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It has been a long time since I’ve devoted a column to answering your questions, but that hasn’t stopped readers from sending me really interesting ones. I figure it’s high time I caught up with some of them. So here goes: Dear Norm: My business partner and I started our company in 2001 and have now begun to do some transition planning. We doubt that the company will be acquired, and we don’t know if an ESOP is right for us. The most appealing option would be to hire our replacements and eventually move into a consulting and oversight role. We hope to do that over the next 10 years or so. Basically, we’re thinking of creating “retirement jobs” for ourselves that will let us dramatically reduce the number of hours we work but retain the ownership of the company. Does this have any chance of succeeding? You described how your five-year life plan took 15 years to achieve. How should we adjust our thinking — and behavior — to make this work? — Timm Moyer Dear Timm: If you and your partner are hoping to hire people like yourselves, I wouldn’t waste a lot of time looking for them. A. They probably don’t exist. B. If they do, you probably wouldn’t want to hire them. Entrepreneurs don’t make good employees. What’s more, they are often crummy managers, and what you really need is a strong management team. If my experience is any guide, it will take you years to build one, but that shouldn’t discourage you. A good management team will make your life easier and your company more valuable. In any case, strong managers will let you lead the kind of life you’re looking for. Ten years should be enough time, although that will depend somewhat on your definition of a “retirement job.” — Norm Dear Norm: I am 17 years old and recently sold a website for $100,000. It took me and my partners eight months to build, and we had to overcome many obstacles. And yet, when we finally sold it, I didn’t feel excited or elated. Rather, I’ve been really depressed. I went to a dance with a date last Friday and had a horrible time. It reminded me how out of touch I’ve been. As I was building the business, I kept thinking, What are you willing to give up to get what you want? I gave up everything. I haven’t watched TV in months, and so now I can’t talk with friends about the shows they’ve seen. I gave up piano. I haven’t read a good book of fiction in a while. I haven’t done sports such as swimming, and I used to be one of the fastest swimmers in the club at my school. So even though I reached my goal, I am not a happy kid. I’ve decided I need to quit business — or at least take a break for a while. I’m planning to study hard and go through school as normal people do. Do you think I’m making the right decision? — Hanson So Dear Hanson: The question is whether you feel you’re making the right decision. I’d guess the answer is a yes. I know what it’s like to be consumed by business. You miss out on all the other stuff that makes life worth living. Fortunately, you’ve learned that lesson at a young age. I was in my mid-40s when I learned it, and by then I’d already missed the childhood of my eldest daughter. So consider yourself lucky. And since, like me, you’re obviously very goal oriented, I’d suggest you develop a life plan detailing what you want to be doing in five or 10 years. Think about the kind of life that will make you really happy. Business should help create a happy life, not be a substitute for it. — Norm Dear Norm: I own an IT consulting business that has been quite successful. Our revenue last year was about $7 million, with net profit of about $750,000. I have been approached by business brokers asking me if I’m willing to sell my company, and a couple of them say they have buyers. They both are asking an upfront fee of about $30,000 to $50,000 to start the process. I do not want to pay that kind of money in advance without knowing where this is heading. What is the best approach to take? Is this the right time to sell, given the state of the economy? I am in no hurry. The company is doing well, with no major problems. — Gary Sennett Dear Gary: I wouldn’t get too excited about these calls. The business brokers are just trolling for business. I used to get calls from brokers who said they had a buyer for a company of mine that had been defunct for 10 years! I’d be very skeptical of any broker who says he or she already has a buyer lined up, and I certainly wouldn’t pay an upfront fee. If you want to sell your company, talk to people who’ve already sold similar businesses and find out whom they used. But no, this isn’t a great time to sell. Valuations peaked in August 2007 and have been going down ever since, although I think they may have bottomed out in March. So I would advise you to wait if you can. — Norm Dear Norm: I have a wonderful opportunity to start a business in New York City. I have the financial aspect under control, but I’ll need a couple of people I can rely on. I’d want them to stay as long as possible and share in whatever success we have. I’m thinking about letting them invest with sweat equity. I’d have a one-year waiting period and five-year vesting. At the end of six years, they would own 5 percent of the business. I am also planning to offer above-market salaries, provide health insurance, and match 401(k) contributions. The employees will not have to put up any capital. What would be a fair arrangement, considering that I’m taking the risk? I’ve been discussing this with a lawyer. What I thought was a simple gesture to inspire two people is turning into something very complicated. What do you advise? — Eliot Poole Dear Eliot: It’s a bad idea to offer ownership in a new business to people who are making no investment but their time. You won’t really know them until you’ve worked with them for several years. Of course, the picture changes when people have proved themselves. But even then, remember that it’s easy to give away part of your company but really hard to get it back. An above-market salary, health insurance, and 401(k) match should be enough to get someone on board. If not, you