When I speak of my clients’ difficulties involving the constant struggle to make payroll and have enough left over to pay themselves, you may think the underlying problem is cash flow. But poor cash flow is only a symptom. The underlying problem is generally a business model that is not well thought out or well executed.

Before you get hung up on the phrase “business model”, let me tell you what it means in real world small business terms. Your business model is basically what you do and how you get paid to do it. For an example, let’s look at eBay. eBay’s basic model is that it makes money by serving as a go between bringing buyers and sellers together. In exchange for providing the meeting ground and facilitating the sale, eBay receives fees. It isn’t a complicated business model at its core, the difficulty is in executing the model in a way that satisfies customers and makes a profit for eBay at the same time. If the customers are unhappy, the model fails. If eBay can’t operate at a profit, the model fails.

The second half of that equation is where my clients ran into problems. They provide a valuable service to a growing market but providing the service carries a high payroll and a high rate of liability and workers compensation insurances. For every dollar in sales, they pay out about 65 cents in payroll and insurance. That leaves 35 cents of every dollar for rent, utilities, telephone, marketing, advertising, etc. Trying to wring out enough money for the owners to get paid a living wage was usually impossible.

The owners were able to keep their heads firmly buried in the sand for only so long. We sat down one day and had a very in depth conversation about what the business could potentially produce for income for the owners in the short and long term. We weighed all the benefits, the costs, and the risks. The bottom line was that the business could not realistically support the owners in a way that would allow them to support their families in even a modest way.

Normally, this type of a hard look at a business reveals any number of opportunities for improving the business. In this case, it simply was not possible to make the changes necessary to make things work better for all involved. Let’s explore why…

My client’s were first time business owners. They are both professionals with years of experience in their own fields who both found themselves laid off by their respective companies. They knew each other through church and had been friends for some time. Working with agencies set in place to help them find new work, they were introduced to a program set up to help displaced workers start their own businesses. The program provided advice, resources, and structure for new business owners.

The friends decided to explore opening a business as partners. They began exploring different businesses and were drawn to franchising because of the remarkably high percentage of success for franchise outfits. Their interest in franchises led them to investigate a local operation that was selling franchises. The franchiser was new to the franchising business and had sold only one franchise to an employee so the model was largely untested.

The franchiser led the partners to believe that all was rosy with the original business that spawned the franchising. Although the potential business owners didn’t know it at the time, this was not the case. The original business and the first franchise were actually operating at a deficit and were being propped up by continued investments of personal funds by the owners. The original owner was far more interested in selling franchises than in giving a realistic view of expected results. The business model had some flaws that made it difficult to do well in this business even though the service was a very valuable one to the target market.

Flaw #1—Slim Margins make Slim Pickin’s.

As I mentioned before, every dollar in sales cost 65 cents in payroll and insurances. An additional 3-7% (depending on the price structure they chose in buying the franchise) went for royalties. Once you subtract out rent, utilities, office supplies, and so forth, there was little if any left over for advertising and marketing. And the owners were left without a paycheck most weeks.

Flaw #2—Built in Cash Flow Issues.

Employees were paid every two weeks for work performed. Customers were billed every two weeks for services already rendered. So the cash leave

The second half of that equation is where my clients ran into problems. They provide a valuable service to a growing market but providing the service carries a high payroll and a high rate of liability and workers compensation insurances. For every dollar in sales, they pay out about 65 cents in payroll and insurance. That leaves 35 cents of every dollar for rent, utilities, telephone, marketing, advertising, etc. Trying to wring out enough money for the owners to get paid a living wage was usually impossible.

The owners were able to keep their heads firmly buried in the sand for only so long. We sat down one day and had a very in depth conversation about what the business could potentially produce for income for the owners in the short and long term. We weighed all the benefits, the costs, and the risks. The bottom line was that the business could not realistically support the owners in a way that would allow them to support their families in even a modest way.

Normally, this type of a hard look at a business reveals any number of opportunities for improving the business. In this case, it simply was not possible to make the changes necessary to make things work better for all involved. Let’s explore why…

My client’s were first time business owners. They are both professionals with years of experience in their own fields who both found themselves laid off by their respective companies. They knew each other through church and had been friends for some time. Working with agencies set in place to help them find new work, they were introduced to a program set up to help displaced workers start their own businesses. The program provided advice, resources, and structure for new business owners.

The friends decided to explore opening a business as partners. They began exploring different businesses and were drawn to franchising because of the remarkably high percentage of success for franchise outfits. Their interest in franchises led them to investigate a local operation that was selling franchises. The franchiser was new to the franchising business and had sold only one franchise to an employee so the model was largely untested.

The franchiser led the partners to believe that all was rosy with the original business that spawned the franchising. Although the potential business owners didn’t know it at the time, this was not the case. The original business and the first franchise were actually operating at a deficit and were being propped up by continued investments of personal funds by the owners. The original owner was far more interested in selling franchises than in giving a realistic view of expected results. The business model had some flaws that made it difficult to do well in this business even though the service was a very valuable one to the target market.

