

  1. Unstable U.S. economy--47%
  2. Rising health-care costs--43%
  3. Shortage of qualified workers--41%
  4. Weak market demand--40%
  5. Rising oil/energy costs--24%
  6. Rising interest rates--24%
  7. New government regulations--22%
  8. Weaker capital spending--18%
  9. Weakening world economy--14%
  10. Increased global competition--12%
  11. Decreased access to capital--11%
  12. Sudden drop in U.S. real estate market--10%
  13. Tax increases--10%
  14. Inflation--9%

Source: Entrepreneur magazine and PricewaterhouseCoopers' 2006 "Entrepreneurial Challenges Survey"

Your New Year's Resolutions

Resolution #1: Make your employees matter
Entrepreneurs who want to compete with big companies for the best hires should focus first on offering candidates competitive retirement plans, says Barry Barnett, principal in PricewaterhouseCoopers' HR practice. "The issue you need to deal with is pension equity," he says. "Give them some sort of retirement benefits they can see." A 401(k) or other tax-deferred plan should do the job, he says.

Health-care benefits are also important for older workers, Barnett adds. Some older workers may already be receiving pension benefits from companies they have retired from. "They will work at a reduced salary for health-care benefits."

Attracting older workers is important, because some entrepreneurs say this is a key market of talented employees. Pete Radatti, president and founder of CyberSoft Operating Corp. in Conshohocken, Pennsylvania, says he has helped his company by removing the upper age limit on hiring. Many big corporations have mandatory retirement ages, while others have laid off large numbers of people in their 40s and 50s. Radatti says hiring these retirees provides him with talented and reliable employees no longer wanted by their former employers. "They appreciate that we care about our employees," he says, "and they like the small-company environment."

Small companies need to offer key hires the ability to share in the company's growth, says Barnett. "On the compensation side, cash itself is not the main issue in a small entrepreneurial firm," he says. "It's more about the ability to cash in as the company becomes successful." Sharing profits and equity can help employers fill critical positions with top-quality talent.

Resolution #2: Heal Your Health Plan
The hot new trend in health insurance is the consumer-directed plan. It comes in numerous varieties, including health savings plans and medical savings accounts. Its essential feature is that it makes consumers responsible for controlling health-care costs by making them pay many of the costs out of their own pockets. "It makes a lot of sense for the entrepreneur," says Barry Barnett, principal in PricewaterhouseCoopers' HR practice.

Consumer-directed plans have lower premiums and, since employees have more latitude to spend money from their health savings accounts, can provide better coverage as well. The savings accounts can transfer to different employers and can be used after retirement as well. "It's a tax-efficient way of funding retirement medical," says Barnett. Insurers are refining their consumer-directed offerings with many new options, including low-paperwork plans that allow employees to tap their health savings accounts with debit cards.

Joe Popper, 43-year-old owner of Computer Gallery in Palm Desert, California, is working to upgrade his employees' coverage as part of his effort to attract better hires. "We have to have reasonable health care to be competitive," he says. "You're not going to hire a top-quality person without reasonable health insurance."

Resolution #3: Spice Up Your Sales
Even in the second decade since e-commerce became a reality, many companies that could generate increased sales, build revenue and tap sources of demand online have failed to do so as well as they could, says Pete Collins, director of Barometer Surveys for PricewaterhouseCoopers. "Few people are doing business exclusively through e-business," he says. "But there are a lot of indirect sales that can come from it." Paying attention to a website's ability to provide information, direct shoppers to brick-and-mortar locations and otherwise augment traditional business can generate important added revenue, he says.

International markets represent another revenue-building opportunity for small companies. "If optimism in the U.S. is down, it's important to be doing business abroad," Collins reasons. "Among companies we surveyed, 45 percent were doing business abroad, and their overseas revenues are projected to be up 20 percent in the next 12 months."

Finally, small companies shouldn't overlook incremental opportunities available by extending product lines, introducing new colors, flavors, sizes and other variations. Although many firms start with one big idea, they can generate a lot of additional growth by refining versions of that idea. "It's very important to try to expand your line, not necessarily with blockbusters," says Collins. "Line extension can be a good source of volume."

About PricewaterhouseCoopers:
PricewaterhouseCoopersprovides industry-focused assurance, tax and advisory services to build public trust and enhance value for its clients and their stakeholders. More than 150,000 people in 148 countries work collaboratively using Connected Thinking to develop fresh perspectives and practical advice.

The Technology, InfoComm and Entertainment & Media practices serve the specialized needs of more than 1,400 VC-backed private companies with extraordinary growth potential in the computing, networking, software, semiconductor, life sciences, internet, telecommunications, entertainment and media industries. The Private Equity practice works with more than half of the 100 most active VC firms in the U.S. For more information, visit www.pwc.com/tice, www.pwc.com/privateequityand www.pwcv2r.com.

PricewaterhouseCoopers' Private Company Services practice is an integrated team of audit, tax and advisory professionals who focus on the unique needs of private companies and their owners. Within the practice, dedicated professionals concentrate on the needs of manufacturing, retail, wholesale and distribution, construction, food and beverage, and private equity portfolio companies, as well as on the needs of law firms and other service organizations. Private Company Services professionals are committed to delivering cost-effective, practical solutions and responsive services with the quality clients expect from PricewaterhouseCoopers. For more information, visit www.pwc.com/pcs.

Survey Methodology:
Entrepreneur magazine and PricewaterhouseCoopers' "Entrepreneurial Challenges Survey" is an annual telephone survey of more than 300 CEOs of privately held, U.S.-based businesses recognized for their sustained, rapid growth. They average $31.5 million in annual revenue with an average of 185 employees, and have an ongoing annual growth rate of more than 23 percent. Forty-seven percent are technology companies; 53 percent are nontech. Fifty-six percent are service businesses; 44 percent are in the product sector. Survey interviews were completed in the third quarter of 2005 by independent research firm BSI Global Research Inc. under the direction of PricewaterhouseCoopers.

More details and current findings on a variety of business climate and management issues are available at www.barometersurveys.com. Or with a mobile device, go to wap.barometersurveys.com.

Mark Henricks is Entrepreneur's "Staff Smarts" columnist.