might question whether you’ve found the right person. As for your lawyer, I’m sure he or she is just trying to protect you. That’s a lawyer’s job, and it often involves making things complicated. If you take out the equity piece, everything will be simpler and go faster. — Norm Dear Norm: I live in Singapore and just completed my freshman year of college. I am hoping to open an infant-care-services business this summer with my family. The other members of my family feel strongly that we should also do kindergarten, even though there is already very strong competition in that business. My family’s strategy would be to copy what the established players do but at a cheaper price. My instinct is to focus on infant care. Kindergarten is not our forte, and the Singapore market is small. I see little point in copying other people. What do you think? — Sharon Lourdes Paul Dear Sharon: I have one overriding rule for everybody who seeks my advice: Always follow your gut instinct about what to do, even if it’s different from what I’ve told you. If you don’t and then you fail, you won’t take responsibility for the failure, which means it won’t provide you with the lessons you need to learn. As for your family’s strategy of getting sales by charging less, I think that’s a terrible idea. I would never go that route unless I’d figured out a different business model that allowed me to have substantially lower costs. Charging less probably won’t work, particularly in child care; that is, it won’t work if you’re lucky. If you’re unlucky, it will work, and you’ll be trapped in a low-margin, commodity-type business. — Norm Dear Norm: My partner and I have a four-year-old, eco-friendly home accessories company that manufactures organic cotton bedding, pillows, wall art, baby blankets, and the like. As designers running a business, we’ve had to learn a lot of lessons the hard way. Nevertheless, we’ve had success in building our brand. In the process, we have put all our own capital into the company, as well as a lot of heart and soul and guts. But we are feeling the full impact of the bad economy and are not able to predict one month to the next. How do you actually know whether or not your business is viable? — Kristina de Corpo Dear Kristina: Your business is viable — by definition — if it’s able to support itself on its own internally generated cash flow. In times like these, it is natural to worry about survival. But you need to remember that recessions don’t last forever. I’m already seeing early signs of a recovery. Just try to avoid making the usual mistakes. Now is not the time to cut back on your marketing or new product development. If possible, I’d increase both. Whatever you do, don’t fall into the trap of cutting prices. Offer additional services instead. Your niche will only get stronger as time goes by. Hang in there. — Norm Norm Brodsky is a veteran entrepreneur. His co-author is editor-at-large Bo Burlingham. Their book, The Knack, was published by Portfolio last fall.

So you want to know how life changes after you sell a majority interest in your company to an outside investment firm and give up day-to-day management? Let me put it this way: Now I know how Colonel Sanders felt. OK, maybe that’s going a little too far. I’m not a complete figurehead. I still have responsibilities. These days, I work on things like long-term planning, mergers and acquisitions, and putting up new buildings. But my partner Louis Weiner is the president, and he and his managers run the business. Sometimes, it’s hard for me to keep from butting in. I’m talking about simple things, like going through the mail. I used to do it fairly often. It would give me a good feel for the business. Not that I sorted the mail or opened all the letters; I just flipped through them quickly. Occasionally, one would catch my attention, and I’d think, Hmm, what’s this all about? I’d also learn things about our customers — how much business they were doing with us, how fast they paid their bills. It’s easy to lose track of that stuff as a company grows. Going through the mail helped keep me up to date, and it became a habit. So one day in early January, when I heard the usual announcement over the public-address system that the mail had arrived, I didn’t think twice about going to see what was in it. “Where are you going?” Louis asked. “I’m going for the mail,” I said. “You shouldn’t be doing that,” he said. “That’s my job now.” And he was right. I wasn’t even an employee anymore, let alone the boss. As soon as the deal with Allied Capital (NYSE:ALD) closed, on December 21, I no longer had a job at CitiStorage. My wife, Elaine, and I are still shareholders. I still have my office. I’m still getting paid — but the money is a consulting fee, not a salary. That’s a big adjustment, and I haven’t finished making it, though almost six months have passed since the company was sold. A lot has happened in that time. CitiStorage is already a different business from the one I used to be in charge of, though the great majority of our employees probably don’t notice the change. That’s mainly because Allied Capital is committed to maintaining the culture. We continue to buy baseball and basketball season tickets for our employees. We continue to contribute $1.60 for every dollar that an employee puts in his or her 401(k). We continue to run our box game, handing out bonus checks whenever we hit a new milestone. We have the same health-insurance plan as before. We continue to reimburse employees for education expenses, to subsidize their movie tickets, to run our employee training sessions, and to offer all the perks we’ve had in the past. The Allied people regard the substantial cost of all that the way I used to — as a smart investment. But although the culture hasn’t changed, there’s an entirely new way of making decisions and managing the business, and I see evidence of it every day. For example, my partner Sam Kaplan and I are working on acquisitions, some of which are really just purchases of accounts, not whole companies. Before, I would go to look at the boxes, do a little checking, and