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Starting a Business? Keep Costs Down

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Don't go overboard in your early years.

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We've all heard stories of famous businesses like Amazon.com (AMZN) or Dell (DELL) that started on a small budget in the founders' garages or college dorm rooms. Still, it's not as easy as it looks to run a start-up frugally.

Many business owners, especially those who are flying solo after a corporate career, feel like their ventures don't look legitimate if, say, they opt to work from home instead of renting an office for the first year or don't hire someone to answer the phones.

These entrepreneurs tap out their savings and credit to create the perfect image for their business right out of the starting gate -- only to discover later that this approach can be very risky. (For tips on establishing your business, see the Small Business Administration's planner and Business.gov's "10 Steps to Starting a Business." For advice on establishing a business presence, see the marketing guide in the Business Owner's Toolkit.)

Nathan McKelvey, 40, founder of CharterAuction.com Inc., a private jet charter flight service, took out $270,000 in debt on both personal and business credit cards and on bank loans that he guaranteed during 10 years of running the company. Each time he borrowed money, McKelvey felt it was absolutely necessary to maintain the firm's competitive edge, whether it was to hire a salesperson or to fine tune his website.

"Even in the early stages of the company, I had it in my head that I had all of these competitors and pressures," he says. For a while, his aggressive approach to investing in the company's growth worked. It was bringing on more than $43 million in sales by 2007, he says, and made it into the Inc. 500 that year.

Then sales dipped, as clients cut back on using charter flights during the slow economy. It was hard to for the company to keep up with its debts. The firm is now involved in an assignment for the benefit of creditors (ABC), according to McKelvey. In an ABC, a process that some states allow, a company gives a trustee the authority to liquidate its property, in order to raise money to pay its debts.

(State rules for conducting ABCs vary, and the length of time they take depends on the type of assets being sold, so it's wise to get legal advice if you're considering this option). McKelvey, who says he previously got back about $20,000 of the money he borrowed for the company, hopes to recover more in the ABC but isn't sure how much it will be.

While in retrospect McKelvey says he couldn't have avoided all the borrowing he did -- for instance, there was no way around an industry practice of prepaying for the charter flights he booked for clients -- he does regret some of the other company spending.

"Thinking back, I would have hired a lot fewer employees," he says. There were times, he said, that he decided it was essential to hire someone with a particular expertise, such as sales, when he could have handled that job himself. "It's turning wants into needs," he says. "That's what it comes down to." In hindsight, he says he borrowed a fair amount of the money to avoid laying off members of a staff that was bigger than it needed to be. "You make promises to people you want to hold up," he says.

With the company's assets now sold off, McKelvey runs Hidden Equity (hiddenequity.com), a consulting firm in Hull, Mass., where he advises other entrepreneurs on online marketing and other business issues.

As a general rule, he tells them to make sure they have the profits to cover expenses like the hiring of a new employee. But even then, he encourages them to investigate less costly alternatives, such as finding ways for the existing team to accomplish more by working efficiently -- so their businesses don't wind up with overhead they can't afford in the long run.

"The risks of taking on more debt are greater than growing slowly," says McKelvey who knows what it is like to shoulder that burden while supporting two young children. When in doubt, he says, entrepreneurs should ask themselves a simple question: "Do you really need it?" Often, he says, those "pressing" business expenses can wait.

For more about husband/wife start-up companies such as Cisco (CSCO) and Estee Lauder (EL), see Copreneurs: Coupling Business With Pleasure.
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