8 Hidden Costs of Starting and Running a Business
If you aren't prepared for hidden costs, you'll find yourself in a compromising situation much sooner than you ever thought possible.
Regardless of what anyone else tells you, running a business isn’t cheap or easy. In addition to the expenses you probably know about, there are a number of hidden costs of starting and running a business. I personally find that easily sneak up on you. It can even erode your bottom line if you aren’t careful.
Understanding startup costs
According to a well-cited study from the Kauffmann Foundation, a small business startup takes an average of $30,000 to get off the ground and running. There are businesses that take $300 and $3 million, but this average figure gives you a good ballpark estimate of what many entrepreneurs are forking over.
Startup costs can pile up, but at least you know what to expect (for the most part). It’s pretty easy to price out things like real estate, website development, initial inventory, opening promotions, fees for licenses and all of the things that go into opening the business up.
The problem is that this is only the beginning. Getting the business off the ground and successfully maneuvering a grand opening is one thing. Turning your new startup into an established business that’s poised for long-term growth is something else entirely. If you aren’t prepared for hidden costs, you’ll find yourself in a compromising situation much sooner than you ever thought possible.
8 hidden costs of starting and running a business
Perhaps you’ve taken a look at the research study that says 9 out of 10 startups fail. It’s a sobering, yet realistic look at the challenges that exist in starting, building and sustaining a business over the long haul. And while businesses fail for dozens of reasons, some of the most common factors have to do with money.
Based on an analysis of 101 startup post-mortems, the study determined that 29 percent of startups fail because of a lack of capital. Roughly 1 in 5 startups -- 18 percent to be exact -- have pricing and cost issues.
While a lack of capital and pricing/cost issues can refer to any number of issues, it’s clear the properly managing finances is a major challenge. If you, as a business owner and entrepreneur, are able to master this aspect of running a company, you stand a much greater chance of being successful.
As mentioned, the trickiest part of this equation is the hidden costs. You need to understand what you’re going to face before you actually deal with it -- or at least quickly enough that you’re able to respond in an efficient manner.
The exact expenses your business deals with will vary based on any number of factors, but you should be aware of the following hidden costs that almost always emerge from the shadows at the most inopportune of times.
1. Expensive loans
Most entrepreneurs need some sort of loan to finance a startup. This often comes in the form of a small business loan from a bank or other traditional lender. And if you don’t have any business experience or an established company with the right tax and revenue documents, that loan is most likely going to be based on your own personal situation. Thus, if you have a bad credit score, you’re going to get some pretty bad terms on the loan (if you get approved at all).
Unfortunately, this often starts a cycle. You get bad terms because of your bad credit. Which in turn means you spend thousands more in interest payments over the course of the loan. And because you’re spending more in interest, you’re less likely to be able to make payments on time. This drags your credit score down further, which costs you even more in the future.
You need to be aware of the hidden cost that is loan interest. Fixing credit on the front end will save you a lot of money in the years to come.
2. Employee benefits and perks
It’s not enough to calculate what you’ll pay an employee in terms of salary. If you don’t account for taxes, benefits and perks, you’ll quickly find yourself in a hole.
According to research from Joseph G. Hadzima Jr. of the MIT Sloan School of Management, the overall cost can run from 1.25 to 1.4 times the basic pay. The increase is due to things like employment taxes, workers’ compensation and fringe benefits (healthcare, retirement, vacation, etc.).
Using Hadzima’s multiplier factor, a $50,000 salary could cost as much as $70,000. And when you account for multiple employees, the disparity in what you actually pay versus what you expected to pay could be enough to run your business into the ground.
For companies that sell physical products, there’s always the risk of shrinkage. Whether purposeful or unintentional, shrinkage actually costs retailers an estimated $45 billion per year in the U.S. alone.
Shrinkage can result from any number of causes and isn’t just reserved for retailers. Examples include shoplifting, employee theft, paperwork errors and vendor fraud. Then, there are the roughly 6 percent of losses that can’t be accounted for under any of these categories. They’re simply mysteries!
If you’re aware that shrinkage is an issue, you can be proactive and prevent many of the factors that cause it. It’s nearly impossible to avoid shrinkage altogether, but you should be able to mitigate it enough that it doesn’t negatively impact your company’s bottom line.
When you first start out, you might not need a lot of insurance. However, as time goes on, the need for various insurance policies increases. These include things like general small business insurance, liability insurance, errors and omissions insurance, workers’ compensation insurance, property insurance and cyber insurance.
How much you spend on a given policy is based on numerous factors, including the type of business, size of the business, industry, location, revenue, previous issues, present risk factors and number of employees. You can easily spend $1,000 or more per policy per year. For a business that’s already operating on a tight budget, these hidden costs can make it difficult to stay on track.
5. Legal fees
You probably don’t go into business thinking you’re going to generate a bunch of legal fees. That doesn’t mean they don’t exist. In some cases, legal fees might be the number one hidden cost.
“Small businesses are the target of many frivolous lawsuits because trial lawyers understand that a small business owner is more likely than a large corporation to settle a case rather than litigate,” NFIB explains. “Often small business settlements are less than $5,000, but even $1,000 settlements are significant for businesses.”
And even if you settle a suit, you can expect to see insurance premiums rise as a result. This drives up costs even further.
Coming from a career where you were an employee, you probably didn’t think much about taxes. Sure, you paid your fair share of taxes, but it was largely automated by the payroll department. Your company probably covered part of your bill. Unfortunately, things are different as a self-employed business owner.
Even if you aren’t generating a ton of money for yourself, you’re still going to owe Uncle Sam something. And because you’re on your own, self-employment tax becomes a real thing. Be sure you take this into account.
7. Fees and permits
Depending on what industry you operate in and what products you sell, you might need various fees and permits to be considered legal. Many entrepreneurs don’t realize this and find themselves spending thousands on something they didn’t know about.
The classic example is the alcohol permit for businesses that sell and/or serve alcohol. When Mark Aselstine and Matt Krause started a wine club company in California, they found the process of getting permits to be very expensive. Between all of the permits, Aselstine estimates that he and his business partner spent close to $15,000 in their first year of business.
8. Administrative costs
Finally, administrative costs will sneak up on you if you aren’t prepared. This includes all of the things you previously took for granted when you worked for someone else:
- Filing cabinets
- Paper clips
- Office cleaning supplies
Individually, these items might not cost that much. They only add up to thousands of dollars over the course of a year. Do yourself a favor and account for them when you prepare your budget.
Can you handle the cost of business?
There’s an old saying that says, It takes money to make money. In other words, you need money in order to make more of it. As motivating as it might be to claim that you only need a good idea and lots of ambition, the reality is that very few entrepreneurs make it anywhere without:
- Having money
- Using that money wisely
As with anything, there are exceptions, but this is the general rule of thumb.
Whether you’re planning on starting a business, recently launched a company, or are in the growth stage of building a brand, you have to be aware of just how important money is in the equation. Specifically, you must be aware of the hidden costs.
(By Serenity Gibbons)