make a decision. I didn’t need anyone’s permission. If I didn’t have the money to do the deal, I’d borrow it from a bank, using the contract as collateral. Now I don’t have to worry about financing, but I can’t make the decision on my own, which is strange to me. The Allied people warned me that the changes would take some getting used to. “The biggest thing for you,” they said, “is that we look at everything, and you cannot make on-the-spot decisions anymore. You did a fabulous job building this as an entrepreneurial company, but in order to get to the next level, there has to be more structure. You have to understand that.” And I do. The changes they’re making are just what CitiStorage needs if it’s going to make the transition from a small giant, so to speak, to a much larger, professionally managed business. Indeed, those are precisely the changes that I refused to make in my first company, Perfect Courier, 20 years ago. Back then, I was also buying companies and doing private equity deals, but I had no structure, didn’t ask anyone for advice, reported to no one, and wound up in Chapter 11. I firmly believe, moreover, that our people will benefit greatly from the growth we’re going to see. Much as I hate to admit it, they had very limited opportunities to advance as long as I remained the majority owner. There was a danger that they would find their work less and less challenging, maybe even boring, as time went along. I began to see a few signs of this in the past couple of years, and it concerned me, but what could I do? I really didn’t want to put in the time and effort required to build a huge company, and I knew from experience that I wasn’t any good at it. At my stage in life, moreover, it didn’t pay for me to take additional risk with my equity, and aggressive growth always involves risk. Now, with Allied Capital, we’ll be taking calculated risks with the goal of getting much, much bigger in four to six years. That will open up opportunities for people throughout the organization. Some will thrive in the new environment, and some won’t, but no one will be bored. No one, that is, except maybe me. Actually, bored is probably the wrong word to describe how I’m feeling. Unsettled is better. Before, I was the benevolent dictator of CitiStorage, but the company isn’t a dictatorship anymore. Although Sam, Elaine, Louis, the senior managers, and I still own about a third of the stock, the mindset is different. There’s a board of directors, which I’m not a member of — by choice. Sam and Elaine represent the minority shareholders; the other three directors are from Allied Capital. The officers of the company report to the board. The board reports to the stockholders. So everybody answers to somebody, and here I am, an undisciplined guy all my life, never answering to anybody, except maybe my parents when I was a kid — and even then I was an independent little kid. Now, suddenly, I have to get used to a different way of operating. I have to become a team player, which means adapting to Allied’s methods. Allied’s people don’t make snap decisions. They have standards. They look at formulas and ratios. They go into a level of detail that feels excruciating to a nondetail person like me. They have to do it because they need the approval of a committee to get the money for buying a company or building a new warehouse. We never had a committee. Our decision-making process was simple: Order a couple of corned beef sandwiches, and hash it out over lunch. Don’t get me wrong. We were prudent. If we were buying a business, we checked out the customers, the contracts, the receivables, and so on. But we didn’t go to anywhere near the lengths that Allied Capital goes. When Allied was buying our company, for example, it hired a big consulting firm to call our customers and find out how happy they were with our service. The firm produced a report of a couple hundred pages, and it was very interesting. We learned about some improvements we could make. The report cost Allied Capital many thousands of dollars. I would never have done such a survey, let alone spent that much money on it. But money doesn’t play the same role for Allied’s people that it played for us. They have it, we didn’t, and that makes all the difference. If we were buying land to put up a new warehouse, financing was the first thing we thought about. For Allied Capital, it’s the last. Its people want to look at the returns. They want to take into account what might happen with our other buildings. They want to think about renting instead of buying and building. They want to consider how big the warehouse really needs to be. For me, the process can get a little tedious, but I understand why they do it their way. Maybe I make one mistake in a hundred, and they make one mistake in a thousand. That’s how you have to do things in a large, public company, when you’re taking risks with other people’s money. Meanwhile, I have to get used to other changes in my life. For example, I used to have a lot of expenses I could charge to the company — like when I took business associates out to dinner or bought a car to use on company business. I was also in control of my own salary, which I could adjust based on the company’s performance. Because of that, we never had to touch the money that Elaine put in our emergency fund, as she called it. Now, whatever I spend comes out of my pocket. Granted, there’s enough money in that pocket. I’m certainly not complaining, but that’s another psychological adjustment I’ve had to make. The biggest problem, however, is that I don’t have a clear idea of what I’m doing or where I’m going anymore. My work for CitiStorage doesn’t fill all of my time or get my juices flowing the way starting a business does. There’s a bit of a hole in my life at the moment, and I don’t know yet how I’m going to fill it. So while I loved chasing the rainbow, I have to say that I have mixed feelings about having caught it. Any suggestions? Norm Brodsky is a veteran entrepreneur whose six businesses have included a three-time Inc. 500 company. His co-author is editor-at-large Bo Burlingham.

