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Common MLM Start-Up Pitfalls

December 9, 2010

Launching a new MLM is exciting!

Everyone involved is giving 110% and has visions of breaking all sales and enrollment records with their new top-of-the-line products and sizzling new compensation plans. Such enthusiasm is great, but enthusiasm and 110% efforts alone won’t support your new company for very long. The unfortunate truth about startups is that most do not survive beyond 12 months. They go out of business for a variety of reasons such as poor management, lack of demand for their products or services, poor marketing, and operational challenges to name but a few. However, the number one reason why I have seen startups fail within their first year in business is the result of under capitalization.

I inquire of every prospective start-up client whether they have prepared a business plan or at least determined how much cash they will need to get the business up and running and through the first year. Rarely have they assembled a formal business plan. Rather, the most common response I get is that the new company is running on a shoe-string budget, but anticipates a positive cash flow within two or three months. This is a big mistake, for in all but exceptional situations, these businesses will fail.

It is widely recognized that the barriers to entering the MLM sales channel are substantially less than starting a business utilizing traditional retail channels. However, this does not mean starting an MLM is cheap! Entrepreneurs will be amazed to find that at every step of the start-up process, someone will be there with his palm out waiting to be paid. Consultants of every variety, hardware and software vendors, manufacturers, landlords, telecommunications equipment, insurance agents, accountants, and of course, the lawyers will all be in line. These goods and services are important to successfully launch a company, but it frequently amazes me how many entrepreneurs fail to anticipate and adequately budget for these and other expenses they will incur throughout their initial year in business. Furthermore, while they expect to quickly generate a positive cash-flow, they lack a business plan that identifies how they will build their sales.

Thus, my first and most important piece of advice to any startup company is to prepare a comprehensive business plan and accurately project capital needs for at least your first year in business. In making this projection, do not make the assumption you can cash-flow the business in the first year. If you are able to cash-flow in your first year – great! However, my experience with the majority of start-ups is to the contrary. Given the up-front expenses facing startups, and typically slower than expected sales rates, positive cash-flow rarely occurs as fast as anticipated, and the funds that do come in are insufficient to protect the company from financial starvation.

The next big question for startups is “Where do I get the money I need?” This question is fairly easy to answer, but in today’s current economy, the follow-through is far more difficult. For those who are not able to personally fund their businesses, traditional sources such as bank and SBA loans are another option. The down side to loans is that you will be required to pledge your personal assets as collateral, and if the business fails, your personal assets are at stake. The better option is to find outside investors. The downside is that outside investors normally insist on taking equity in the company, so you will lose a portion of the company’s profits, which can be significant. However, you will be able to launch the company and avoid the risk of losing your personal assets beyond that which you have invested in the company. All things considered, this is a fair tradeoff so long as the entrepreneur is shrewd enough in the negotiation process not to give up control of the company or too much of his or her stake in the proceeds.

So how do you find these investors? It used to be fairly easy to generate capital if you had a good idea. However, in today’s poor economy, venture capital is tough to come by. There are very few venture capitalists that will consider multilevel businesses, but if you look hard enough you may be able to find them. Bear in mind that if you intend to court a venture capitalist, you must prepare a comprehensive business plan before your first meeting.

A fairly fertile source of capital exist through individuals who have been successful MLM distributors. I have noticed that successful MLM distributors are a lot like actors. Just as many successful actors migrate toward directing and producing films, successful distributors (the really successful ones, not those who pretend to be) often harbor a desire to own an MLM (this does not mean that they are always good at managing a company – it just seems to be part of the evolutionary process). The benefit is that a successful distributor will be likely to understand the vision of the startup entrepreneur and can identify a good opportunity. Thus, if you can identify and approach a successful distributor, you may find that they have the desire to shift their career path yet remain in the MLM field.

At this juncture a word of caution is in order. A critical mistake that I see consistently repeated is the sale of top positions in a company’s genealogy to secure seed capital. A common scenario is that the entrepreneur sells top genealogy slots for $10,000.00 or more per slot. This is a great way to quickly generate several hundred thousand dollars to get the company going, but it also causes the program to fall subject to state business opportunity laws, franchise laws, and state and federal securities laws. While an entrepreneur may elect to comply with these laws and thereby legally sell the top positions, the burden and expense of securing legal counsel to guide you through these confusing laws can itself cost in excess of six-figures, thereby negating the advantage of selling the positions. For those who elect to sell top positions without complying with these laws, they face a substantial risk of being sued personally by the investors if the business fails and they lose their investments.

Starting an MLM business has challenges that are unique to the distribution channel. However, when it comes to launching an MLM and making it through the first year, MLMs share a common challenge with non-MLM businesses of securing sufficient capital to sustain the business until it generates enough revenue to survive on its own merits. Therefore, before launching a new business, MLM startups should follow solid business management principles and prepare a comprehensive business plan to determine their cash needs during the first year in business before they open their doors.

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