Jim O's second and final part in a series of three that discusses the benefits, and drawbacks, of going into business for oneself.

If you’re a sports fan, you may have noticed that great athletes don’t necessarily make the best coaches. A person blessed with great athletic ability typically has trouble understanding and motivating players with lesser skills. Great ballplayers succeed through raw talent and hard work.

Coaches need people skills and strategic vision. It’s rare to find all of those ingredients in one package. The same holds true for trade workers. A first-rate craftsman gets that way through mechanical skills. But being a great craftsman does not automatically translate to business success. The skills required for business have little to do with tool-working ability. Businesses almost never fail because the owner lacks sufficient technical ability to do the work. It’s usually because of a lack of good business sense. The keys to success in business lay in three areas: financial, marketing and people skills. You have to be a good money manager, a good people manager and a good promoter. If none of this sounds appealing, better think twice about starting a business.

Overhead headaches

In Part 1, I identified money as the main reason most people go into business for themselves. I stated that owning a business offers the possibility of getting rich and that many business owners make six-figure incomes. However, they are not the majority. A harsh fact of life is that the vast majority of new businesses fail within the first few years of existence. Many more contractors go broke than get rich.

If succeeding in business were easy, everyone would start his own company. What stops most people is the risk involved. Big rewards entail big risk. As an employee, if you lose your job the worst thing that’s likely to happen is that you’ll be unemployed for a period of time and lose income during that period. When a business fails, not only does the owner lose an income, he will be out all the money invested in the business, plus all that may be owed to creditors. It might be your own savings that go down the drain, or it may be money borrowed from a bank, or from friends or relatives. In any case, it’s not a good feeling to wonder how you’re going to put food on the table plus pay back what you owe.

Even if the company doesn’t go bankrupt, drywalling is a tough business with much competition. A few companies become very successful and generate the six-figure incomes for their owners that I spoke of in Part 1. But many more are barely getting by and their owners make nowhere near six figures. Many contractors end up earning less than they could working for someone else.

The main reason for this is that most drywallers who go into business for themselves don’t have a clue about business economics. A trade worker’s eyes get big seeing the difference between what he is making and what the company charges for labor. A drywaller might be getting paid, say, $15 an hour, and notices that the company bills for labor at $60 or $70 an hour. He starts to think, “I could make two or three times as much working for myself.”

This common type of thinking fails to account for overhead. A contractor needs expensive equipment in order to operate: trucks, tools, computer, radios and cell phones, insurance, and so on. A lot of people entering the business think they can cut costs to the bone by working out of their homes and scraping by with old equipment. But even doing that, there are certain large expenses that can’t be cut very much.

Insurance, tools, advertising and so on cost more than most new business owners imagine going in. The suppliers of those things must be paid if you are going to stay in business. So when money gets tight, the most convenient expense to cut is the owner’s income. For every owner making a hundred grand a year, there are dozens struggling to make ends meet.

The office slave

Another trap many fledgling contractors fall victim to involves the spouse working in the business at little or no salary. Typically, hubby works in the field while the wife answers the phone, sends out invoices, pays bills, keeps the books, etc. They think of themselves as a team and they figure this is a great way to keep costs down instead of hiring someone to do the office work.

Think hard about this for a moment. Are they really coming out ahead? If the wife is smart enough to run their business, she’s smart enough to earn a salary managing someone else’s office. So even if she’s not getting paid, the company must factor into its overhead what’s known as an opportunity cost. The time she spends keeping the family business books for free is time she could be out earning money working for someone else. Even though the owner isn’t paying his wife, it may be costing $30,000 to $40,000 a year or more, i.e., whatever she could command in the open market as an employee of some other firm. The spouse’s services may seem free but it’s an illusion.

Yes, six-figure salaries are possible, but they almost never take place from the start. Successful business owners typically work their fannies off for many years taking in modest incomes before they build a business that supports an elevated lifestyle.

Another downside to running your own business is the hours you must put in. It’s never a 40-hour-a-week job and the first few years after start-up are the most grueling of all. Expect to put in 60 hours a week minimum, and don’t be surprised if it escalates to 70- and even 80-hour weeks during peak periods or when problems develop. Don’t expect to take many days off and forget about vacations for many years.

If start-up owners have children, they better resign themselves to the fact that they are going to miss out on school plays, ball games and other events that are part of growing up—and once missed can never be made up. They can try their best to make time to attend some of them, but when they’re starting out in business, it’s very difficult to find the time.

Many of the hours they work are going to be unpaid time. They’ll be working 12-hour days and more but out of that they will be lucky to come up with five or six billable hours. The rest of the time will be spent visiting prospective customers to give free estimates, working up job quotes, putting together advertising, paying bills, dealing with suppliers and so on.

Let’s be optimistic and say that during the first year in business, a contractor earns $50,000 in income before taxes and deductions. This is a realistic number. It’s not exactly getting rich but it’s enough for most people to survive on when starting out. But what will it take to generate that income? A contractor would almost certainly have to put in at least 3,000 hours of work that year. This, too, is a realistic number, even a bit on the conservative side. It averages out to 50 weeks at 60 hours a week.

Now divide that $50,000 income by 3,000 hours. It comes to an hourly wage of about $16.67 an hour. How does this compare with what he can earn as an employee? In many cases, it’s not much more. It might even be less. And if he has the wife working in the business for free, he needs to add her hours into the equation. Let’s say she’s only needed part-time to keep the books, say 1,000 hours a year. Now divide that $50,000 by 4,000 hours. As a couple, they would be working for an average of $12.50 an hour.