A while ago, I received a message from a reader that brought back some bad memories. He wrote: “I know you believe that, if you run your business right, departing salespeople shouldn’t be able to take your customers with them. So what am I doing wrong? I give our project managers and salespeople a lot of freedom to serve customers. After a year or two, the employees walk off with the account. Each time, I get the same feeling in my stomach that I have when I receive a letter from the IRS.” I can’t tell you how many times I’ve heard similar stories, and not just from inexperienced businesspeople. I remember being approached once at a conference by the founder and CEO of a former No. 1 company on the Inc. 500. He said he needed my advice on a difficult problem he was struggling with, namely, what to do about an 85-year-old salesman who was making from $3 million to $4 million a year in commissions. Aside from creating a tremendous imbalance in the company, the commissions were depriving the business of cash it desperately needed to finance its growth. “I’m at a total loss,” he said. “I made a big mistake in setting up the commission structure like I did, and it has come back to haunt me. He’s just getting too damn much money, but I’m afraid if I cut him back now, he’ll get angry and go to one of my competitors, which would be a disaster. He knows everybody in the industry, and he’s extremely tight with his customers. I could lose half my company overnight! I tell you, I’m scared.” I have to say, I was taken aback. Here was a guy with a $100 million business, making plenty of money, who had received all kinds of honors and awards, and yet he was terrified that if one salesperson left, he would lose half his business. It was his greatest fear. Fortunately, there was an easy solution. I suggested that the CEO talk to the salesman and try to buy him out of his contract in exchange for a deal that would guarantee him an income as long as he lived. At 85, I figured, he just might be willing to go for it. As it turned out, he was. Now, if you’re a longtime reader of this column, you already know what I think about sales commissions (see ” The Sales Commission Dilemma ,” May 2003), and I don’t intend to rehash those arguments here. Suffice it to say that commissions make it more difficult to solve the underlying problem in these situations. I’m talking about the problem of customers feeling greater loyalty to the salesperson than to the company that is actually providing them with a product or service. When salespeople are compensated based only on their relationship with their customers, they have a vested interest in making sure that the loyalty problem isn’t solved. In almost all cases, however, the customer’s loyalty to the salesperson is misplaced. (There is an exception, which I’ll get to later.) After all, the salesperson doesn’t create the product or service, and if the customer needs help after the sale, the salesperson is not the one who can provide it. It takes a whole company to satisfy customers, and the company’s leadership should make sure the customers are aware of that. If customers have relationships with people throughout the business and truly understand what everyone contributes, salespeople will have a much harder time taking those accounts with them when they leave. Of course, this lesson — like most business lessons — is one I had to learn by getting whacked in the head a few times. I remember vividly how, at my first company, we would scramble whenever a salesperson left. We would print up a list of his or her customers and make sure that somebody went to see each of them. Then I would say, “Now, you go see the ones I saw, and I’ll see the ones you saw.” The disruption was huge. Yet, no matter what we did, we lost a significant percentage of the salesperson’s customers anyway. And while we were running around trying to shore up those accounts, we stopped focusing on servicing other customers — and lost some of them as a result. It was incredibly frustrating, not to mention a big waste of time and energy. In my heart, I knew there had to be a better way, but it took me a long time to figure out what it was — mainly, I’m sure, because it required an enormous change in how I recruited, trained, deployed, and compensated salespeople. I didn’t begin implementing the new system until I had been in business for nine years. I should have started much sooner. As you would expect, a big part of the implementation challenge had to do with persuading salespeople to move from commission to salary plus annual bonus, but my