Shark Tank Jump Start Your Business: How to Launch and Grow a Business from Concept to Cash (8 page)

Before you can decide how much you’ll charge for a product or service, you must take into account everything from market to consumer to competition. As with business models, there are many strategies to consider—more than twenty popular ones—but here are five of the most common pricing strategies you’ll encounter:

Cost-plus pricing:
By far the most basic, cost-plus pricing combines the price of producing a product with the percentage of profit the company wishes to make. The result of that equation is the selling price. Let’s say, for instance, that your variable costs (materials, labor, production) come to $8 per unit while your fixed costs are $12 per unit, totaling $20 in cost. To make a steady profit, you want to operate at a 30 percent markup, so you add an additional $6 to the cost, which gives you a total selling price of $26.

Although this model may sound like the simplest way to ensure profitability, its simplicity can also be its downfall. The problem with cost-plus pricing is that it doesn’t take into account important factors like demand and competition. Without having more information about the market, it’s difficult to know if your product or service will be able to actively compete.

Value-based pricing:
An effective choice for both product and service businesses, this strategy is based on the perception of value your product or service provides, not on any actual production costs. Take, for example, the eyewear industry. Whether you charge $50 or $500 for a pair of sunglasses, the production cost varies only slightly. You don’t pay $500 for a pair of sunglasses because the materials cost ten times as
much. No, what you’re paying for is the perceived value of those sunglasses (e.g., the belief that you’ll look more fashionable). For this pricing strategy to be effective you must have an in-depth knowledge of your market.

Price skimming:
Most business owners think that for profit to be high, the volume of sales must also be high. But that’s not always the case. Price skimming works the opposite way: relatively lower sales at a higher profit. A good example would be a boutique consulting firm. Instead of trying to secure ten clients at $10,000 an engagement, under this strategy the business owner would seek to gain four clients at a $25,000 price point.

Why would anyone want to adopt a strategy that assumes lower sales? Depending on your business, having fewer customers that spend more money might actually be a better solution. Not only do you create more exclusivity for your brand, the clientele you attract generally tends to become better customers. Of course, the danger with this strategy is that losing a handful of customers at the wrong time can greatly impact your organization. Still, it can be the ideal choice for certain types of businesses, especially service-based companies with premium offerings and deeply loyal consumers.

Penetration pricing:
Sign up now and get twelve months of high-speed Internet service for only $29.99 a month. Sound familiar? That’s a perfect example of penetration pricing. Using this strategy, a business sets low initial rates in order to gain market share and then eventually raises prices. That promise of twelve months of cheap Internet usually comes with the caveat that you sign a two-year contract. And chances are, the second year will be billed at a significantly higher rate than the first. The key to using this pricing strategy effectively is to be transparent from the start. It’s not smart to hike up your
rates without warning your customers in advance. Remember what happened when Netflix did that?

Psychological pricing:
Let’s go back to the example of twelve months of high-speed Internet service for only $29.99 a month. Would that deal have been as appealing if offered for $30.00 a month? Experts aren’t so sure. Psychological pricing assumes that certain price points—usually just a few pennies short of the dollar—have a more favorable psychological impact.

For many, the first instinct when thinking about pricing is to charge as little as possible. But that’s not always the best way to go. Undercutting your competition for the sake of short-term gain can be damaging to both your business and industry. The race to the bottom is a quick one, and before you know it you’ll have put yourself out of business. Instead, the smarter choice is to develop a keen understanding of your market and create a pricing strategy that will help your business achieve sustainable growth.

A business plan, in its simplest form, outlines the goals of a business and the steps required to achieve them.

A business plan can be as long or as short as you want. It can be scribbled on the back of a napkin or laid out with thought and care. It can be presented to a team of investors or shared with nobody at all. But even though your business plan can take on whatever shape you’d like it to, there is a fairly specific template that most people choose to follow:

Executive summary:
This is a clear statement that summarizes the overall business. Essentially it’s a bird’s-eye view of the what, why, and how of your business.