This just addresses income. People who are self-employed also need to provide health insurance for themselves, and ideally, some kind of retirement savings plan. And what happens if they come down with the flu? Who is going to handle the work? I’ve seen self-employed trade workers force themselves to work when they’re so sick they can hardly walk. Serious illness is unthinkable. You better have terrific disability or worker’s comp insurance. However, the sad truth is that most novice contractors are uninsured or underinsured.

Of course, once a business becomes established and successful, the owners don’t have to work so hard. Workers may see their bosses taking afternoons off to play golf and maybe disappear for several weeks a year on exotic vacations. That’s the reward for operating a successful business. But most of those people spent many years working 3,000 hours and more at pitiful incomes to build their business to the point where they can take it easy.

One-man operation

Most contractors start out as a one-person operation, maybe with the spouse pitching in. At most, they may have a partner and perhaps an employee or two. Few new contractors can afford to support multiple trucks and an office staff. That’s why they can expect to put in so many hours. Some people think one of the attractions of owning your own business is the ability to work at their own pace and take time off when they feel like it. That works in theory but the reality for most small contractors is that survival means spending almost every waking hour either working or thinking about the business.

Still, many company owners choose to remain small. They believe this creates fewer headaches. This is a personal decision and not necessarily a bad one depending on their goals. There are indeed fewer headaches when you have only yourself to manage. But keep in mind that staying small also has its drawbacks.

The biggest is simply that it limits one’s income potential. For instance, a rule of thumb for small shops is that the owner can expect to take home about 10 percent of billings as personal compensation. So to make $50,000 a year, the contractor needs to book around $500,000 worth of work. How realistic is that? It comes out to almost $42,000 a month, which translates to a little under $10,000 a week, or a little under $2,000 a day, every working day. How many of you have the capability of booking that much work? Even if you could pull it off, it virtually guarantees 60- and 70-hour work weeks when you factor in paperwork, marketing and other administrative tasks.

And this is just to earn $50,000. If your goal is that magic six-figure income, it’s so much harder to obtain as a one-person operation.

Like all rules of thumb, the 10-percent rule is not carved in stone. Some small contractors put more than 10 percent of billings in their pocket and as companies grow larger the percentage taken by the owner tends to decrease. For example, you won’t find many owners of a $10 million business compensating themselves to the tune of $1 million a year. As contractors grow larger, additional overhead tends to eat up money at a faster rate. Nonetheless, if making big bucks is your goal, it virtually demands that you grow your business to a decent size.

Growth means hiring other people to work for you. Finding good people is perhaps the most difficult part of running a business.

Managing people

Even if they find good employees, keeping them happy is not easy. Managing people is an art. Big corporations devote many hours of training before they put someone in charge of others. People in a small company seldom get any management training at all. They simply get promoted and suddenly find themselves supervising other people.

A contractor wouldn’t think of sending a raw novice out to a job site without some amount of craft training and close supervision. Well, people are even more complicated than the construction of walls and ceilings, yet most contractors put crew leaders or foremen in charge of other people without a single minute of management training. One reason why so many trade workers are itching to go to work for themselves is because they confront so many supervisors who are ill-equipped for the role.

And thus, the cycle perpetuates itself. Trade workers who get treated like dirt become business owners and treat their people the same way, because that’s all they know. But if they want to grow their company, success will depend not on them alone, but on the people they hire. Somehow, they must motivate them to peak performance. Some may have the ability, the vast majority do not. As we noted, just as great athletes don’t necessarily make the best coaches, there is not a shred of correlation between craftsmanship and leadership ability. There might even be a slight negative correlation, because superior craft workers tend to be at their best working alone.

Our legal and regulatory system presents another formidable obstacle to those who would run their own business. Business owners often spend more time filling out government paperwork than they do managing their businesses. Every government agency from OSHA to EPA to EEOC to DOE to DOT has its hands in the work done by construction contractors.

Also, all contractors live under the constant threat of lawsuits for things beyond their control. Something can go wrong at the job site that injures someone or causes damage to the customer’s premises. Lawsuits can get filed by workers who get hurt on the job, by employees who feel they’ve been mistreated, by customers who think they got a raw deal. Sooner or later, most businesses get caught up in litigation of some kind and if you want to see how fast money can get sucked into a black hole, just wait until you start dealing with lawyers.

The verdict

Just as we did with the plus side, let’s summarize the downsides of owning one’s own business:

• You probably won’t make as much money as you think you will.

• You risk the money you’ve invested and maybe borrowed to open up shop.

• You are guaranteed to work long hours.

• As a one-person operator, you need to provide some sort of backup plan in case you get sick or want to take some time off.

• If you are not a one-person operator, you have the headaches of hiring and managing other people—and the unpleasant duty of firing some along the way.

• You will spend a disproportionate amount of time dealing with legal matters and government regulations.

In summary, the odds are against people who start their own business. I don’t want to paint an overly bleak picture of business ownership but I do think people need to go into such an important venture with their eyes fully open.

Obviously, the obstacles that I’ve just discussed can be overcome. Despite the odds, a fair number of trade workers do start up their own companies and succeed. Many live happy lives because they enjoy what they are doing. A few become wealthy beyond their wildest dreams.

What it boils down to is risk and hard work on one side of the equation, balanced by rewards on the other. Risk and rewards go hand in hand with business ownership. You can’t have one without the other.