new approach involved much more than a change in compensation practices. I wanted people throughout the company to work together — supporting one another, covering for one another, relying on one another. If we were short-handed in customer service, I wanted our head of operations to feel he could call any of our salespeople and say, “We’re in trouble. Could you come in here and answer the phones for a while?” If a problem arose with a customer, I wanted our sales manager to know he could always ring up our customer service people and say, “Hey, I got a call from a customer. I know you guys are really busy there. But can you do me a favor?” And he wouldn’t have to yell or scream, because they would all understand that they were members of the same team. Developing that kind of esprit de corps took some time. For openers, we had to make sure the salespeople understood the inner workings of the business. So we had them spend time inside the business, answering customer questions on the phone and putting boxes on shelves. New salespeople didn’t do anything else for the first six to eight weeks after they were hired. By the time they finished their training, they knew the whole operation and could explain to a customer exactly what happened in every area of the company. What’s more, they knew the operations people personally and understood what each person did to contribute to our success. We also provided customer service training to all of our full-time salaried employees. In the process, people began to understand better what role each of them played, what challenges their co-workers faced, and how important it was that they all work together. Among other things, they started providing more feedback to one another. When customers called in with praise, the telephone representatives made sure that the warehouse workers heard about it. When there were complaints or special requests, employees were able to coordinate among themselves to do what had to be done. As the barriers between departments broke down, something interesting began to happen: Employees throughout the company became more visible to customers. The salespeople played a key role here, often bringing operations people on sales calls. As a result, when customers had issues they wanted to discuss, they didn’t have to contact the salesperson and then wait for him or her to come back with an answer. They could go directly to the employee or executive who could give them the answer right away. Granted, the customers usually had a closer relationship with their salespeople than with other employees, but the customers knew that servicing the account wasn’t the salesperson’s job. If there was a billing problem, they went to the accounting department. If they needed to talk about storage or delivery issues, they called the operations person. If they had a question about their contract, they got in touch with me or Louis Weiner, the company president. When that happens — when customers see the business as a whole — the danger of losing them to a departing salesperson goes away. Not that they will necessarily stay with you forever. You still have to give them great service and do it at a price that keeps you competitive. But they aren’t going to leave just because a salesperson moves to another company. It has been many years since we lost a salesperson to a competitor, but if we lost one today, I wouldn’t worry for an instant about him or her taking customers along. Our customers know that their satisfaction depends on a team of people. No matter how close they may be to the salesperson in question, they are going to say, “Well, I hope you’re happy at your new job, but I don’t know these new people you’re with, and I do know the people at CitiStorage. They do a great job for me. Why would I leave?” I believe that almost any company can develop such a relationship with customers. It’s more difficult to do with a commissioned — as opposed to a salaried — sales force, but even then, there are things you can do to make sure customers know they are being served by a whole company and not just a salesperson. The exception: personal services businesses in which the salesperson is, in fact, providing the service as well as making the sale. I’m talking about real estate brokers, travel agents, hairdressers, investment advisers, and the like. Those businesses call for a different approach — but that’s a subject for another column. Norm Brodsky is a veteran entrepreneur. His co-author is editor-at-large Bo Burlingham. Their book, The Knack, will be published by Portfolio in October.