Business description:
The business description is a basic overview of your industry, markets, and business. It should include information about your target audience and how you’ll differentiate yourself in the marketplace.

Market analysis:
While the business description is very high-level, this section details your business’s target market and the industry as a whole.

Competitor analysis:
The competitor analysis offers a snapshot of the competitive landscape, including competitors’ strengths and weaknesses, potential barriers to entry, and strategies to stand out.

Marketing plan:
This plan will provide a detailed outline of the pricing strategy, sales plan, and advertising and promotion activities. It should describe how you’ll get your product to consumers and bring in business.

Management plan:
The management plan is a description of the legal structure of your business, roles and responsibilities of the management team, and any additional human resources needs you may require.

Operating plan:
This should outline your daily operational strategy, including location, employment needs, manufacturing process, and inventory requirements.

Financial plan:
The financial plan provides a detailed breakdown of your business’s financial data, including funding requirements and financial analysis.

When putting together a traditional business plan try to keep it around twenty to thirty pages in length. While business plans have traditionally been longer, today the trend is for a quicker and simpler approach. In other words, get to the point. It’s also important to add any appropriate visual elements (graphs, charts, etc.). Image matters, and a poorly laid out business plan is not the best way to get attention, at least not the kind of attention you want.

The challenge with this type of business plan is that today’s startups have the ability to test their ideas and adjust their strategy more rapidly than ever before. The more traditional business plan just doesn’t leave a lot of room for flexibility and alteration. Furthermore, most entrepreneurs would rather use the time it takes to write an elaborate business plan to actually test their idea. So in the last few years, numerous other approaches have been invented. From Eric Ries’s Lean Model Canvas to David Madié’s Growth Wheel, business experts from a variety of backgrounds have begun to offer plans that reflect the real challenges a new business faces.

Whether you choose to create a classic business plan or explore a more modern approach, it is important that you have a clear way forward. You wouldn’t explore new territory without a road map, and you shouldn’t launch a new venture without some sort of plan. To find examples of a few thoughtful business plans, flip to the Tools and Resources section in the back of this book.

Introducing the government to your new venture is an essential step toward taking your idea from concept to creation. But before you can do that, you must first decide how your business will be organized and which type of legal structure is the best fit. Luckily, your options are fairly limited. In fact, there are really only four basic legal structures to consider:

• Sole proprietorship
  
• Partnership
  
• Limited liability company (LLC)
  
• Corporation
  

Deciding which type of incorporation status you’ll seek may seem like a small decision, but it will play a pivotal role in how you start and run your business. It can also greatly affect how much money you’ll owe the IRS at tax time.

“The importance of incorporating is something that a lot of entrepreneurs don’t learn until it’s too late,” says Moshe Weiss, founder of SoundBender, who appeared on Season 4
of
Shark Tank
. “You could file as one type of entity and all of the sudden owe the government $20,000, which could have been avoided if you had just filed differently.”

The basic legal structure you choose depends primarily on two key pieces of information: how much liability you wish to take on and how many people will own the business. Once you know that information, deciding which form of incorporation to select is a fairly straightforward task. Still, it’s important to understand the benefits and implications of each:

Sole proprietorship:
Believe it or not, you may already own a sole proprietorship and not even know it.
According to the United States government, a sole proprietorship, also referred to as a “sole trader” or “proprietorship,” is an unincorporated business that is owned and run by one individual, with no distinction between the business and the owner.
A freelance photographer or nanny, for instance, is by default a sole proprietor.

Since the individual is the sole beneficiary of the business, it is he who is personally responsible for both the profits and the losses. Therefore, when it’s time to pay taxes, it’s not necessary to file a separate business return; all income is reported directly on the entrepreneur’s personal tax return.

Keep in mind that many states require most sole proprietorships to acquire certain permits and licenses, depending on the type of business. Research what kind of documentation your business may require—even if it’s already up and running. Otherwise, you could face a major headache later.

