A first-time entrepreneur experiences plenty of exciting first-time milestones, but few match the thrill when you make your first sale. This is the moment that all of your efforts have been moving towards. You figure you’ll be in the black by the end of the year.
If you’re lucky, that might be true. But it might not, and that’s okay – it’s normal not to turn a profit in your first year.
Before you get discouraged, let’s make one thing very clear. Just because you take a loss doesn’t mean you’ve failed. It doesn’t even mean that you’re destined to fail eventually. Making it through your first year means you’re already ahead of the 33 percent of entrepreneurs who pack it in before their companies’ first birthdays.
Companies Take Time to Turn Profits
When you’re looking at a loss on your balance sheet, it’s easy to feel like everyone else must be doing better than you are. For entrepreneurs, that’s nowhere close to true.
It’s common for new businesses to go through a year or two of financial loss before they become profitable. For many of those businesses, it can be three years or even more before they go into the black.
The IRS, which sees the income and expenses of almost every business in the United States, takes early loss years as the norm. They allow two years of loss out of every five and if it takes longer, you can appeal by showing that you have a real intention of making a profit. The IRS will consider factors like:
You can’t deduct expenses for a hobby, so it’s worth convincing the IRS that what you have is a business. You won’t have to do that until your third year, but it’s worth knowing in case you decide you want to focus on growth over profit at first.
Profits and Growth Aren’t Always Compatible
Your first year in business is mostly about laying a foundation, which costs money. That money goes in a lot of different directions, from marketing costs to the purchase of materials.
At some point during that first year, or more likely at several points, you’ll have to decide whether you want to put more money into your company’s development or work toward your first profit. Which way you go depends on your vision for the company.
Are you going for big growth?
Maybe you’re a “bigger is better” kind of person. You want to hire more people, enter more markets, maybe even expand into bigger facilities.
As the old saying goes, you have to spend money to make money. That means taking a larger percentage of your profits and re-investing it into the business, whether that means hiring more salespeople or ordering more raw materials so you can create more product. And your investment might not generate profits right away, especially if you’re investing in talent.
Let’s say you invest in your business by hiring more salespeople. While they’re building your client contact list, you’re paying their salaries. You’re seeing lower profits, but your customer base is growing. As discouraging as it can be to see your bottom line in the red, this scenario indicates good potential for a new company.
Be Realistic About Your Goals for the Company
Venture capitalists and other investors love to see customer growth, even more than they like to see profits in a company’s first years. When they see you growing, they know you’re taking the long view and that you have the kind of mindset that a promising startup needs to grow.
Are you a committed sole proprietor?
Not every business has to “go big.” There are plenty of sole proprietorships out there – 25.5 million according to the most recent IRS data. Many of these business owners live off of their receipts with just a few employees, if any.
A lifelong sole proprietorship is a perfectly valid goal to have when you start a business. It just means that as the money starts to come in, you won’t be investing quite as much into growth. As long as your revenue is going up, you can be modest with your re-investments and possibly make a profit sooner.
What kind of expectations are realistic?
Even if you’re intentionally building a small business, you’ll still be re-investing a decent portion of what you bring in your first year. Entrepreneurs who go into business after holding a full-time job usually find that they pay themselves less than their former salaries in their first year. If things continue to go well, you might reach your former salary level by your second year and maybe draw that plus profits in your third.
Once you have that understanding, it’s easier to let go of the expectation of quick profits and focus on making it through your first year with your company and your personal life intact.
How to Survive Your First Years in Business
It sounds like a low bar but surviving really is the primary goal of an entrepreneur’s first years. It’s hard to keep a company going when you’re taking most of your revenue and re-investing it. So how do you get through?
Tips for Keeping Your Head Above Water
Keeping your finances viable is one of a new entrepreneur’s biggest challenges, but you can get through it if you’re strategic and careful.
1. Remember, don’t quit your day job.
The topic of the first article in this series bears repeating here – When you start a new business, don’t quit your day job right away. You won’t be earning full-time wages or even working full-time hours at first in your new business, so think twice before you give up a sure thing.
2. Use your regular income to cover business expenses.
If you count any of your regular salary or wages as discretionary income, consider using that to pay the expenses for your new business. It’s your money, so you won’t be incurring any debt by using it.
Funding your new business with your current salary also gives you the motivation to keep working. You’ll probably be much more excited by your new company than your current job, and it’s easy to feel tempted to quit before your financially ready. Thinking of the growth you can fund with your salary will help you to keep your feet on the ground.
3. Get a side hustle.
You might need more start-up money than your main salary can cover, so don’t be afraid to go after some side gigs. Picking up freelance work or a part-time job when you’re trying to start a business might sound like a lot, but you can’t do much with your new business without the money to fund it.
You can always give up your side hustle when your business starts to take off.
4. Cut your personal expenses.
You’re committed to your new business, so use that commitment to tighten your belt a bit in your first years of operation. You’ll find dozens of ways to cut expenses with a simple Google search, but here are some starting points:
Cutting back on recurring expenses like these is the fastest way to see results quickly. There’s nothing wrong with reducing spending one purchase at a time – one fewer latte a week, for example, or washing your car at home instead of taking it to the car wash – but it’s much harder to get consistent savings.
5. Keep your credit strong.
If you apply for a loan in your first years as a new business owner, your lender will probably check your individual credit. You’ll have a lot on your plate with your new business, but make sure that you still pay your bills on time and keep your income higher than your expenses.
Running a new business is scary, especially if you’re doing it on your own. Consider getting a partner or co-founder if you think it might take some of the pressure off, and always keep your eyes on the prize. A bit of courage and determination now will pay off in the future.
Check out all of the articles in the ‘How to Survive the First Year of Your Business’ series: