What is a Small Business?

What is a small business? There are many different perspectives. Businesses that are considered or labeled as small range from a single-person business with minimal revenue to one with 500 employees and annual revenue of $100 million. With a such wide range, lumping all businesses within this range as small is very misleading and not very useful. Businesses at opposite ends of the spectrum have very little, if anything, in common. According to Census Bureau statistics 94% of all businesses in the U.S. have less than 20 employees and annual revenue of under $5 million. An average-sized small, owner-operated business (SOOB) has less than $500,000 in revenue and less than 5 employees. These are the real small businesses.

Owner-operated

Owner-operated means that the business is owned by a single individual or a very small group of people who work in the business on a daily basis. Not as executives but hands-on doing whatever it is that the business does. Sometimes these owners may supervise or manage a few employees but they are never far removed from the frontline. Some examples are: a small accounting firm that is owned by practicing accountants; a plumbing contractor owned by a working plumber; a restaurant owned by the head chef; or a retail store where the owner serves as the general manger. There are few, if any, employees so most back office and/or managerial duties must be done by the owner(s), their family members, or contracted out to service providers. There is no management team, other than the owner(s), and by definition there is no separation of ownership and management.

Purpose & performance

Larger businesses are generally managed to maximize profits and the value of their equity (shareholder value). SOOB’s are typically managed to minimize income taxes by minimizing profits and therefore minimizing the value of their equity (owner equity). Therefore SOOB owners have objectives other than profits and business value. SOOB owners are free to operate their businesses as they see fit and typically use their businesses to pursue both personal and business objectives. There are no clear lines between what’s business and what’s personal. The comingling of business and personal purposes is often considered to be sloppy or a weakness, but it is a primary reason why SOOB’s exist and I consider it a core strength. Analyzing the performance of a SOOB using standard benchmarks may provide relevant  information about business operations but fails to evaluate whether the overall (business & personal) objectives of the owners are being achieved.       

SOOB owners usually make less (compensation & benefits plus business profits) than someone working at a comparable level in the same industry for a number of reasons. One of the primary reasons is that SOOB owners place a higher value on the non-monetary benefits of ownership like being their own boss, and having greater control of their destiny. SOOB owners set their compensation based on many factors, the least of which is the market value of a similar position in the industry. The factors they do consider are: available profits or cash flow; supporting their lifestyle; and allocating discretionary profits between compensation and distributions for payroll tax and retirement benefits purposes.

Small, owner-operated businesses comprise 94% of businesses in the U.S. and are managed to pursue the unique business and personal objectives of the owners. They are not like larger private businesses and should not be placed in the same category with them or evaluated by the same benchmarks. What is a small business? A truly small, owner-operated one.