Those who wish to operate a sole proprietorship under a different name than their own (e.g., Mary’s Day Care Services instead of simply Mary Smith) can file for a “fictitious name,” most often referred to as a DBA (“doing business as”). While
a sole proprietorship is perhaps the easiest and least expensive way to start a business, it’s not the right choice for every new venture.

Because there is no legal separation between the business owner and the business itself in a sole proprietorship, the entrepreneur is responsible for all business debts and obligations. Let’s say, for instance, that a client decides to file suit against Mary’s Day Care Services. If the organization is set up as a sole proprietorship, the plaintiff can go after both Mary’s business and personal assets. This alone makes the sole proprietorship less than ideal for many new business owners.

Partnership:
Not every new entrepreneur is ready to start a company on her own. For some, it’s better to get in business with a person whom they trust and respect. No matter which state you reside in, there are only three different types of partnerships:

General partnership:
Widely considered the most common partnership, in a general partnership all of the profits, management, and liabilities are shared equally between partners.

Limited partnership:
Ideal for ventures backed by partners who are making different investment commitments, in a limited partnership profits, management, and liabilities are limited instead of shared equally.

Joint venture:
Similar to a general partnership, in a joint venture profits, management, and liabilities are shared equally among partners, but only for a specified amount of time.

No matter which type of partnership you choose to form, the first step should be to draw up a partnership agreement that lays out the specific details of your working relationship and describes how general business decisions will be made. Although a partnership agreement isn’t legally required, it’s highly recommend.

As with any kind of partnership, especially a legally recognized one, you should think carefully about whom you wish to align yourself with. Similar to a sole proprietorship, a partnership does not legally separate a business from the owner. This means, for instance, that if your partner makes an unwise financial decision, you too will be responsible for the repercussions. What’s more, under United States law, all partners can be sued for the full amount of any business debt—not just their share. So if your company was sued for $10,000, either partner could be responsible for the full $10,000.

To form a partnership, you must first register with the state and establish your business name. You should also register with the IRS and apply for a federal tax ID number. While partnerships do not have to pay additional business taxes, they are required to report all losses and gains by filing an “informational return” (Form 1065).

Limited Liability Company (LLC):
For many, the idea of being personally liable for business obligations automatically eliminates sole proprietorships and partnerships from the equation. On the other hand, the implications of starting a full-fledged corporation can feel daunting. This is when the limited liability company (LLC) makes the most sense. An LLC combines the best of both worlds: limited personal liability, straightforward tax requirements, and maximum flexibility.

In an LLC, there are no “owners” but instead “members,” who can range from a single individual to a corporation, depending on the state. As in sole proprietorships and partnerships, members must report profits and losses on their personal tax returns and are not taxed as a separate business entity.

Starting an LLC is fairly straightforward. While each state is slightly different, the process generally requires choosing a
unique business name and filing articles of incorporation with the secretary of state. Depending on your type of business, you may also need to acquire certain licenses and permits, and in some states, including New York and Arizona, you must announce your business in a local paper. As with a partnership, when starting an LLC with more than one member, it’s best to draft an operating agreement.

Corporation:
If you’re looking for maximum protection and the largest variety of tax and fringe benefits, like stock options and retirement, the corporation is your best bet. Similar to an LLC, a corporation absolves its owners from all (or at least the majority of) personal liability, making it an attractive choice.

A corporation is an independent legal entity that is separate from its owners, who are also known as shareholders. In a private corporation (i.e., one that is not traded on the stock market), shares are issued to a select individual or group of individuals. Conversely, anyone can purchase shares of a public corporation on the stock market. It’s important to note here that publicly traded corporations are a different beast altogether. For the sake of this book, it’s assumed that if you’re interested in starting a corporation, it will be private, not public.