January is a good month for fresh starts, and so we’ve chosen this issue to begin the next phase in the evolution of Street Smarts. In the coming months, we’re going to follow a handful of businesses as they grapple with the challenges of starting up, growing, or simply surviving in the worst economy we’ve seen in a very long time. The companies involved are those I have been, or will be, mentoring. Regular readers of this column are familiar with a few of them — Brian Kelly’s City Beans and Mike Baicher’s West End Express, to name two. Others you haven’t met yet, as I’ve begun working with them only recently. And three of the businesses will be owned and operated by readers of this column. Yours could be one of them. Let me explain. We began thinking about changing the focus of Street Smarts more than a year ago, as I was getting ready to sell a majority stake in my three principal businesses. I knew I’d be doing more pro bono mentoring of entrepreneurs, and I figured we’d want to write more about the challenges they were facing. I also thought it would be fun to offer readers the opportunity to participate. You may recall the note we ran in several issues inviting people to contact me if they were interested in receiving my advice. We expected to hear from a couple dozen readers. In fact, we got hundreds of responses, which was gratifying but also put us in a quandary. How were we going to decide which companies I should take on, and how would we manage the logistics of building long-distance relationships? As it happened, my co-author, Bo Burlingham, and I were just then finishing our book, The Knack: How Street-Smart Entrepreneurs Learn to Handle Whatever Comes Up. We wanted a website to go with the book, and as I was talking to our website designer, I had an idea: Why don’t we hold a contest? The winners would get an all-expenses-paid trip to New York City, where they would spend a day with me. I’d help them with whatever business challenges they were facing, and we’d lay the groundwork for an ongoing relationship, with the possibility of regular updates on their progress in the pages of Inc. The contest is now up and running at our website, at theknack.info . There you will find a 10-question quiz on general business topics. To qualify for the next round, you have to get all of the answers right, but you can take the quiz as many times as you like. Once you pass Level One, you become eligible for Level Two, a quiz based on the concepts we’ve written about both in these columns and in the book. Those who pass the Level Two quiz will be asked to fill out a brief questionnaire, and we’ll choose the winners from that group. Let me say a few words here about how I choose the people I mentor. I usually start by interviewing them in my Brooklyn office for an hour or so. By the end of the discussion, I know whether or not I have any knowledge or experience that could be helpful to them and whether they are willing to listen to me. Notice I said “listen to me.” I didn’t say “take my advice.” I never tell people what to do. Indeed, if they have a strong gut feeling that is different from mine, I encourage them to go with it. But I want them to be open to looking at their situation in a way different from how they’ve been looking at it before. Otherwise, I will be wasting my time. One of the first steps always is to look at the numbers. Consider, for example, a business whose founders I met through my participation in Inc.’s annual Inc. 500 conference. The founders had all been involved in staging the conferences, either as employees of Inc. or as independent contractors. It’s almost impossible to spend time around successful entrepreneurs without thinking about becoming one of them, and that prospect had proved irresistible for three of the conference producers: Elizabeth Busch, Anne Frey-Mott, and Beckie Jankiewicz. Two of the women, Anne and Elizabeth, already had their own businesses. Anne’s company, Conference Solutions, had been around for 11 years and specialized in selecting sites, negotiating contracts, and managing relationships with hotels and conference centers. Elizabeth, who had launched her business in 2005, focused more on the design and marketing of events. Beckie was director of events for Inc. and its sister publication, Fast Company, and had experience in handling the logistical challenges of developing several projects simultaneously. Although the three of them had no formal link, they often partnered on conferences. Inevitably, they began thinking about starting a business together. The closer they looked at the possibility, the more convinced they became that they could work more efficiently, market more effectively, create more value, and produce better results overall if they were part of the same company — a full-service events business. Last February, Beckie left her job at Mansueto Ventures (Inc.’s parent company), and in April she, Anne, and Elizabeth formed The Event Studio, with each as an equal partner. The plan was for Elizabeth to phase out her company as its current projects were completed, but Anne would keep Conference Solutions alive for the sake of customers that did not need the other services offered by The Event Studio. They were still in the formative stage of their new business when they first came to me for advice in December 2007. Unlike most companies I work with, theirs was essentially a start-up. Then again, I was already familiar with, and had a high opinion of, their work, and I thought their logic for joining forces made sense. But I could also see that, while they had a clear vision of where they wanted to wind up, they didn’t understand the steps they had to take to get there. Having taken those steps many times myself, I offered to be their guide. They readily accepted. As the offspring of two existing businesses, The Event Studio began with a significant advantage not enjoyed by most brand-new ventures: revenue. Anne’s business and Elizabeth’s business both had ongoing, unfinished projects of the sort their new company would be signing up in the future. Anne and Elizabeth could hire The Event Studio to do the remaining work on those projects. When the