Flaw #1—Slim Margins make Slim Pickin’s.

As I mentioned before, every dollar in sales cost 65 cents in payroll and insurances. An additional 3-7% (depending on the price structure they chose in buying the franchise) went for royalties. Once you subtract out rent, utilities, office supplies, and so forth, there was little if any left over for advertising and marketing. And the owners were left without a paycheck most weeks.

Flaw #2—Built in Cash Flow Issues.

Employees were paid every two weeks for work performed. Customers were billed every two weeks for services already rendered. So the cash leave

My client’s were first time business owners. They are both professionals with years of experience in their own fields who both found themselves laid off by their respective companies. They knew each other through church and had been friends for some time. Working with agencies set in place to help them find new work, they were introduced to a program set up to help displaced workers start their own businesses. The program provided advice, resources, and structure for new business owners.

The friends decided to explore opening a business as partners. They began exploring different businesses and were drawn to franchising because of the remarkably high percentage of success for franchise outfits. Their interest in franchises led them to investigate a local operation that was selling franchises. The franchiser was new to the franchising business and had sold only one franchise to an employee so the model was largely untested.

The franchiser led the partners to believe that all was rosy with the original business that spawned the franchising. Although the potential business owners didn’t know it at the time, this was not the case. The original business and the first franchise were actually operating at a deficit and were being propped up by continued investments of personal funds by the owners. The original owner was far more interested in selling franchises than in giving a realistic view of expected results. The business model had some flaws that made it difficult to do well in this business even though the service was a very valuable one to the target market.

Flaw #1—Slim Margins make Slim Pickin’s.

As I mentioned before, every dollar in sales cost 65 cents in payroll and insurances. An additional 3-7% (depending on the price structure they chose in buying the franchise) went for royalties. Once you subtract out rent, utilities, office supplies, and so forth, there was little if any left over for advertising and marketing. And the owners were left without a paycheck most weeks.

Flaw #2—Built in Cash Flow Issues.

Employees were paid every two weeks for work performed. Customers were billed every two weeks for services already rendered. So the cash leave

Flaw #1—Slim Margins make Slim Pickin’s.

As I mentioned before, every dollar in sales cost 65 cents in payroll and insurances. An additional 3-7% (depending on the price structure they chose in buying the franchise) went for royalties. Once you subtract out rent, utilities, office supplies, and so forth, there was little if any left over for advertising and marketing. And the owners were left without a paycheck most weeks.

Flaw #2—Built in Cash Flow Issues.

Employees were paid every two weeks for work performed. Customers were billed every two weeks for services already rendered. So the cash leaves the bank account before it is received. Naturally the customers often took 30 days to pay so the cash flow for every transaction ran as much as six weeks behind the expenditure for payroll for the work performed.

Flaw #3—Pricing Inflexibility.

Franchisees could not lower or increase their pricing based on the market they were serving. In the State of Maine, where this business is headquartered (and this is true of most areas of our country), there is a wide disparity of resources. The southern part of the state has higher income levels than the northern part of the state. The seacoast tends to have higher income levels than the western mountains. Depending on where your franchise is located you could find yourself priced out of the market.

Flaw #4—No Name Recognition.

When you think fast food, you think McDonald’s. When you think McDonald’s you picture the golden arches. You have an expectation of what you will get—the restaurant will look a certain way, the food will be universally awful. You know exactly what to expect. The same is true of every other successful franchise—Dunkin’ Donuts, Olive Garden, Hardee’s, H&R Block, etc. With the business my clients entered, there were no strongly defined franchises so the expectation had not yet been created. This means they had to explain what the business was all about. It wasn’t a case of being able to say, “I own an H&R Block franchise” and everyone knows what you are talking about. This makes it an uphill battle.

Flaw #5—No Strong Marketing Program to Build Name Recognition.

Part of the responsibility of the franchiser organization is to do the legwork to build name recognition. The franchiser did some local advertising through events and radio advertisements which was a good start. I have to say, though, that if I am going to consider buying a franchise I want to see some serious commitment to building name recognition before I sign on the dotted line. When you mention the name of the franchise, I want to be able to immediately know exactly what you are talking about. That kind of familiarity takes a very concerted, and usually expensive, effort on the part of the franchiser.

Flaw #6—Where Are My Step by Step Business Building Techniques?

The glory of a franchise is that for any task or challenge I can simply flip open the operations manual and see step by step exactly what to do. With this franchise, the most important piece was missing…How do I build the business? What specific steps do I take to create buzz before the grand opening? What steps do I take to attract the attention of my target market? How do I get the business to a point where I can make a living?

In addressing these issues with the franchiser, it became increasingly apparent to my clients that their grand dream of making minimum wage for themselves was far off in the distant (and very uncertain) future, hence their decision to sell.

Regardless of whether your business is a franchise or a stand alone entity, hidden flaws in your business model can create any number of obstacles and pitfalls for your business. A carefully thought out and well executed business model is a critical success factor for every business large or small. By rooting out the flaws in your business model, you increase your odds for building a business that is both sustainable and sustaining.