A primary differentiator between a corporation and any of the other legal structures discussed thus far is the tax requirements, which change slightly depending on which specific type of corporation you file under:

C corporation:
This is the most common type of incorporation, and businesses that form under it must pay taxes on whatever profit remains after deducting employee compensation, fringe benefits, and various other appropriate expenses. The C corporation is the most time- and resource-intensive structure—but it also comes with the most benefits.

S corporation:
Similar to the previous forms of incorporation, businesses that form under this legal structure do not pay taxes on the business itself—all profits pass through to the owners. You might wonder why a business would organize under an S corporation when they could just form an LLC. As you’ll read later, there are certain tax benefits that come with the S corporation, and it’s often a better choice if you’re giving away equity. Still, the LLC is quickly becoming the more popular choice.

When choosing which incorporation status to seek, be sure to pick a structure that’s within your price range and comfort level as well as one that can can sufficiently protect and support your organization as it grows.

Perhaps you’ve come up with a wonderful idea. Maybe you’ve invented something profound, the likes of which the world has never seen. Your immediate instinct upon making such a thrilling discovery is probably to protect it—to keep your idea or invention safe from those who could steal it. That reaction is natural; you can find plenty of stories of businesses that were hijacked by their competition. But the reality is that most entrepreneurs spend far too much time
protecting
their idea and not enough time
perfecting
it.

We’re living in the age of information, where ideas—even great ideas—are everywhere. You need only search the phrase “free business ideas” on the Internet to find tens of thousands of pages dedicated to the topic. From a website that ranks the quality of preschools to a smart fridge that automatically orders groceries, there are plenty of ideas floating around in cyberspace, just waiting for the right entrepreneur to come along and make them work. Because that’s really what it comes down to: execution.

For example, how many different barbecue sauces have been invented in the last decade? Ten? Fifteen? Twenty-five? Probably far more than that. Barbecue isn’t a new idea. And yet the founders of Pork Barrel BBQ, who appeared on Season Three of
Shark Tank
and struck a deal with Barbara Corcoran, have been able to do extremely well. Why is that? Is it the recipe? Perhaps. Was it their appearance on
Shark Tank
? Maybe. But they were already in one hundred stores before going into the tank. Brett Thompson and Heath Hall, the founders of Pork Barrel BBQ, have succeeded not just because they had a great idea, but because they were able to execute it with creativity and precision.

For many entrepreneurs like Brett and Heath, protecting an idea isn’t essential. If you’re opening an ice cream shop, for instance, you probably shouldn’t spend countless resources protecting your recipe before you’ve even made your first batch. In fact, most business owners won’t ever need to devote significant time or money to protecting their idea, because most businesses aren’t selling anything proprietary.

There are, however, specific types of businesses where protecting a product can make all the difference. If you feel as though some part of your business is proprietary, below are three of the most popular ways of protecting intellectual property:

Patent:
Granted to an inventor by the United States government, a patent excludes others from “making, using, offering for sale, or selling the invention throughout the United States or importing the invention into the United States.”
Not every idea is patentable.
According to the United States Patent and Trademark Office, the laws of nature, physical phenomena, and abstract ideas cannot be patented.
So, for example, it may be difficult to patent a piece of software that relies heavily on a mathematical algorithm.
Patents
generally range from fourteen to twenty years and carry with them various fees, depending on the specific kind of patent. While there are online resources to help inventors secure patents, the process can be exhausting and complicated. Most of the time it’s worth spending the extra money to hire an attorney who specializes in the process. You’ll learn more about patents later in this chapter.

Trademark:
While a patent protects an idea,
a trademark protects a brand or, more specifically, “a word, phrase, symbol, and/or design that identifies and distinguishes the source of the goods of one party from those of others.”
If you need to protect a service instead of goods, you’d seek a service mark, which, although slightly different, is often also referred to as a trademark. A trademark can be owned or licensed and must be actively maintained through lawful use to avoid abandonment of the mark. Basically, use it or lose it.