old companies got paid by their customers, they could pay The Event Studio, thereby generating the cash flow the new company needed to get off the ground. That’s exactly what Anne and Elizabeth did, but when I spoke with them again several months later, I realized they had neglected a critical step. They hadn’t made sure that The Event Studio submitted bills to their respective companies for the work done. They hadn’t thought of it, of course, because they were the ones doing the work, just as if they had simply continued to partner. Billing their old companies felt like sending invoices to themselves. Problem was, the customers’ contracts were with the old companies, and those were the entities that received the payments. Unless the old companies, in turn, received — and paid — bills from The Event Studio, it would appear that Anne and Elizabeth had taken the money and invested it in the new business. So, you ask, what’s wrong with that? Nothing, in principle. It wouldn’t become a concern for them until they had their accountants figure out their respective tax liabilities for the year. At that point, they would discover they owed a lot more than they expected. Why? Because each of their old companies would have revenue with no expenses to put against it. The expenses would have been incurred by The Event Studio. The money that the old companies received from their customers for the work done by The Event Studio would look like pure profit, on which they would be taxed accordingly. Fortunately, we caught the oversight in time. To be sure, they didn’t necessarily need my help to avoid this particular pitfall. A good accountant might well have discovered what had happened before Anne and Elizabeth were forced to pay taxes they didn’t really owe. Then again, many outside accountants don’t ask all the questions they should about the numbers they’re given. They’re too busy. They have dozens of clients and only so much time to spend on each one. That’s why it’s dangerous for entrepreneurs to rely on an outside accountant to oversee their finances. Like it or not, you need to understand the numbers of your business, and that requires knowing something about accounting. And if there’s one aspect you need to know, it’s the difference between cash- based and accrual-based accounting. Otherwise, you won’t really know whether you’re making or losing money. Here’s the (somewhat oversimplified) difference in a nutshell: With cash-based accounting, you record sales and expenses only when money changes hands. That is, you don’t recognize a sale until you get paid for it or an expense until you hand over the cash. With accrual-based accounting, you record sales and expenses when you do the work involved in creating and delivering the product or service a customer has agreed to purchase. All individuals and most small businesses use cash-based accounting to figure out what taxes they owe, and it’s fine for that purpose. But cash-based accounting doesn’t tell you how you’re really doing as a business, and as a result it can lead you astray. I’ll give you a hypothetical example. Suppose The Event Studio books two new events in December. One is a large conference that will take place the following spring, for which the company receives a deposit of $10,000 but on which it does no work in December. The other is a sales meeting scheduled for February. Let’s say the total fee for that one is $6,000, and the company operates at a 50 percent gross margin, meaning its direct costs will be $3,000. It will be paid half of its total fee for the sales meeting in the middle of January. Nevertheless, it completes a third of the work in December and pays a third of the costs, or $1,000. On a cash basis, the women made $9,000 ($10,000 of cash received minus $1,000 of expenses paid) during the month. If they had no other sales or expenses during the year, that’s the amount on which they would pay taxes. But to understand how the business really did in December, they need to look at sales and expenses on an accrual basis. They can’t include the $10,000 deposit in their sales figure, because they did no work on the conference during the month. On the other hand, since they’ve done a third of the work on the sales meeting, they can record a third of the total fee, or $2,000, as well as the $1,000 they incurred to cover the cost of that work. So their profit for the month was really $1,000, not $9,000. (For the purposes of this example, we’re ignoring overhead expenses.) Now, all that may seem obvious to you, but it doesn’t seem so obvious if you aren’t used to working with the numbers of a business. When I asked The Event Studio women for their 2008 income statement, they had no idea whether to include the deposits in their sales totals. Similarly, they didn’t know whether to include expenses they’d been billed for but hadn’t yet paid. Predictably, what they produced was a mishmash, and not because they’re stupid. On the contrary, all three are extremely bright. But if you’ve never taken the time to learn the basics of accounting, even experienced entrepreneurs can get tripped up. On the other hand, when you do learn the basics of accounting, you realize that the numbers aren’t as complicated as you feared and that you’re finally developing the knowledge you need to be in control of your company. As we went through their income statement, I had the sense that Elizabeth, Beckie, and Anne felt a fog lifting. It was a small step on the road to building their business, but it was a crucial one. We’ll be looking at the next steps in the months ahead. Norm Brodsky is a veteran entrepreneur. His co-author is editor-at-large Bo Burlingham. Their book, The Knack, was published by Portfolio in October.

I doubt that anyone is keeping track, but it’s been exactly three years since the appearance of my first column about the offer I’d received for my records-storage, document-destruction, and trucking businesses. (See ” The Offer, Part One ,” November 2006.) Never in my wildest dreams could I have imagined back then that I’d still be negotiating with potential buyers this far down the line. Yet less than two years after selling my business, it feels like d